Michael C. Jensen

William H. Meckling

University of Rochester, U.S.A.

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


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.


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 ownership structure’ for the firm. In addition to tying together elements of the theory of each of these three areas, our analysis casts new light on and has implications for a variety of issues in the professional and popular literature such as the definition of the firm, the “separation of ownership and control”, the “social responsibility” of business, the definition of a “corporate objective function”, the determination of an optimal capital structure, the specification of the content of credit agreements, the theory of organizations, and the supply side of the completeness of markets problem.

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