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Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure

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Journal of Financial Economics 3 (1976) 305-360. Q North-Holland

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THEORY OF THE FIRM: MANAGERIAL BEHAVIOR, AGENCY COSTS AND OWNERSHIP STRUCTURE
Michael C. JENSEN and William H. MECKLING*

University of Rochester, Rochester, NY 14627, U.S.A.

Received January 1976, revised version received July 1976 This paper integrates elements from the theory of agency. the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optirnality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing tht- creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem. The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frcqucntly watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give thcmsclvcs a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or Icss, in the management of the affairs of such a company. Adam Smith. Tire W&rh of Ndutrs, 1776, Cannan Edition (Modern Library, New York, 1937) p. 700.

I. Introduction and summary

In this paper WC draw on recent progress in the theory of (1) property rights, (2) agency, and (3) finance to develop a theory of...

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