The David Eccles School of Business, University of Utah, Salt Lake City, UT, USA
Short Communication
Should We Maximize Expected Profits or Maximize the Probability of Realizing Profit Targets? Summary of a Discussion on how to Reconcile these Objectives
Author(s): Bardia Kamrad, Keith Ord* and Glen M. Schmidt
It is generally accepted in the operations literature that a firm should strive to maximize its expected profit. However, in practice it is not uncommon
for a firm to offer a bonus to managers for achieving some pre-established target profit, possibly yielding managerial actions that differ from
the profit-maximizing approach (given a profit target, we assume managers will maximize the probability of reaching that target). We use the
Newsvendor framework to illustrate how the firm’s shareholders (e.g., through its board of directors) can align these two seemingly different
decision approaches: maximizing expected profit vs. maximizing the probability of reaching a target profit. Alignment is achieved by setting what we
call an “Aligned Profit Target” (APT) – a target profit that yields the same managerial action namely: contextually, the sam.. Read More»
DOI:
10.37421/2162-6359.2022.11.634
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