Williamson’s Model of Managerial Discretion

Williamson’s model depends on the same assumptions as Baumol’s a weakly competitive environment, a divorce of ownership from control, but a capital market imposed minimum profit constraint. Williamson argues that the most important motives of businessmen are desires of salary, security, dominance, and professional excellence. These can be gained by additional values of expenditure on staff (S), managerial emoluments (M), and discretionary investment (ID). It is argued that these provide additional utility, U, which managers aim to maximize. Hence the manager’s goal is to maximize his/her utility (U). Manager’s utility function (U) is expressed as
U = f (S, M, ID)
Where, the quality and number of staff reporting to a manager enables him to gain promotion, salary and dominance and also security through greater confidence as to his departments survival, and greater professional excellence due to the better services which a larger staff can provide.
Managerial emoluments (M), represent the type and amount of perquisites the manager receives (the lavish offices, personal secretary, expenses account and so on) beyond the level necessary for efficient operation. The greater the M, it is argued, that greater will be the manager’s status, prestige, and satisfaction.
Discretionary investment expenditure (ID) is that investment which exceeds that necessary to achieve the minimum post-tax profits demanded by shareholder’s (denoted p0). Such spending allows managers to pursue their pet-projects, personal investment preferences and to exercise their power and hence it provides utility.
Unlike the models presented earlier, Williamson’s firm announces only ‘reported’ profits, whereas Baumol’s and the profit-maximizing firm report actual profits. Reported profits, the profits admitted by the firm, equal actual profits minimum M. M is deducted because it is an expenditure made and is also tax deductible. Notice that in Willianson’s model, actual profits may not equal maximum profit if the model predicts, S exceeds the profit maximization level.