Rethinking the Purpose of the Corporation
Edward Waitzer / Journal of Applied Corporate Finance • Volume 30 Number 2 / Spring 2018
In 1976 two economists at the University of Rochester, Michael Jensen and William Meckling introduced the concept of “agency costs”—the costs incurred by shareholders of public corporations to get corporate management to act on their behalf. In the Jensen-Meckling view, shareholders were the “principals” in an economic relationship with professional corporate managers who were the “agents.” Principals delegated decision-making authority over a corporation to agents act in their interests. Inevitably, the financial interests of principals and agents differed at least slightly, hence the various possible agency costs borne by shareholders including salaries, incentive compensation, inefficiency, suboptimal decision-making, and corporate empire-building.
In legal and finance theory, agency costs came to be understood as a bundle of cash costs and opportunity costs involved in trying to align the incentives of different corporate actors. This characterization of the mission of corporate law has led to a 40 plus year search for an organizational Holy Grail—how to align the interests of shareholders and managers (and of controlling and minority shareholders) through a series of techniques, including regulatory standards, independent directors, take-overs and activist shareholders.