Agency Problems and the Theory of the Firm

TLDR

Large corporations separate ownership and control, treating management and risk‑bearing as distinct functions, and managers operate under market discipline and opportunity. The paper seeks to explain how separating ownership and control can be an efficient economic organization. Competition forces firms to develop mechanisms that efficiently monitor overall and individual performance. The study demonstrates that separating ownership and control is an efficient economic organization.

Abstract

This paper attempts to explain how the separation of security ownership and control, typical of large corporations, can be an efficient form of economic organization. We first set aside the presumption that a corporation has owners in any meaningful sense. The entrepreneur is also laid to rest, at least for the purposes of the large modern corporation. The two functions usually attributed to the entrepreneur--management and risk bearing--are treated as naturally separate factors within the set of contracts called a firm. The firm is disciplined by competition from other firms, which forces the evolution of devides for efficiently monitoring the performance of the entire team and of its individual members. Individual participants in the firm, and in particular its managers, face both the discipline and opportunities provided by the markets for their services, both within and outside the firm.