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3.1.1 Sizes and types of firms

Sizes and types of firms 

Private sector

The section of the economy not under state control. Ownership of the firm is private, not owned by government. Firms will either be:

 Privately held

 The firm doesn't sell shares to the general public, and is instead owned by a relatively small number of shareholders. 
e.g local restaurants, start-ups 
Some larger companies such as MARS and John Lewis are also privately held. 

 Publicly traded

 Where ownership of the firm is for sale on public exchange, so shares can be bought. 
e.g Apple, Amazon, HSBC, Exxon Mobil

Public sector 

The section of the economy controlled by the state. Firm is government owned or government managed/highly regulated.  

e.g Government departments, NHS, TfL, Post office (note that Royal Mail is in the private sector) 

All firms can be either: 

For Profit

Where any profit made is either reinvested in the firm, or returned to the owners. 
(Profit = total revenue - total costs)

Non-profit

Where all operating profit must be reinvested, and cannot be returned to the owners. 
e.g schools, charities 

Divorce of ownership from control: the principal-agent problem

In small firms, the owner often manages the company directly, but as firms grow and the owners may choose to sell shares to generate finance. These new shareholders own part of the business now and so the firm is run by a board of directors who are appointed to control the firm with the shareholders' interests in mind. 

This is known as a divorce of ownership from control - the owners are no longer directly in control of the firm. 

The directors may have different objectives to the owners, and other stakeholders in the firm such as workers may also have different objectives. 

All these varying incentives may lead to the principal-agent problem. 

This is where a principal (i.e shareholders) pays for an agent (i.e manager) to act in their interests, but because the agent is self-interested, and their incentives are misaligned with the principal's they pursue different objectives. 

e.g if the shareholders/owners want to maximise profits, but the manager's pay/bonus/job security is tied to the revenue generated, then they will choose to revenue max rather than profit max. 

e.g directors want to maximise market share because they enjoy the prestige of running a large corporation, or it is good for their career. they may do this over what the owners want (prof max) 

e.g employees are likely to aim to maximise their pay or benefits over the profits of the company. 

Eval 

Owners can retain control by keeping agents accountable. They can realign incentives by communicating more - forcing agents to justify their past actions and explain future plans and intentions. 
May align incentives by linking their objectives to the agent's 
e.g bonus linked to profits, or bonuses paid in company shares. 


Stakeholders in a firm and their objectives: 

 Owner 
Aims to maximise profit. Other aims are secondary to this. For example may want to maintain high quality products in order to maximise profit. 

 Has the most influence in privately held, smaller firms (due to principal agent problem) 
Owner is able to control the size of the company however, and makes final decisions. 

 Director/manager
Aims are to prestige and to maximise the perks they receive (e.g free healthcare, bonuses, etc), as an increase in profit does not affect them as it affects the owners because they are usually paid a fixed wage. Instead they want to grow the company to build their good name, and so may aim to maximise revenue, out of which salaries and other benefits are paid, not profits. 

 Managers have the most influence in a publicly traded, large company (due to PAP) 

 Worker
Aims are higher wages and job security, as well as good working conditions. 

 Has the most influence in a highly-skilled industry and in small, firms or unionised firms, where workers have grouped together to collectively bargain. 

 Consumer
Aims to minimise price, and maximise quality of good. 

 Most influence in competitive industry, as if there are a lot of substitutes to a good, firms need to be flexible with prices, or they will die out. 

 State
Aims to maximise tax revenue and minimise unemployment, so want the firm to employ as many people as possible, and survive and prosper.  They can regulate and enforce laws.

 Most influence in the public sector, as these firms are state owned, and in domestic firms, as international firms can avoid tax by putting their HQs abroad. 

Pressure group
Aims of these group vary, but some examples are environmentally oriented groups like Greenpeace, which aim to do what is best for the environment. Other examples are workers rights groups. 

 Have the most influence with public support or in competitive industry where they can arrange boycotts for example. 

Why do some firms remain small? 


96% of UK businesses have fewer than 10 employees. 

This may be because:

- They don't have the finances to expand (banks may not wish to lend them money as they are deemed too 'risky' 
- Limited market demand for their product/service ('niche') 
- there may be significant diseconomies of scale that prevent a firm from wanting to expand 
- Tax or subsidy incentives are removed for businesses as they grow 
- The entrepreneur may be content with their income and work/life balance and prefer more free time over extra profits. 
- Legal requirements for smaller firms are simpler and less expensive to comply with. 


Conversely, firms choose to grow to: 

- Increase profits 
- Decrease risk 
- Benefit from economies of scale 

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