Firm Behavior

Abstract

Economists view the firm as a key locus of supply-side decision-making. In fact, much of the world's business is done by complex multi-unit, multi-location organizations operating in an environment of uncertainty, imperfect internal information flows, and unclear or disputed goals. In both pricing and investment decisions, tradeoffs must be made between short-run and long-run profit maximization on conceptual bases that are not unambiguously established. Satisficing behavior may substitute for profit maximization and rules of thumb may be used in place of procedures that track more exactly the theoretical logic of profit maximization. At the summit of firms organized as corporations, the board of directors is responsible for inducing managers to maximize profits rather than pursuing their idiosyncratic goals. Corporate governance reforms have led boards to execute their responsibilities more effectively. Maintaining incentive systems that induce operating-level managers and employees to pursue higher-level organizational goals is also difficult. In competitive but not necessarily in monopoly milieus, natural selection weeds out firms that stray too far from the path of profit maximization.