Agency Theory (Jensen-Meckling)

Michael Jensen and William Meckling's 1976 paper 'Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure' reconceived the corporation as a legal fiction serving as a nexus for contracting relationships among individuals. The central problem, in their framework, was the agency problem: managers (agents) controlling corporate resources on behalf of shareholders (principals) had incentives to pursue their own interests—empire building, perquisite consumption, risk avoidance—rather than maximizing shareholder value. The solution was to align managerial incentives with shareholder interests through compensation tied to stock price performance. This theoretical apparatus provided intellectual legitimation for the governance transformation Lazonick documents: the shift from managerial capitalism (where executives exercised strategic control based on productive knowledge) to financial capitalism (where executives operated as agents of shareholders focused on stock price maximization). Jensen and Meckling's framework assumed that shareholder value maximization would produce productive efficiency and innovation. Lazonick's empirical research demonstrates the opposite: governance structures that maximize shareholder value systematically degrade the institutional conditions—strategic control, organizational integration, financial commitment—that sustained innovation