Jensen and Meckling 1976 Summary

Topics: Economics, Property, Cost Pages: 3 (845 words) Published: September 27, 2014

Theory of the Firm: Managerial Behavior,
Agency Costs and Ownership Structure
By: Michael Jenson and William Meckling

Introduction and Summary
1. Motivation
a. Draw on property rights, agency and finance to develop ownership structure theory 2. Theory of the Firm: An Empty Box
a. Meet inputs and outputs to maximize profits
3. Property Rights
a. Means “human rights” in this paper
b. Affected by contracts
i. Behavior of managers effected
4. Agency Costs
a. Sum of
i. Monitoring expenditures by the principal
ii. Bonding expenditures by the agent
iii. Residual loss
b. Includes principal – agent relationship and cooperative effort c. Most literature focuses on how to structure contracts between principal and agent to minimize agency costs (maximize principals welfare) 5. Some General Comments on the Definition of the Firm

a. Legal fictions which serve as a nexus for a set of contracting relationships among individuals i. Existence of divisible residual claims on the assets and cash flows of the organization which can generally be sold without permission of the other contracting individuals

The Agency Cost of Outside Equity
1. Overview
a. Compare behavior of manager who owns 100% vs. less than 100% i. Wholly owned he makes operating decisions which maximize his utility 1. Pecuniary returns and non-pecuniary aspects
ii. Manager will expend resources to the point where the marginal utility derived from a dollar’s expenditure equals the marginal utility of additional purchasing power iii. As percent ownership falls, increased monitoring costs 2. Simple Formal Analysis of the Sources of Agency Costs of Equity and Who Bears Them a. Permanent Assumptions on page 314

b. Temporary assumptions on page 314
c. Figure 1
i. The value of the firm and the level of non-pecuniary benefits consumed when the fraction of outside equity is (1-a)V and utility curves representing owner’s indifference curves between wealth and non-pecuniary benefits d....
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