ON THE THEORY OF DIVERSIFICATION: A COMMENT
| Published date | 01 February 1974 |
| DOI | http://doi.org/10.1111/j.1467-9485.1974.tb00178.x |
| Date | 01 February 1974 |
| Author | R. M. Grant |
Scvttish Journal
of
Political
Economy
Vol.
XXI,
No.
1,
February 1974
COMMUNICATIONS
ON
THE THEORY
OF
DIVERSIFICATION:
A COMMENT
R.
M.
GRANT*
In basing a theory of diversification on
a
non-optimising managerial model
of
the firm
C.
J.
Sutton (1973) encounters two problems common to many
attempts to apply the newer models of the firm to business behaviour and
industrial organisation
:
1. Testable predictions over a wide range of business behaviour are not
readily derived from these models. The comparative static properties
of
the models are clearly defined
only
for the output decision of the firm,
the response of other aspects of business behaviour, in particular the
investment decision to changes in exogenous variables is unclear.
2.
Where definite predictions are derived from the newer models they are
often consistent with the predictions of the profit maximising model. Since
the former involve working with more variables and constraints, the
principle of Occam’s razor suggests a preference for the latter.
This comment makes the following points
:
1.
The investment behaviour
of
the firm cannot easily be predicted
from
the
objective function of the firm postulated by Sutton and his theory
of
diversification is the result of questionable ad hoc behavioural assump-
tions (Section
I).
2.
Sutton’s theory is consistent with the behaviour of the profit maximising
firm. The profit maximising approach is to be preferred as simpler and
less restrictive, and, since
it
an
more easily take account
of
the influence
of uncertainty, a potentially more predictively accurate theory (Section
U).
Section
I11
examines Sutton’s arguments for preferring the
‘
behavioural
’
approach.
The objective function
of
the firm in Sutton’s model is taken from
Williamson’s
‘
staff model
’
(Williamson, 1964) where managerial utility
is a function
of
the level
of
staff expenditure
(5‘)
and the size of the dis-
cretionary investment budget
(ID)
which
is
the residue
of
after tax profits
(T)
in excess of the minimum level of profit consistent with the existing
management maintaining control of the
firm
(TJ.
U
=
U(S,
ID)
(1)
whereID
=
R
-
C
-
S
-
IT^
(2)
and
R
=
R(X,
S)
(3)
R
-
total revenue
C
-
total cost
x
-
output
*
I
am grateful
to
G.
K.
Shaw and
M.
Jones-Lee for
comments.
Errors
are
my
own.
77
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