Managerial Decision Making in Balfour Wimpey Builders
The traditional neo-classical model of the firm assumes that all firms regardless of their size have one sole objective, to maximise profit. Since the creation of this theory many new theories have come out trying to shed light on how firms behave. These latter theories consider the firms as complex organisations, with having more variety in their decisions, that the separation of owners (shareholder) from the decision maker (managers) can cause the firm to behave differently i. e. not only to maximise profits.
Balfour Wimpey Builders (BWB) is a medium sized firm with a management team of 5 people and 200 of other personnel. Assuming it is very likely that it will have some regional market power, BWB is an ideal firm for many firm behaviour theories. In this assignment BWB will also be assumed to have a “U” form management structure, which can be imagined to suit its size and the nature of its business best. Neo-classical model has been challenged many of newer theories which came out during the 1950s and 1960s.
These different theories put forward the idea that as long as the firm is not run by its owner, that is as long as there is an agent-principal relationship, the manager will always have conflict in interest with the owner; this problem is called the principle agent problem. This agency problem can result in the managers making decision which will not satisfy and contradict with the demands of the principles. The owners (shareholders) of most companies see the best solution to this problem is to give substantial amount of ownership of the company to the managers.
This is done so that the agency problem can be minimised by setting the aims of the managers in the same line with the goal of the stakeholders, the goal for the shareholder (which now managers become a part off) is to maximise profits (MDM Course Handbook, P19). But to what extent does this strategy work? Does it effectiveness vary depending on the type of business, the level of competition, threats of takeover, or any other internal or external factors? The latter part of this essay will examine this.
In principal-agent relationship, even when the manager owns some of the company, there will always be an agent-principle problem to some degree i. e. the problem of agent-principle can never be solved 100%. This is because the managements could always find themselves in situations where the gain of taking advantage of the situation would have a greater personal pay-off compared to taking profit maximising path and earning extra dividends, even if the consequences of participation in that situation will result in lower dividends for every shareholder. The temptations of this sort will sometimes will be too great for the managers to resist.
BWB is 30% owned by the management, 30% owned by other staff % and 40% owned by outside people (some of which is the local bank). The local bank is quiet familiar with the construction company as the bank helped to finance the company when it needed expansion. All firms are likely to go through bad times, when the company is not doing so well, losing the value of its shares and having difficult making profits. In these times the firms are likely to face a threat of takeover, especially when a substantial amount of its shares are owned by another company or a bank.
Since BWB currently having difficulty staying profitable, it is in a vulnerable situation for a take over bid. In the case of BWB the local bank is the most likely candidate to make a bid for the company. The 200 workers of BWB who own 30% of the company are more likely to sell their shares at this time when the company is not performing so good, they would want to get rid of the shares as its not giving out much dividends, and also take advantage of the rising prices of shares which is the consequence of the take over battle, selling the shares would not affect their future position in the bid.
The bank would need to collect more that 50% of the company shares in order to succeed in its bid. A successful bid would be a financial and humiliating disaster and for the company managers, who are very likely to lose their jobs after a takeover. Even thought the managers have a substantial ownership of the firm, in this situation the managers would take decisions about the firm that would improve their job security rather than to try and maximise their profits. In this case they would behave in accordance to the Behaviour models (Simon 1959/Cyert & March, 1963, P21).
These behaviour models argue that firms are complex organisations that do not have one definitive goal, instead the stakeholders of the organisation have goals, and if there is more than one stakeholder then there are multiple goals in the organisation. This means that the organisations goal is not to maximise anything, but rather to satisfy and achieve satisfactory levels in different goals “Satisficing”. In the case of BWB to deter the threat of a bid the managers would want to maximise the growth (Marris, 1964 P20) or sales of the firm in order to keep the value of the shares high.
Depending on the market power of the firm, the company might want to expand the volume of its sales, and grow in size, which might be in line with their long-term goal of higher profits, therefore even thought they may want higher profits in the long run, short run strategy will be concentrated on growth and sales volume and valuation ration (to attract finance & raise funds, money lenders usually looks at sales volumes and share value), the firm might also have to change its location in the short run for many different reasons therefore profit maximisation might have to be sacrificed.
These theories were made in the 1950s and 1960’s and are considered old fashioned and out of date, the firms nowadays might be facing different environments or managers might have different gains from different places. The firm are now also facing much fierce competition due to globalisation therefore they might need other strategies in order to survive i. e building niche market.
Balfour Wimpey Builders have three options that they need to choose between, where each one of them are mutually exclusive (they cannot only chose one of them), this part of the assignment will try and help BWB make up their decision on what they should do and also advise them on what other information if any they need (both quantitative and qualitative) in order to make the best decision.
The characteristics of the decisions made by the company a long term strategic decisions, Option 1 is highly risky in it nature because you have a chance to make a loss, but the chances for making high profits are also high (ideal for risk lovers and risk neutral people). Because the options are ‘mutually exclusive, a simultaneous decision tree assessment is not an option .
Sequential decision tree can also be considered as the firm only has limited time and resources for one. After drawing the decision three (which can be found in the appendices), the following results have been obtained for the Expected value of each decision. The highlighted letter for each option is the optimal expected value of each option.