Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure
1976 · paper · Economics
Combines agency theory, property rights theory and finance to develop a theory of a firm's ownership structure. It defines agency costs, examines those generated by debt and outside equity, who bears them, and their Pareto optimality, and offers a new definition of the firm.
Checked: PDF from josephmahoney.web.illinois.edu, fetched 5 Oct 2026. Page numbers are those of that PDF.
6 findings
Substance p. 327 reads 'which Berle and Means (1932) popularized 157 years later', but the epigraph dates the Smith passage to 1776, which is 156 years before 1932.
- p. 23 Section 2.5, p.327
(1932) popularized 157 years later
- p. 1 Epigraph
Adam Smith, The Wealth of Nations, 1776
- p. 23 Section 2.5, after Fig. 4
which Berle and Means (1932) popularized 157 years later
- p. 1 epigraph
The Wealth of Nations, 1776
Judge's note: The epigraph on p. 1 reads 'Adam Smith, The Wealth of Nations, 1776, Cannan Edition (Modern Library, New York, 1937) p. 700'. The image of p. 23 reads 'popularized 157 years later'. The paper gives no other Smith date (the 1937 date belongs to the reprint), so the interval does not match the paper's own dates.
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Reference or label Footnote 3 cites "Machlup (1961)", but the only Machlup entry in the reference list is "Machlup, F., 1967, Theories of the firm: Marginalist, behavioral, managerial", which footnote 2 cites as "Machlup (1967)".
- p. 3 Footnote 3
Machlup (1961) and Alchian (1965)
- p. 3 Footnote 2
Machlup (1967)
- p. 55 References
Machlup, F., 1967, Theories of the firm
- p. 55 References
Machlup, F., 1967, Theories of the firm: Marginalist, behavioral, managerial
Only the authors can say what is right here.
Judge's note: In the page 3 image, footnote 3 reads 'Machlup (1961)' and footnote 2 reads 'Machlup (1967)'. The reference list (page 55 image, ref. p. 359) has one Machlup entry, dated 1967. Either the year in footnote 3 is wrong or a 1961 entry is missing; only the authors can say which.
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Reference or label Footnote 2 cites "Peterson (1965)", but the reference list has no Peterson entry (the P entries are Penrose 1958 and Preston 1975 only).
- p. 3 Footnote 2
Reviews of this literature are given by Peterson (1965)
- p. 56 References (P entries)
Penrose, E., 1958
- p. 56 References (P entries)
Penrose, E., 1958, The theory of the growth of the firm
Only the authors can say what is right here.
Judge's note: The page 3 image shows 'Peterson (1965)' in footnote 2. I checked the reference pages: page 55 runs from Hirshleifer to Myers, and page 56 begins with Penrose, then Preston, then Ross. There is no Peterson entry.
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Reference or label Footnote 34 cites 'Alchian-Demsetz (1972, p. 709)', but the reference list gives that article as 'American Economic Review LXII, no. 5, 777-795'.
- p. 28 Footnote 34
Alchian-Demsetz (1972, p. 709) argue
- p. 53 References
American Economic Review LXII, no. 5, 777-795.
- p. 56 References, Ross 1973
American Economic Review LXII, May, 134-139
- p. 53 References, Alchian and Demsetz 1972
American Economic Review LXII, no. 5, 777-795
Only the authors can say what is right here.
Judge's note: Footnote 34 on p. 28 reads 'Alchian-Demsetz (1972, p. 709)'. The reference entry on p. 53 gives pages 777-795, so p. 709 lies outside the listed range. No reprint or second Alchian-Demsetz 1972 work is listed. Only the authors can say which page is meant. A second point in this cluster rests on outside knowledge: the true volume of the 1973 AER May issue. The Ross 1973 entry on p. 56 prints 'American Economic Review LXII, May, 134-139'. On the list's own year-to-volume pattern (Demsetz 1967 LVII, Coase 1964 LIV, Alchian-Demsetz 1972 LXII), a 1973 issue would be LXIII. I offer this only as a query.
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Reference or label Footnotes 36 and 53 cite 'Kraus and Litzenberger (1972)', but the reference list's only entry is 'Kraus, A. and R. Litzenberger, 1973, A state preference model of optimal financial leverage'.
- p. 29 Footnote 36
See Kraus and Litzenberger (1972) and Lloyd-Davies (1975).
- p. 37 Footnote 53
Kraus and Litzenberger (1972) and Lloyd-Davies (1975) demonstrate
- p. 55 References
Kraus, A. and R. Litzenberger, 1973, A state preference model of optimal financial leverage
- p. 37 footnote 53
Kraus and Litzenberger (1972) and Lloyd-Davies (1975)
Judge's note: Footnote 36 (p. 29) and footnote 53 (p. 37) both print 1972. The reference list on p. 55 has a single Kraus-Litzenberger entry, dated 1973 (Journal of Finance, Sept.). No 1972 entry or working-paper version is listed.
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Wording p. 336 prints 'σ2² < σ1², the equity value S1 is less than S2', which reverses the ordering defined on p. 335 ('differ only by their variances with σ1² < σ2²').
- p. 31 Section 4.1, p.335
The distributions differ only by their variances with
- p. 32 Section 4.1, p.336, first paragraph
the equity value S1 is less than S2
- p. 32 first paragraph, option-pricing argument
σ2² < σ1², the equity value S1 is less than S2
- p. 31 setup of the two distributions
σ1² < σ2²
Only the authors can say what is right here.
Judge's note: The setup on p. 335 shows σ1² < σ2². The text then calls distribution 2 'the higher variance distribution' and says 'by promising to take the low variance project ... then taking the high variance project'. On p. 336 the inequality appears with subscript 2 on the left. My reworking: by Merton's result, which the paper cites, equity (a call option) rises with variance. S1 < S2 therefore needs σ1² < σ2², so the inequality as printed contradicts the conclusion drawn from it. The conclusion itself (S1 < S2, B1 > B2) stands, so I rate this a faulty step (S3).
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24 minor (typos and the like; most checked by the judge only)
Reference or label Footnote 69 cites 'Fama (1970)' with no suffix, but the reference list has 'Fama, E.F., 1970a, Efficient capital markets...' and '1970b, Multiperiod consumption-investment decisions'.
- p. 50 Footnote 69
See Fama (1970) for a survey of this 'efficient markets' literature.
- p. 54 References
Fama, E.F., 1970a, Efficient capital markets
- p. 54 References
Fama, E.F., 1970a, Efficient capital markets: A review of theory and empirical work
Judge's note: Footnote 69 is on p. 50. The two Fama 1970 entries are on p. 54. From context ('efficient markets' literature) the intended entry is 1970a; the missing suffix makes the citation key ambiguous.
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Reference or label Section 6.7 cites 'Rubinstein (1974), Ross (1974) and others' with no suffix, but the reference list has Ross 1974a and Ross 1974b.
- p. 52 Section 6.7
Ross (1974) and others
- p. 56 References
Ross, S.A., 1974b, Options and efficiency
- p. 52 Section 6.7, first sentence
Rubinstein (1974), Ross (1974) and others
Judge's note: The citation is on p. 52. The p. 56 reference list has Ross 1974a ('The economic theory of agency and the principle of similarity') and Ross 1974b ('Options and efficiency'). From context 1974b is probably meant, but the citation does not identify a single entry.
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Wording Section 1.4 says "leads to a theory of the ownership (or capital) structure of the firm", although footnote 1 says "We do not use the term 'capital structure' because that term usually denotes the relative quantities of bonds, equity...".
- p. 5 Section 1.4, second paragraph
leads to a theory of the ownership (or capital) structure of the firm
- p. 1 Footnote 1
We do not use the term 'capital structure' because that term usually denotes
Judge's note: Page 1, footnote 1, separates ownership structure from capital structure. Page 5 then treats the two terms as synonyms in a parenthesis. This is a terminology inconsistency, not a substantive error.
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Wording Fig. 1 caption: "when the fraction of outside equity is (1−α)V", whereas the parallel Fig. 3 caption reads "when outside equity is (1−α)".
- p. 12 Fig. 1 caption
the fraction of outside equity is (1−α)V
- p. 20 Fig. 3 caption
when outside equity is (1−α)
Judge's note: The page 12 image shows '(1−α)V' in the Fig. 1 caption, and the page 20 image shows '(1−α)' in the Fig. 3 caption. A fraction should be (1−α); (1−α)V is the value of the outside claim. This is a caption inconsistency only.
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Wording Footnote 24, condition (4): "Among all points (α̂, F̂, Ŵ_T) satisfying conditions (1)-(3), (α, F, W_T) gives the manager highest utility. This implies that (α̂, F̂, Ŵ_T) satisfy condition (3) as an equality." The hats appear to be swapped.
- p. 17 Footnote 24, condition (4)
gives the manager highest utility. This implies that
Only the authors can say what is right here.
Judge's note: I checked the crop of page 17. Conditions (2) and (3) characterise the equilibrium with hatted variables. As printed, condition (4) makes the unhatted tuple the maximiser over a set of hatted points, then draws a conclusion about the hatted tuple. The statement only reads coherently if the hats go on the maximiser and the comparison set is unhatted. The intended equilibrium characterisation is clear from context.
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Wording X̃_j is introduced as 'a random payoff', then 'X̃ is defined as the logarithm of the final payoff', and the bond payoff 'R_j = X*, if X̃_j ≥ X*' then uses X̃ as the payoff level.
- p. 31 Section 4.1, p.335
is defined as the logarithm of the final payoff
Judge's note: The p. 335 image shows all three uses. One symbol stands for both the payoff and its logarithm. The intended meaning can be recovered, but the notation is inconsistent.
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Typo Abstract: "show its relationship to the 'separation and control' issue" drops 'ownership'; elsewhere the paper says "separation of ownership and control".
- p. 1 Abstract
show its relationship to the 'separation and control' issue
- p. 2 Section 1.1
"separation of ownership and control"
Judge's note: In the page 1 image the abstract reads 'separation and control'. Page 2 (Section 1.1), page 5 and footnote 10 all say 'separation of ownership and control' or 'ownership and control'. A word is missing.
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Typo Section 1.4: "inadequcy of the current theory" should read 'inadequacy'.
- p. 4 Section 1.4
inadequcy of the current theory
Judge's note: The crop of page 4 clearly shows 'inadequcy'.
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Typo p. 309: "generated by the corporate form are born leads" and "how and why they are born will lead" use 'born' where 'borne' is meant.
- p. 5 p.309
generated by the corporate form are born leads
- p. 5 p.309
how and why they are born will lead
- p. 5 Section 1.4, para 2
the agency costs generated by the corporate form are born
- p. 5 Section 1.4, para 3
how and why they are born will lead to a rich theory
Judge's note: Both instances appear in the page 5 image. The sense is costs being borne.
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Typo p. 309: "The development of theories tp explain": the second letter of 'to' is printed as a p/ρ-like glyph.
- p. 5 Section 1.4, para 3
The development of theories tp explain
Judge's note: In the crop the glyph after 't' is an 'o' with a descender, not a clean 'o'. It may be a damaged or wrongly set type sort rather than a spelling error. Either way it is cosmetic.
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Typo p. 309: "Since the relationship between the stockholders and manager of a corporation fit the definition": the singular subject needs 'fits'.
- p. 5 Section 1.4, para 2
Since the relationship between the stockholders and manager of a corporation fit the definition
Judge's note: The page 5 image shows 'fit'.
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Typo p. 311: "(some of whom may 'represent' other oganizations)" should read 'organizations'.
- p. 7 p.311
other oganizations
Judge's note: The page 7 image shows 'oganizations' in the second paragraph. The text layer for this passage is garbled, so I relied on the image.
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Typo Footnote 14: "Statutory laws sets bounds": the plural subject needs 'set'.
- p. 7 Footnote 14
Statutory laws sets bounds
Judge's note: The page 7 image, footnote 14, shows 'Statutory laws sets bounds'.
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Typo Contract (ii), p. 325: "limit the owner-manager's consumption of perquisites to F;." should read F″.
- p. 21 Contract (ii), p.325
consumption of perquisites to F;.
Judge's note: The crop shows 'F;.'. Fig. 3 and the following text ('perquisites to F″ from F′') show the intended symbol is F″.
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Typo p. 325: "financial accounts audited by a public account" should read 'public accountant'.
- p. 21 Analysis of bonding expenditures
audited by a public account
Judge's note: The crop of page 21 shows 'public account,'.
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Typo Section 6.6 (p. 52) reads "the structure outlined in the proceeding pages", where "preceding" is meant. Section 3.2 (p. 27) reads "many other stockholder's also existed", where the plural "stockholders" is meant.
- p. 52 Section 6.6
outlined in the proceeding pages
- p. 27 Section 3.2
many other stockholder's also existed
- p. 52 Section 6.6
the structure outlined in the proceeding pages
Judge's note: Checked both crops. The p. 52 crop shows 'proceeding pages'. The context is the analysis already set out earlier in the paper, so 'preceding' is the intended word. The p. 27 crop shows 'stockholder's' with an apostrophe, used as a plural ('many other stockholder's also existed'). Both are cosmetic typos.
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Typo Misspellings: 'preferred stock or warrnts' (p. 333) and 'illustrates very nicley' (footnote 39); these should read 'warrants' and 'nicely'.
- p. 29 p.333
preferred stock or warrnts
- p. 30 Footnote 39
illustrates very nicley
- p. 30
illustrates very nicley the potential inconsistency
Judge's note: Both misspellings are visible in the images of p. 29 (body text) and p. 30 (footnote 39).
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Typo Misspellings: 'in determing the yield to maturity' (footnote 47) and 'in the bond identure' (footnote 48); these should read 'determining' and 'indenture'.
- p. 34 Footnote 47
in determing the yield to maturity
- p. 35 Footnote 48
in the bond identure
Judge's note: Footnote 47 on p. 34 shows 'determing' and footnote 48 on p. 35 shows 'identure'.
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Typo Typo: 'both debt snd outside equity' (p. 340); this should read 'and'.
- p. 36 p.340, first paragraph
both debt snd outside equity
Judge's note: The 'snd' is visible in the crop of p. 340.
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Typo Wrong word: 'rather than principle and interest payments' (p. 342); this should read 'principal'.
- p. 38 p.342
rather than principle and interest payments
Judge's note: The crop of p. 342 shows 'principle'. The context is debt repayment, so 'principal' is meant.
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Typo 'One other conditions also has to hold' (footnote 57) should read 'condition', and 'the initial set of contracts are consumated' (Section 6.1) should read 'consummated'.
- p. 39 Footnote 57
One other conditions also has to hold
- p. 47 Section 6.1
are consumated
- p. 47 Section 6.1
the initial set of contracts are consumated
Judge's note: Both forms are visible in the crops of p. 39 (footnote 57) and p. 47 (Section 6.1).
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Typo Subject-verb disagreement: 'In addition warrants represents a claim on the upper tail'; this should read 'represent'.
- p. 49 Section 6.3, last line
In addition warrants represents a claim on the upper tail
Judge's note: The wording is visible in the crop of p. 49.
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Typo Section 6.6 (p. 52) reads "One of the most serious limitation of the analysis", where the plural "limitations" is needed.
- p. 52 Section 6.6
One of the most serious limitation of the analysis
Judge's note: The crop shows the singular 'limitation' after 'One of the most serious'. This is a number-agreement slip and is cosmetic.
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Typo Section 6.6 (p. 52) reads "space limitations precludes discussion of these issues here". The plural subject needs "preclude".
- p. 52 Section 6.6
space limitations precludes discussion
Judge's note: The crop shows 'space limitations precludes'. This is a subject-verb agreement error and is cosmetic.
Second check: none (judge only)