Michael C. Jensen
Jesse Isidor Straus Professor of Business Administration, Emeritus

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Abstracts of Publications

Published Articles

Michael C. Jensen and Joseph Fuller,  'What's a Director to Do?,' Harvard NOM Research Paper No. 01-01 (October 2002).  Forthcoming in Best Practices: Ideas and Insights from the World's Foremost Business Thinkers, (Cambridge, MA: Perseus Publishing and London, Bloomsbury Publishing, 2002).

 

The recent wave of corporate scandals provides continuing evidence that boards have failed to fulfill their role as the top-level corporate control mechanism. Destroyed companies, ruined reputations and in some cases jail sentences have created an environment in which substantial changes in the role of the board may occur. To solve the problems boards must change fundamentally their approach to the job. We recommend that boards focus on the following areas:

--Be clear about the decision rights and role of the boardñbeing careful to see that the board holds and exercises the top-level control rights in the organization, including the rights to initiate and implement decisions such as the right to hire, evaluate, compensate, and fire the top management team, board members, and the auditors.

--Change the structural, social, psychological and power environment of the board so that board members are no longer effectively the employees of the CEO.

--Change the philosophical mindset of the board from one of careful review and compliance to one of insatiable curiosity and clarity.

--Take seriously the role of the board as the body ultimately responsible for ensuring the integrity of the organization in all matters. This means individual board members must come to understand and institutionalize the notion that honesty and integrity in our actions and our words are most valuable to others when it costs us something to adhere to them. Yet we tend to forgive ourselves the obligation to uphold these values in exactly those situations where there are high costs (whether monetary, psychological, and/or reputational) to ourselves, the CEO and others, or the company. Restoring integrity to the system will require men and women of courage and conviction on boards and in management teams to incur costs in the short run to preserve their reputations and the reputation and value of the organizations they serve.

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Michael C. Jensen, 'Value Maximization and the Corporate Objective Function,' forthcoming in Business Ethics Quarterly, Vol. 12, No.1, Jan 2001, and in the European Financial Management Review, 2001. Earlier versions of this paper appear in: Breaking The Code Of Change, Michael Beer and Nithan Norhia, eds, Harvard Business School Press, 2000; presented at WP EFMA Athens 2000, and were published as Harvard NOM Research Paper No. 00-04 and Harvard Business School Working Paper No. 00-058.

This paper examines the role of the corporate objective function in corporate productivity and efficiency, social welfare, and the accountability of managers and directors. I argue that since it is logically impossible to maximize in more than one dimension, purposeful behavior requires a single valued objective function. Two hundred years of work in economics and finance implies that in the absence of externalities and monopoly (and when all goods are priced), social welfare is maximized when each firm in an economy maximizes its total market value. Total value is not just the value of the equity but also includes the market values of all other financial claims including debt, preferred stock, and warrants.

In sharp contrast stakeholder theory, argues that managers should make decisions so as to take account of the interests of all stakeholders in a firm (including not only financial claimants, but also employees, customers, communities, governmental officials, and under some interpretations the environment, terrorists, and blackmailers). Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing interests they leave managers with a theory that makes it impossible for them to make purposeful decisions. With no way to keep score, stakeholder theory makes managers unaccountable for their actions. It seems clear that such a theory can be attractive to the self interest of managers and directors.

Creating value takes more than acceptance of value maximization as the organizational objective. As a statement of corporate purpose or vision, value maximization is not likely to tap into the energy and enthusiasm of employees and managers to create value. Seen in this light, change in long-term market value becomes the scorecard that managers, directors, and others use to assess success or failure of the organization. The choice of value maximization as the corporate scorecard must be complemented by a corporate vision, strategy and tactics that unite participants in the organization in its struggle for dominance in its competitive arena.

A firm cannot maximize value if it ignores the interest of its stakeholders. I offer a proposal to clarify what I believe is the proper relation between value maximization and stakeholder theory. I call it enlightened value maximization, and it is identical to what I call enlightened stakeholder theory. Enlightened value maximization utilizes much of the structure of stakeholder theory but accepts maximization of the long run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders. Managers, directors, strategists, and management scientists can benefit from enlightened stakeholder theory. Enlightened stakeholder theory specifies long-term value maximization or value seeking as the firm's objective and therefore solves the problems that arise from the multiple objectives that accompany traditional stakeholder theory.

I also discuss the Balanced Scorecard, the managerial equivalent of stakeholder theory. The same conclusions hold. Balanced Scorecard theory is flawed because it presents managers with a scorecard which gives no score--that is, no single-valued measure of how they have performed. Thus managers evaluated with such a system (which can easily have two dozen measures and provides no information on the tradeoffs between them) have no way to make principled or purposeful decisions. The solution is to define a true (single dimensional) score for measuring performance for the organization or division (and it must be consistent with the organization's strategy). Given this we then encourage managers to use measures of the drivers of performance to understand better how to maximize their score. And as long as their score is defined properly, (and for lower levels in the organization it will generally not be value) this will enhance their contribution to the firm.

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Michael C. Jensen, George P. Baker, Carliss Y. Baldwin, and Karen H. Wruck, 'Organizations and Markets at Harvard Business School, 1984-1996,' in The Intellectual Venture Capitalist: John H. McArthur and the Work of the Harvard Business School, 1980-1995, Thomas K. McCraw and Jeffrey L. Cruikshank, Eds., (Harvard Business School Press, 1998).

This paper describes the history of the development of the course Coordination, Control and the Management of Organizations (CCMO) from its initiation by Michael C. Jensen and William H. Meckling at the University of Rochester in 1973 to its current state as one of the most highly demanded elective courses in the second year of the MBA program at Harvard Business School. CCMO regularly attracts between 500 and 600 of the 850 second-year MBA students.

CCMO presents a new theory of organizations that draws on economics, finance, psychology, neuroscience, and human resource management. In developing our theory, we focus particularly on four interrelated areas: 1) the nature of human beings and their behavior; 2) compensation, career systems, and performance measurement; 3) task structure, organizational boundaries, and technology; and 4) governance, corporate finance, and organizational performance. This paper presents specifics in each of these four categories.

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Michael C. Jensen with Donald H. Chew, 'U.S. Corporate Governance: Lessons from the 1980s,' in The Portable MBA in Finance and Accounting, John Leslie Livingstone, Ed., (John Wiley & Sons, 1995), pp. 337-404. Abridged version published in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

Corporate governance is a concern of great importance to owners of common stocks, because stockholder wealth depends in large part upon the goals of the people who set the strategy of the corporation. Who is the boss, and whose interests come first?

The objectives of corporate managers often conflict with those of the shareholders who own their companies. Laws and regulations enacted since the 1930s have effectively put most of the power in the hands of management, frequently at the expense of the interests of the owners of the corporation. At the same time, boards of directors have tended to go along with management and to ignore the interests of the very party they were created to protect.

The takeover boom of the 1980s brought the subject of corporate governance to the front pages of the newspapers, as a revolution was mounted against the power complexes at corporate headquarters. The mergers, acquisitions, LBOs, and other leveraged restructurings of the 1980s constituted an assault on entrenched authority that was long overdue. Control of the corporation was transformed from a means of perpetuating established arrangements into a marketplace where the highest bidder made certain that the owners' interests would prevail. In many cases, the result was a convergence of interest between management and owners. New methods of finance meant that even large companies were vulnerable to attack; the steady increase in the size of the deals culminated in the $25 billion buyout of RJR-Nabisco in 1989 by KKR, a partnership with fewer than 60 employees.

The effect of such transactions was to transfer control over vast corporate resources-often trapped in mature industries or uneconomic conglomerates-to those prepared to pay large premiums to use those resources more efficiently. In some cases, the acquirers functioned as agents rather than principals, selling part or all of the assets they acquired to others. In many cases, the acquirers were unaffiliated individual investors (labeled 'raiders' by those opposed to the transfer of control) rather than other large public corporations. The increased asset sales, enlarged payouts, and heavy use of debt to finance such takeovers led to a large-scale return of equity capital to shareholders.

The consequence of this control activity has been a pronounced trend toward smaller, more focused, more efficient-and in many cases private-corporations. While capital and resources were being forced out of our largest companies throughout the 1980s, the small- to medium-sized U.S. corporate sector experienced vigorous growth in employment and capital spending. And, at the same time our capital markets were bringing about this massive transfer of corporate resources, the U.S. economy experienced a 92-month expansion and record-high percentages of people employed.

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Karen Hopper Wruck and Michael C. Jensen, 'Science, Specific Knowledge, and Total Quality Management,' Journal of Accounting and Economics (1994) pp. 247-287. Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

We analyze Total Quality Management (TQM) from an economic and organizational perspective. We find that TQM is a new organizing technology that is science-based, non-hierarchical and non-market-oriented. It improves productivity by encouraging the use of science in decision-making and discouraging counter-productive defensive behavior. It also encourages effective creation and use of specific knowledge throughout the organization. Effective implementation of TQM generally requires major changes in all three components of the organizational rules of the game, namely systems for allocating decision rights, performance measurement systems, and reward and punishment systems.

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Michael C. Jensen and William H. Meckling, 'The Nature of Man,' The Journal of Applied Corporate Finance (Summer 1994), pp. 4-19. Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

Understanding human behavior is fundamental to understanding how organizations function, whether they are profit-making firms, non-profit enterprises, or government agencies. Much disagreement among managers, scientists, policy makers, and citizens arises from substantial differences in the way we think about human nature-about their strengths, frailties, intelligence, ignorance, honesty, selfishness, and generosity. In this paper we discuss five alternative models of human behavior that are commonly used (though usually implicitly). They are the Resourceful, Evaluative, Maximizing Model (REMM), Economic (or Money Maximizing) Model, Psychological (or Hierarchy of Needs) Model, Sociological (or Social Victim) Model, and the Political (or Perfect Agent) Model. We argue that REMM best describes the systematically rational part of human behavior. It serves as the foundation for the agency model of financial, organizational, and governance structure of firms.

The growing body of social science research on human behavior has a common message: Whether they are politicians, managers, academics, professionals, philanthropists, or factory workers, individuals are resourceful, evaluative maximizers. They respond creatively to the opportunities the environment presents, and they work to loosen constraints that prevent them from doing what they wish. They care about not only money, but about almost everything-respect, honor, power, love, and the welfare of others. The challenge for our society, and for all organizations in it, is to establish rules of the game that tap and direct human energy in ways that increase rather than reduce the effective use of our scarce resources.

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Michael C. Jensen, 'Self Interest, Altruism, Incentives, and Agency Theory,' The Journal of Applied Corporate Finance (Summer 1994), pp. 40-45. Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

Many people are suspicious of self-interest and incentives and oppose motivating humans through incentives. I analyze the meaning of incentives in the logic of choice and argue that it is inconceivable that purposeful actions are anything other than responses to incentives. Money is not always the best way to motivate people. But where money incentives are required, they are required precisely because people are motivated by things other than money.

Self-interest is consistent with altruistic motives. Agency problems, however, cannot be solved by instilling greater altruism in people because altruism, the concern for the well-being of others, does not make a person into a perfect agent who does the bidding of others.

I discuss the universal tendency of people to behave in non-rational ways. Though they are Resourceful, Evaluative Maximizers (REMMs), humans are imperfect because their brains are biologically structured so as to blind them from perceiving or correcting errors that cause psychic pain. The result is systematic, non-functional behavior. I discuss a Pain Avoidance Model (PAM) that complements REMM by capturing the non-rational component of human behavior (the crux of human self-control problems). Recognizing these self-control problems leads to an expansion of agency theory since they are a second source of agency costs in addition to those generated by conflicts of interest between people.

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Michael C. Jensen, 'The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems,' The Journal of Finance, (July, 1993). Reprinted in the Journal of Applied Corporate Finance, (Winter 1994) Vol. 6, No. 4, and in Finanzmarkt und Portfolio Management, (January 1993), Vol 7, No. 3. Reprinted in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

Since 1973 technological, political, regulatory, and economic forces have been changing the worldwide economy in a fashion comparable to the changes experienced during the nineteenth century Industrial Revolution. As in the nineteenth century, we are experiencing declining costs, increasing average (but decreasing marginal) productivity of labor, reduced growth rates of labor income, excess capacity, and the requirement for downsizing and exit. The last two decades indicate corporate internal control systems have failed to deal effectively with these changes, especially slow growth and the requirement for exit. The next several decades pose a major challenge for Western firms and political systems as these forces continue to work their way through the worldwide economy.

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Michael C. Jensen and William H. Meckling, 'Specific and General Knowledge, and Organizational Structure,' in Contract Economics, Lars Werin and Hans Wijkander, eds., (Blackwell, Oxford 1992), pp. 251-274. Reprinted in Journal of Applied Corporate Finance, (Fall 1995) and Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998)

This paper reviews the relations between knowledge, control and organizational structure both in the market system as a whole and in private organizations Limitations on the mental capacity of the human mind and the costs of producing and transferring knowledge means that knowledge relevant to all decisions can never be collected in the mind of a single individual or a small body of experts. This means that if the knowledge valuable to a particular decision is to be used in making that decision there must be a system for partitioning out decision rights to individuals who already have the relevant knowledge and abilities or who can acquire or produce them at lowest cost. Self interest on the part of individual decision-makers means a control system is required to motivate individuals with the decision rights and the relevant knowledge to use those decision rights appropriately. The control problem is solved in a capitalist economy by the system of alienable property rights.

Alienable rights cannot generally solve the control problem in firms, and the assignment of decision rights in firms does not generally include the assignment of alienability. Indeed this is one of the major distinctions between firms and markets. The inalienability of rights within an organization means control problems must be solved by alternative means. Organizations solve these problems by establishing internal rules of the game that provide:

(1) a system for partitioning decision rights out to agents in the organization

(2) a control system that provides:

(a) a performance measurement and evaluation system
(b) a reward and punishment system.

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Michael C. Jensen, 'Corporate Control and the Politics of Finance,' Journal of Applied Corporate Finance (Summer, 1991), pp. 13-33.

In this paper I explore the effects of politics on corporate finance, including the determinants of capital structure and the regulatory and legal factors governing the market for corporate control. I examine the effects and consequences of the active corporate control market of the 1980s, then I outline the enormous political controversy and inaccurate media portrayals that ensued, and contrast them to the results obtained from intensive study of the phenomena by academic economists.

First, I review new macroeconomic evidence on changes in productivity in American manufacturing that is dramatically inconsistent with popular claims that corporate control transactions were crippling the industrial economy in the 80s. Second, I show how the restructuring movement of the 1980s reflected the re-emergence of active investors in the U.S. and how restructuring addressed the conflict between management and shareholders over control of corporate 'free cash flow.' Third, I summarize my conception of 'LBO associations' as new organizational forms that overcome the deficiencies of large public conglomerates. I also discuss the similarity between LBO associations and Japanese business financing networks known as keiretsu. Fourth, I argue that the highly-leveraged financial structures of the 1980s should lead to a Japanese-style 'privatization' of bankruptcy (i.e., out-of-court reorganization). Fifth, I present a theory of 'boom-bust' cycles in venture markets that explains why many companies involved with late-1980s leveraged transactions encountered financial distress. Sixth, I argue that misguided changes in the tax and regulatory codes and in bankruptcy court decisions have distorted the normal economic incentives for out-of-court reorganizations, resulting in increased costs of financial distress and a sharp rise in the number of Chapter 11 filings. Seventh and last, I propose a set of changes in the Chapter 11 process designed to reduce the costs of financial distress and thus maximize the total value of the firm to all investors.

Michael C. Jensen and Kevin J. Murphy, 'CEO Incentives: Its Not How Much You Pay, But How,' Harvard Business Review (May/June, 1990), pp. 138-153.

Paying top executives 'better' would eventually mean paying them more. The arrival of spring means yet another round in the national debate over executive compensation. Soon the business press will trumpet answers to the questions it asks every year: Who were the highest paid CEOs? How many executives made more than a million dollars? Who received the biggest raises? Political figures, union leaders, and consumer activists will issue now-familiar denunciations of executive salaries and urge that directors curb top-level pay in the interests of social equity and statesmanship.

The critics have it wrong. There are serious problems with CEO compensation, but 'excessive' pay is not the biggest issue. The relentless focus on how much CEOs are paid diverts public attention from the real problem-how CEOs are paid. In most publicly held companies, the compensation of top executives is virtually independent of performance. On average, corporate America pays it most important leaders like bureaucrats. Is it any wonder then that so many CEOs act like bureaucrats rather than the value-maximizing entrepreneurs companies need to enhance their standing in world markets?

We recently completed an in-depth statistical analysis of executive compensation. Our study incorporates data on thousands of CEOs spanning five decades. The base sample consists of information on salaries and bonuses for 2,505 CEOs in 1,400 publicly held companies from 1974 through 1988. We also collected data on stock options and stock ownership for CEOs of the 430 largest publicly held companies in 1988. In addition, we drew on compensation data for executives at more than 700 public companies for the period 1934 through 1938.

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Michael C. Jensen and Kevin J. Murphy, 'Performance Pay and Top Management Incentives,' Journal of Political Economy (April, 1990), pp. 225-265. Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998). Related work: Michael C. Jensen and Kevin J. Murphy, 'A New Survey of Executive Compensation,' Full Survey and Technical Appendix to 'CEO Incentives-It's Not How Much You Pay But How,' Harvard Business Review (May/June 1990)

Our estimates of the pay-performance relation (including pay, options, stockholdings, and dismissal) for chief executive officers indicate that CEO wealth changes $3.25 for every $1,000 change in shareholder wealth. Although the incentives generated by stock ownership are large relative to pay and dismissal incentives, most CEOs hold trivial fractions of their firms' stock, and ownership levels have declined over the past 50 years. We hypothesize that public and private political forces impose constraints that reduce the pay-performance sensitivity. Declines in both the pay-performance relation and the level of CEO pay since the 1930s are consistent with this hypothesis.

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Michael C. Jensen, 'Eclipse of the Public Corporation,' Harvard Business Review(September-October, 1989). Reprinted in The Law of Mergers, Acquisitions, and Reorganizations, Dale A. Oesterle, ed. (West Publishing, 1991).

The publicly held corporation has outlived its usefulness in many sectors of the economy. New organizations are emerging. Takeovers, leveraged buyouts, and other going-private transactions are manifestations of the change. A central source of waste in the public corporation is the conflict between owners and managers over free cash flow. This conflict helps explain the prominent role of debt in the new organizations. The new organizations' resolution of the conflict explains how they can motivate people and manage resources more effectively than public corporations. McKinsey Award Winner.

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Michael C. Jensen, 'Active Investors, LBOs, and the Privatization of Bankruptcy,' Journal of Applied Corporate Finance, Vol. 2, No. 1 (Spring 1989), pp. 35-44. Reprinted in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

The corporate sector of the U.S. economy has been experiencing major change, and the rate of change continues as we head into the last year of the 1980s. Over the past two decades the corporate control market has generated considerable controversy, first with the merger and acquisition movement of the 1960s, then with the hostile tender offers of the 1970s and most recently, with the leveraged buyouts and leveraged restructurings of the 1980s. The controversy has been renewed with the recent $25 billion KKR leveraged buyout of RJR-Nabisco, a transaction almost double the size of the largest previous acquisition to date, the $13.2 billion Chevron purchase of Gulf Oil in 1985.

These control transactions are the most visible aspect of a much larger phenomenon that is not yet well understood. Though controversy surrounds them, and despite the fact that they are not all productive, these transactions are the manifestation of powerful underlying economic forces that, on the whole, are productive for the economy. Thorough understanding is made difficult by the fact that change, as always, is threatening -- and in this case the threats disturb many powerful interests.

One popular hypothesis offered for the current activity is that Wall Street is engineering transactions to buy and sell fine old firms out of pure greed. The notion is that these transactions reduce productivity, but generate high fees for investment bankers and lawyers. The facts do not support this hypothesis even though mergers and acquisitions professionals undoubtedly prefer more deals to less, and thus sometimes encourage deals (like diversifying acquisitions) that are not productive.

There has been much study of corporate control activity, and although the results are not uniform, the evidence indicates control transactions generate value for shareholders. The evidence also suggests that this value comes from real increases in productivity rather than from simple wealth transfers to shareholders from other parties such as creditors, labor, government, customers or suppliers.

I have analyzed the causes and consequences of takeover activity in the U.S. and elsewhere. My purpose here is to outline an explanation of the fundamental underlying cause of this activity that has to date received no attention. In this paper I define 'active investors,' explain their fundamentally important role in generating corporate efficiency, show how current corporate control activity is part of a larger set of economic changes sweeping the world, provide perspective on how LBOs, restructurings, and increased leverage in the corporate sector fit into the overall picture, and discuss some reasons why high debt ratios and insolvency are less costly now than in the past. Because of its topical relevance, I pay particular attention to LBOs and their role in the restoration of competitiveness in the American corporation.

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Michael C. Jensen, Steven Kaplan, Laura Stiglin, 'Effects of LBOs on Tax Revenues of the U.S. Treasury,' Tax Notes, Vol. 42, No. 6 (February 6, 1989), pp. 727-733. Reprinted in The Law of Mergers, Acquisitions, and Reorganizations, Dale A. Oesterle, ed. (West Publishing, forthcoming 1991).

In this special report, the tax effects of leveraged buyouts (LBOs) based on the current tax law and data from LBOs during the period 1979 through 1985 are examined. The analysis challenges the argument that LBOs result in net losses of tax revenues to the U.S. Treasury. Five ways are shown in which LBOs can generate incremental revenues to the U.S. Treasury: increased capital gains taxes for shareholders; increased operating revenues; interest income earned by LBO creditors; more efficient use of capital; and asset sales triggering additional corporate taxes on the capital gains. Offsetting these incremental revenue gains are: increased interest deductions on the LBO debt and lower tax revenues on dividends foregone. It is concluded that the U.S. Treasury's revenues from LBO firms have increased over the time period examined and that policies that restrict LBOs likely will reduce future tax revenues received by the Federal government.

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George P. Baker, Michael C. Jensen and Kevin J. Murphy, 'Compensation and Incentives: Practice vs. Theory,' Journal of Finance (July, 1988). Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

A thorough understanding of internal incentive structures is critical to developing a viable theory of the firm, since these incentives determine to a large extent how individuals inside an organization behave. Many common features of organizational incentive systems are not easily explained by traditional economic theory-including egalitarian pay systems in which compensation is largely independent of performance, the overwhelming use of promotion-based incentive systems, the absence of up-front fees for jobs and effective bonding contracts, and the general reluctance of employers to fire, penalize, or give poor performance evaluations to employees. Typical explanations for these practices offered by behaviorists and practitioners are distinctly uneconomic-focusing on notions such as fairness, equity, morale, trust, social responsibility, and culture. The challenge to economists is to provide viable economic explanations for these practices or to integrate these alternative notions into the traditional economic model.

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Michael C. Jensen and Jerold B. Warner, 'The Distribution of Power Among Corporate Managers, Shareholders, and Directors,' Journal of Financial Economics (February 1988). Reprinted in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

This article surveys the seventeen papers in this special issue of the Journal of Financial Economics, and related work. The major findings are: (1) patterns of stock ownership by insiders and outsiders can influence managerial behavior, corporate performance, and stockholder voting in election contests; (2) corporate leverage, inside stock ownership by managers, and the control market are interrelated; (3) departures from one share/one vote affect firm value and efficiency; (4) takeover resistance through defensive restructurings or poison pill provisions is associated with declines in share price; and (5) top management turnover is inversely related to share price performance.

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Michael C. Jensen, 'Takeovers: Their Causes and Consequences,' Journal of Economic Perspectives, Vol. 2, No. 1 (Winter, 1988). Reprinted in Readings in Mergers and Acquisitions, Patrick A. Gaughan, ed., (Basil Blackwell, 1993).

Economic analysis and evidence indicate that the market for corporate control is benefiting shareholders, society, and the corporate form of organization. The value of transactions in this market ran at a record rate of about $180 billion per year in 1985 and 1986, 47 percent above the 1984 record of $122 billion. The gains to shareholders from these transactions have been huge. The gains to selling firm shareholders from mergers and acquisition activity in the ten-year period 1977-86 total $346 billion (in 1986 dollars). The gains to buying firm shareholders are harder to estimate, and no one to my knowledge has done so as yet, but my guess is that they will add at least another $50 billion to the total. These gains, to put them in perspective, equal 51 percent of the total cash dividends (valued in 1986 dollars) paid to investors by the entire corporate sector in the past decade.

These corporate control transactions and the restructurings that often accompany them are frequently wrenching events in the lives of those linked to the involved organizations: the managers, employees, suppliers, customers and residents of surrounding communities. Restructurings usually involve major organizational change (such as shifts in corporate strategy) to meet new competition or market conditions, increased use of debt, and a flurry of recontracting with managers, employees, suppliers and customers. This activity sometimes results in expansion of resources devoted to certain areas and at other times in contractions involving plant closings, layoffs of top-level and middle managers, staff and production workers, and reduced compensation.

Those threatened by the changes that restructuring brings about argue that corporate restructuring is damaging the American economy, damaging the morale and productivity of organizations, and pressuring executives to manage for the short-term. Further, they hold that the value restructuring creates does not come from increased efficiency and productivity; instead, the gains come from lower tax payments, broken contracts with managers, employees and others, and mistakes in valuation by inefficient capital markets. Since the benefits are illusory and the costs are real, they argue, takeover activity should be restricted.

The controversy has been accompanied by strong pressure on regulators and legislatures to enact restrictions that would curb activity in the market for corporate control. Dozens of congressional bills in the last several years have proposed new restrictions on takeovers, but none have passed as of this writing. The Business Roundtable, composed of the chief executive officers of the 200 largest corporations in the country, has pushed hard for restrictive legislation. Within the past several years the legislatures of New York, New Jersey, Maryland, Pennsylvania, Connecticut, Illinois, Kentucky, Michigan, Ohio, Indiana and Minnesota have passed antitakeover laws. The Federal Reserve Board implemented new restrictions in early 1987 on the use of debt in certain takeovers.

In all the controversy over takeover activity, it is often forgotten that only 40 (an all-time record) out of the 3,300 takeover transactions in 1986 were hostile tender offers. There were 110 voluntary or negotiated tender offers (unopposed by management) and the remaining 3,100-plus deals were also voluntary transactions agreed to by management, although this simple classification is misleading since many of the voluntary transactions would not occur absent the threat of hostile takeover. A major reason for the current outcry is that in recent years mere size alone has disappeared as an effective takeover deterrent, and the managers of many of our largest and least efficient corporations now find their jobs threatened by disciplinary forces in the capital markets.

The market for corporate control is creating large benefits for shareholders and for the economy as a whole by loosening control over vast amounts of resources and enabling them to move more quickly to their highest-valued use. This is a healthy market in operation, on both the takeover side and the divestiture side, and it is playing an important role in helping the American economy adjust to major changes in competition and regulation of the past decade.

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Michael C. Jensen, 'Free Cash Flow and the Effects of Mergers and Acquisitions on the Economy,' in The Merger Boom, Federal Reserve Bank of Boston, Vol. 31 (January 1988).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Takeover Controversy: Analysis and Evidence,' The Midland Corporate Finance Journal (Summer, 1986), also appears in Knights, Raiders and Targets: The Impact of the Hostile Takeover, John Coffee, Louis Lowenstein, and Susan Rose-Ackerman, editors (Oxford University Press, 1988), and Joel M. Stern, G. Bennett Stewart III, and Donald H. Chew, eds., Corporate Restructuring & Executive Compensation (Ballinger Publishing, Cambridge, MA, 1989), pp. 3-43.

The market for corporate control is fundamentally changing the corporate landscape. Transactions in this market in 1985 were at a record level of $180 billion, 47 percent above the $122 billion in 1984. The purchase price in 36 of the 3,000 deals exceeded a billion dollars in 1985, compared with 18 in 1984. These transactions involve takeovers, mergers, and leveraged buyouts. Closely associated are corporate restructurings involving divestitures, spinoffs, and large stock repurchases for cash and debt.

The changes associated with these control transactions are causing considerable controversy. Some argue that takeovers are damaging to the morale and productivity of organizations and are therefore damaging to the economy. Others argue that takeovers represent productive entrepreneurial activity that improves the control and management of assets and helps move assets to more productive uses.

The controversy has been accompanied by strong pressure on regulators and legislatures to enact restrictions that would curb activity in the market for corporate control. In the spring of 1985 there were over 20 bills under consideration in Congress that proposed new restrictions on takeovers. Within the past several years the legislatures of New York, New Jersey, Maryland, Pennsylvania, Connecticut, Illinois, Kentucky, and Michigan has passed antitakeover laws. The Federal Reserve Board entered the fray early in 1986 when it issued its controversial new interpretation of margin rules that restricts the use of debt in society.

This paper analyzes the controversy surrounding takeovers and provides both theory and evidence to explain the central phenomena at issue. The paper is organized as follows. Section 2 contains basic background analysis of the forces operating in the market for corporate control -- analysis which provides an understanding of the conflicts and issues surrounding takeovers and the effects of activities in this market. Section 3 discusses the conflict between managers and shareholders over the payout of free cash flow and how takeovers represent both a symptom and a resolution of the conflict. Sections 4, 5, and 6 discuss the relatively new phenomena of, respectively, junk-bond financing, the use of golden parachutes, and the practice of greenmail. Section 7 analyzes the problems the Delaware court is having in dealing with the conflicts that arise over control issues and its confused application of the business judgment rule to these cases.

The following topics are discussed:

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Michael C. Jensen, William H. Meckling and Clifford G. Holderness, 'Analysis of Alternative Standing Doctrines,' International Review of Law and Economics(December, 1986).

The right to bring an action in court is an important right which many argue should be granted liberally. The United States Supreme Court, for example, has held that under certain situations access to court is a citizen's 'fundamental' right. This paper discusses one facet of access to the courts, namely, 'standing' to sue: the legal doctrine shaped by both courts and legislatures which determines who can bring a particular lawsuit.

Discussions of standing have tended to focus on normative arguments about what standing should be while often neglecting positive implications of alternative standing doctrines. Standing doctrines that either increase or decrease access to court have predictable consequences relevant to the Supreme Court's admonition that standing decisions should be predicated not only upon constitutional considerations but also on 'practicalities and prudential consequences.' Our analysis shows that many liberalizations of standing block the transfer of resources from less valuable to more valuable uses. In that regard they are, to use the Supreme Court's language, 'impractical and imprudent.' In economic terms, standing that is too liberal generates inefficiencies.

Section I explores the different consequences of polar standing rules: A rule that allows only one person standing in a particular suit is contrasted with a rule that allows everyone standing. Here, as in most of the paper, the analysis focuses on private lawsuits and ignores lawsuits brought against public officials. Section II summarizes the relevant literature and reviews the liberalizations of standing over the past twenty years. Section III discusses the largely unrecognized relationship between restrictive standing, alienable rights, and efficiency; also reviewed here are class action lawsuits and standing to sue public officials. Section IV contains the conclusions.

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Michael C. Jensen, 'The Agency Costs of Free Cash Flow: Corporate Finance and Takeovers,' American Economic Review, Vol. 76, No. 2 (May, 1986), also appears in Management Buy-Outs, Mike Wright editor, part of the International Library of Management, series editor Keith Bradley (Dartmouth Publishing, England and Vermont 1994), pp. 3-9. Reprinted in abridged form as 'Agency Costs of Free Cash Flow and Takeovers,' in Simon Management Review, (Winter, 1986).

Corporate managers are the agents of shareholders, a relationship fraught with conflicting interests. Agency theory, the analysis of such conflicts, is now a major part of the economics literature. The payout of cash to shareholders creates major conflicts that have received little attention. Payouts to shareholders reduce the resources under managers' control, thereby reducing managers' power, and making it more likely they will incur the monitoring of the capital markets which occurs when the firm must obtain new capital. Financing projects internally avoids this monitoring and the possibility the funds will be unavailable or available only at high explicit prices.

Managers have incentives to cause their firms to grow beyond the optimal size. Growth increases managers' power by increasing the resources under their control. It is also associated with increases in managers' compensation, because changes in compensation are positively related to the growth in sales. The tendency of firms to reward middle managers through promotion rather than year-to-year bonuses also creates a strong organizational bias toward growth to supply the new positions that such promotion-based reward systems require.

The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows, 2) how debt can substitute for dividends, 3) why 'diversification' programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidation-motivated takeovers, 4) why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil, and 5) why bidders and some targets tend to perform abnormally well prior to takeover.

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Michael C. Jensen, 'Takeovers: The Controversy and the Evidence,' Proceedings of the William G. Karnes Symposium on Mergers and Acquisitions(Bureau of Economic and Business Research, University of Illinois, 1986).

*** Abstract not available at this time.***

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Michael C. Jensen and Clifford W. Smith, Jr., 'Stockholder, Manager, and Creditor Interests: Applications of Agency Theory,' Recent Advances in Corporate Finance, E. Altman and M. Subrahmanyam, Editors (Dow-Jones Irwin, 1985). Reprinted in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

We review some of the recent work in agency theory that has implications for the structure of the corporation, in particular the resolution of conflicts of interest among stockholders, managers, and creditors. We analyze the nature of residual claims and the separation of management and risk bearing in the corporation. This analysis provides a theory based on trade-offs of the risk sharing and other advantages of the corporate form with its agency costs to explain the survival of the corporate form in large-scale, complex, non-financial activities. We then discuss the structure of corporate bond, lease, and insurance contracts, and show how agency theory can be used to analyze contractual provisions for monitoring and bonding to help control the conflicts of interest between these fixed claim holders and stockholders.

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Eugene F. Fama and Michael C. Jensen, 'Organizational Forms and Investment Decisions,' Journal of Financial Economics, Vol. 14, No. 1 (March, 1985). Reprinted in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

This paper analyzes investment rules for various organizational forms that are distinguished by the characteristics of their residual claims. Different restrictions on residual claims lead to different decision rules. The analysis indicates that the investment decisions of open corporations, financial mutuals and nonprofits can be modeled by the value maximization rule. However, the decisions of proprietorships, partnerships, and closed corporations cannot in general be modeled by the market value rule.

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Michael C. Jensen, 'Takeovers: Folklore and Science,' Harvard Business Review (November-December, 1984). Earlier versions of this paper entitled 'Corporate Control: Folklore vs. Science,' were published in the Graduate School of Management, University of Rochester Management Journal , Vol. 2, No. 2 (Autumn, 1983) and as International Institute for Economic Research Reprint Paper 19 (June, 1984).

Shareholders, who are the most important constituency of the modern corporation because they bear its residual risk, benefit most directly from acquisitions because of the increase in the value of target company shares. Many current criticisms directed at takeover activity are wrong or based on faulty logic. Takeovers protect shareholders from mismanagement of a corporation as they allow alternative management teams to compete for the right to manage the corporation's assets. The takeover market provides a unique, powerful, and impersonal mechanism to accomplish the major restructuring and redeployment of assets continually required by changes in technology and consumer preferences.

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Michael C. Jensen and Clifford W. Smith, 'The Theory of Corporate Finance: A Historical Overview,' in ed. Michael C. Jensen and Clifford W. Smith, The Modern Theory of Corporate Finance, (McGraw-Hill, 1984), pp. 2-20.

*** Abstract not available at this time.***

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Eugene F. Fama and Michael C. Jensen, 'Agency Problems and Residual Claims,' Journal of Law and Economics, Vol. 26, No. 2 (June, 1983). Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

Social and economic activities, like religion, entertainment, education, research, and the production of other goods and services, are carried on by different types of organizations, for example, corporations, proprietorships, partnerships, mutuals and nonprofits. There is competition among organizational forms for survival. The form of organization that survives in an activity is one that delivers the product demanded by the customers at the lowest price while covering costs.

The characteristics of residual claims are important both in distinguishing organizations from one another and in explaining the survival of organizational forms in specific activities. This paper develops a set of propositions that explain the special features of the residual claims of different organizational forms as efficient approaches to controlling agency problems.

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Eugene F. Fama and Michael C. Jensen, 'Separation of Ownership and Control,' Journal of Law and Economics, Vol. 26, No. 2 (June, 1983) reprinted in Management of Non-Profit Organizations, Sharon M. Oster, Editor (Dartmouth Publishing Co., 1994) and Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

This paper analyzes the survival of organizations in which decision agents do not bear a major share of the wealth effects of their decisions. This is what the literature on large corporations calls separation of 'ownership' and 'control.' Such separation of decision and risk bearing functions is also common to organizations like large professional partnerships, financial mutuals and nonprofits. We contend that separation of decision and risk bearing functions survives in these organizations in part because of the benefits of specialization of management and risk bearing but also because of an effective common approach to controlling the implied agency problems. In particular, the contrast structures of all these organizations separate the ratification and monitoring of decisions from the initiation and implementation of the decisions.

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Michael C. Jensen and Richard S. Ruback, 'The Market for Corporate Control: The Scientific Evidence,' Journal of Financial Economics, Vol. 11, Nos. 1-4 (April, 1983).

This paper reviews much of the scientific literature on the market for corporate control. The evidence indicates that corporate takeovers generate positive gains, that target firm shareholders benefit, and that bidding firm shareholders do not lose. The gains created by corporate takeovers do not appear to come from the creation of market power. With the exception of actions that exclude potential bidders, it is difficult to find managerial actions related to corporate control that harm shareholders. Finally, we argue the market for corporate control is best viewed as an arena in which managerial teams compete for the rights to manage corporate resources.

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Michael C. Jensen and William H. Meckling, 'Corporate Governance and ëEconomic Democracy': An Attack on Freedom,' in Corporate Governance: A Definite Exploration of the Issues, C. J. Huizenga, Editor (1983).

*** Abstract not available at this time.***

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Michael C. Jensen, 'Organization Theory and Methodology,' The Accounting Review, Vol. LVII, No. 2 (April, 1983). Reprinted in Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998).

The foundations are being put in place for a revolution in the science of organizations. Some major analytical building blocks for the development of a theory of organizations are outlined and discussed in this paper. This development of organization theory will be hastened by increased understanding of the importance of the choice of definitions, tautologies, analytical techniques, and types of evidence. The two literatures of agency theory are briefly discussed in light of these issues. Because accounting is an integral part of the structure of every organization, the development of a theory of organizations will be closely associated with the development of a theory of accounting. This theory will explain why organizations take the form they do, why they behave as they do, and why accounting practices take the form they do. Because such positive theories as these are required for purposeful decision making, their development will provide a better scientific basis for the decisions of managers, standard-setting boards, and government regulatory bodies.

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William H. Meckling and Michael C. Jensen, 'Reflections on the Corporation as a Social Invention,' in Controlling the Giant Corporation: A Symposium(Center for Research in Government Policy and Business, Graduate School of Management, University of Rochester, 1982). Reprinted in the Midland Corporate Finance Journal , Vol. 1, No. 3 (Autumn, 1983); reprinted in International Institute for Economic Research Reprint Paper 18 (November, 1983).

The corporation as an organizational form is an enormously productive social invention. Partly because of its success it is under increasing attack from various quarters, often under the guise of “protecting” investors from self-interested managers. Some of these attacks are successful simply because the corporation is a poorly understood entity. This paper discusses what the corporation is, what it is not, and how certain misconceptions about the corporate form are fostered by its critics as part of their attack.

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Michael C. Jensen, 'Toward a Theory of the Press,' in Economics and Social Institutions, Karl Brunner, Editor (Martinus Nijhoff Publishing Company, 1979).

A major social problem we face today is how to control the political process that is eroding the free enterprise market system. Although I am pessimistic that we will in fact ever resolve this problem completely, we will surely never solve it unless we develop a viable positive theory of the political process. Such a political theory will not be complete until we also have developed a theory that explains why we get the results we do out of the mass media.

This paper is a first step in an attempt to develop a formal analysis of the behavior of the 'press' (a term I use as a shorthand reference to all the mass media, including not only newspapers but news magazines, magazines, radio, and television).

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Michael C. Jensen and William H. Meckling, 'Rights and Production Functions: An Application to Labor Managed Firms and Codetermination,' Journal of Business, Vol. 52, No. 4 (October, 1979). Reprinted in Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

It is traditional in the theory of the firm to define the production opportunity set available to the firm in terms of its boundary -- the maximum attainable set of output quantities for various input quantities, given the state of technology and knowledge. This boundary is the production function of the firm. One of our purposes here is to point out the dependence of such production functions on the structure of property rights and contracting rights within which the firm exists. We redefine the production function in order to recognize the dependence of output on the structure of property and contracting rights. That expanded framework is then used to discuss a concrete set of problems surrounding the role of labor in the firm ranging from the 'labor-managed firm' system (in which tradable capital value residual claims [common stock] are legally prohibited), and the codetermination and industrial democracy movements (in which management participation by labor is required by law), to cooperatives and professional partnerships (i.e., quasi-labor-managed firms which arise out of the voluntary contracting process), and the capitalist corporation.

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Michael C. Jensen, 'Some Anomalous Evidence Regarding Market Efficiency,' Journal of Financial Economics, Vol. 6, Nos. 2/3 (1978).

*** Abstract not available at this time.***

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Michael C. Jensen and William H. Meckling, 'Can the Corporation Survive?,' reprinted by Rockwell International (January, 1978); the Financial Analysts Journal (January/February, 1978); The Company Corporation Newsletter, Vol. 4, Nos. 2, 3, 4, 5 (1977/1978); International Institute for Economic Research Reprint Paper 6 (July, 1977); ERC Transcript Reprint Series, No. 5 (May, 1977); Iowa Life Underwriters' Life Lines (March, 1977); American Institute's Economic Education Bulletin, Vol. XVII, No. 3 (March, 1977); MBA Magazine (March, 1977); Bethel Home News (January-February, 1977); Black & Decker, 1976 Annual Report, Supplement (1976); Castle & Cooke, Inc. (1976).

One of the tactics politicians use in their quest for power is to draw a false distinction between “human rights” and “property rights.” Property rights are, in the last analysis, rights of individuals. As investors, who have a direct stake in the property rights of corporation, become less certain that society will honor those rights, the capitalized values of corporate securities will erode—ultimately to the point that many corporations will be able to remain in business only so long as they can finance their operations from internally generated cash flow or public subsidy.

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Michael C. Jensen and William H. Meckling, 'Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,' Journal of Financial Economics, Vol. 3, No. 4 (1976). Excerpted in Issues in Accountability, No. 6 (March, 1981), and Economics of Corporation Law and Securities Regulation, Richard A. Posner and Kenneth E. Scott, Editors, Little Brown & Company (1980). Reprinted in The Modern Theory of Corporate Finance, Michael C. Jensen and Clifford W. Smith, Jr., Editors, McGraw-Hill Publishing Company (1984); Michael C. Jensen, Foundations of Organizational Strategy, (Harvard University Press, 1998); and Theory of the Firm: Governance, Residual Claims, and Organizational Forms, (Harvard University Press, 2000).

This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the 'separation and control' issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.

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Michael C. Jensen, 'Reflections on the State of Accounting Research and the Regulation of Accounting,' Stanford Lectures in Accounting (Graduate School of Business, Stanford University, Palo Alto, California (1976)).

*** Abstract not available at this time.***

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Michael C. Jensen, 'Tests of Capital Market Theory and Implications of the Evidence,' in Is Financial Analysis Useless?, Proceedings of a Seminar on the Efficient Market and Random Walk Hypotheses (The Financial Analysts Research Foundation, 1975). Reprinted in Handbook of Financial Economics, J. L. Bicksler, Editor (North-Holland Publishing Company, 1979).

*** Abstract not available at this time.***

Michael C. Jensen, 'Optimal Utilization of Market Forecasts and the Evaluation of Portfolio Performance,' in Mathematical Methods in Finance , G. P. Szego and Karl Shell, Editors (North-Holland Publishing Company, 1972).

*** Abstract not available at this time.***

Michael C. Jensen, 'Capital Markets: Theory and Evidence,' Bell Journal of Economics and Management Science , Vol. 3, No. 2 (Autumn, 1972).

*** Abstract not available at this time.***

Martin J. Bailey and Michael C. Jensen, 'Risk and the Discount Rate for Public Investment' in Studies in the Theory of Capital Markets, M. C. Jensen, Editor (Praeger Publishers, 1972).

*** Abstract not available at this time.***

Fischer Black, Michael C. Jensen, and Myron Scholes, 'The Capital Asset Pricing Model: Some Empirical Tests,' in Studies in the Theory of Capital Markets, M. C. Jensen, Editor (Praeger Publishers, 1972).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Foundation and Current State of Capital Market Theory, in Studies in the Theory of Capital Markets, M. C. Jensen, Editor (Praeger Publishers, 1972).

*** Abstract not available at this time.***

Michael C. Jensen and John B. Long, Jr., 'Corporate Investment Under Uncertainty and Pareto Optimality in the Capital Markets,' Bell Journal of Economics and Management Science , Vol. 3, No. 3 (Spring, 1972).

*** Abstract not available at this time.***

Michael C. Jensen and George A. Benington, 'Random Walks and Technical Theories: Some Additional Evidence,' Journal of Finance (May, 1970). Reprinted in Security Evaluation and Portfolio Analysis, E. Elton and M. Gruber, Editors (Prentice-Hall, 1972), and Investment Management: Some Readings, J. Lorie and R. Brealey, Editors (Praeger Publishers, 1972).

*** Abstract not available at this time.***

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Michael C. Jensen, 'Risk, the Pricing of Capital Assets, and the Evaluation of Investment Portfolios,' Journal of Business, Vol. 42 (April, 1969). Reprinted in Frontiers of Investment Analysis, E. Bruce Fredrikson, Editor (International Textbook Company, 1971).

*** Abstract not available at this time.***

Eugene F. Fama, Lawrence Fisher, Michael C. Jensen and Richard Roll, 'The Adjustment of Stock Prices to New Information,' International Economic Review, Vol. 10 (February, 1969). Reprinted in Investment Management: Some Readings, J. Lorie and R. Brealey, Editors (Praeger Publishers, 1972), and Strategic Issues in Finance, Keith Wand, Editor, (Butterworth Heinemann, 1993).

There is an impressive body of empirical evidence which indicates that successive price changes in individual common stocks are very nearly independent. Recent papers by Mandelbrot and Samuelson show rigorously that independence of successive price changes is consistent with an 'efficient' market, i.e., a market that adjusts rapidly to new information.

It is important to note, however, that in the empirical work to date the usual procedure has been to infer market efficiency from the observed independence of successive price changes. There has been very little actual testing of the speed of adjustment of prices to specific kinds of new information. The prime concern of this paper is to examine the process by which common stock prices adjust to the information (if any) that is implicit in a stock split. In doing so we propose a new 'event study' methodology for measuring the effects of actions and events on security prices.

Michael C. Jensen, 'The Performance of Mutual Funds in the Period 1945-1964,' Journal of Finance (May, 1968). Reprinted in Investment Management: Some Readings, J. Lorie and R. Brealey, Editors (Praeger Publishers, 1972).

*** Abstract not available at this time.***

Books

Theory of the Firm: Governance, Residual Claims, and Organizational Forms, Harvard University Press, December 2000)
Link to the Harvard University Press Online Catalog Entry for this book.

This collection examines the forces, both external and internal, that lead corporations to behave efficiently and to create wealth. Corporations vest control rights in shareholders, the author argues, because they are the constituency that bear business risk and therefore have the appropriate incentives to maximize corporate value. Assigning control to any other group would be tantamount to allowing that group to play poker with someone else's money, and would create inefficiencies. The implicit denial of this proposition is the fallacy of the so-called stakeholder theory of the corporation, which argues that corporations should be run in the interests of all stakeholders. This theory offers no account of how conflicts between different stakeholders are to be resolved, and gives managers no principle on which to base decisions, except to follow their own preferences.

In practice, shareholders delegate their control rights to a board of directors, who hire, fire, and set the compensation of the chief officers of the firm. However, because agents have different incentives than the principals they represent, they can destroy corporate value unless closely monitored. This happened in the 1960s and led to hostile takeovers in the market for corporate control in the 1970s and 1980s. The author argues that the takeover movement generated increases in corporate efficiency that exceeded $1.5 trillion and helped to lay the foundation for the great economic boom of the 1990s.

Foundations of Organizational Strategy, Michael C. Jensen (Harvard University Press, 1998)
Link to the Harvard University Press Online Catalog Entry for this book.

There are three main elements in an organization's total strategy: its competitive strategy, its organization strategy, and its human strategy. This volume contains twelve articles written over the last twenty-five years which deal with a firm's organizational strategy. In these articles my co-authors (noted in each chapter) and I lay out the foundations of a theory of organizations that is both integrated and powerful. The development of this material had its genesis in the early 1970s at the University of Rochester, where two complementary initiatives spurred this effort. One was the research that William Meckling and I began on agency theory in 1973, which opened up a new set of insights into the behavior of managers and firms. The second was the course development effort that Meckling and I began at the same time, which has led to major courses at both Rochester and Harvard.

In our course at Harvard Business School, entitled 'Coordination, Control, and the Management of Organizations' (CCMO), my colleagues (George Baker, Carliss Baldwin, Karen Wruck, and Malcolm Salter) and I apply the concepts to a wide range of management and organizational problems. The course, one of the most successful in the second year of the MBA program, attracts about 600 students each year. The history of the course is summarized in 'Organizations and Markets at the Harvard Business School, 1984-1996' by Michael C. Jensen, George Baker, Carliss Baldwin, and Karen H. Wruck, in The Intellectual Venture Capitalist: John H. McArthur and the Work of Harvard Business School 1980-1995, edited by Thomas K. McCraw and Jeffrey L. Cruikshank (Harvard Business School Press, 1998). This article and a complete description of the CCMO course, including the course syllabus, reading list, course notes, and practice questions, are available in four electronic documents on the Internet from the Social Science Research Network Electronic Library at: http://ssrn.com/ABSTRACT=58704.

Corporate Control and Organizational Change , Michael C. Jensen (Harvard University Press, in process).

*** Abstract not available at this time.***

The Modern Theory of Corporate Finance , Michael C. Jensen and Clifford W. Smith, Jr., Editors (McGraw-Hill Publishing Company, 1984).

*** Abstract not available at this time.***

Democracy in Crisis, Michael C. Jensen and William H. Meckling (unpublished manuscript, 1977).

*** Abstract not available at this time.***

Studies in the Theory of Capital Markets, Michael C. Jensen, Editor (Praeger Publishers, 1972).

*** Abstract not available at this time.***

Symposia

Michael C. Jensen and Richard S. Ruback, eds., 'The Structure and Governance of Enterprise,' Journal of Financial Economics, Vol. 27, Nos. 1-2 (October, 1990).

*** Abstract not available at this time.***

Michael C. Jensen and Jerold Warner, eds., 'The Distribution of Power Among Corporate Managers, Shareholders And Directors,' Journal of Financial Economics, Vol. 20, Nos. 1-2 (Jan.-March, 1988).

This article surveys the seventeen papers in the special issue of the Journal of Financial Economics volume 20, and related work. The major findings are: (1) patterns of stock ownership by insiders and outsiders can influence managerial behavior, corporate performance, and stockholder voting in election contests; (2) corporate leverage, inside stock ownership by managers, and the control market are interrelated; (3) departures from one share/one vote affect firm value and efficiency; (4) takeover resistance through defensive restructurings or poison pill provisions is associated with declines in share price; and (5) top management turnover is inversely related to share price performance.

Michael C. Jensen and Clifford W. Smith, Jr., eds., 'Investment Banking and the Capital Acquisition Process,' Journal of Financial Economics, Vol. 15, Nos. 1-2 (January/February, 1986).

*** Abstract not available at this time.***

Michael C. Jensen and Jerold L. Zimmerman, eds., 'Management Compensation and the Managerial Labor Market,' Journal of Accounting and Economics, Vol. 7, Nos. 1-3 (April, 1985), pp. 1-257.

*** Abstract not available at this time.***

Michael C. Jensen, ed., 'The Market for Corporate Control: The Scientific Evidence,' Journal of Financial Economics, Vol. 11, Nos. 1-4 (April, 1983), pp. 1-475.

*** Abstract not available at this time.***

Michael C. Jensen, ed., 'Some Anomalous Evidence Regarding Market Efficiency,' Journal of Financial Economics, Vol. 6, Nos. 2-3 (June/September, 1978), pp. 93-330.

*** Abstract not available at this time.***

Comments and Other Articles

Michael C. Jensen and Perry Fagan, 'Capitalism Isn't Broken,' Wall Street Journal , (March 29, 1996), p. A10.

*** Abstract not available at this time.***

Michael C. Jensen, ' A Revolution Only Markets Could Love,' Wall Street Journal , (January 3, 1994), p. A6.

*** Abstract not available at this time.***

Michael C. Jensen, 'The Market for Corporate Control,' in New Palgrave Dictionary of Money and Finance (London, 1992).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Pros and Cons of Restructuring,' in 'Restructuring America Forum,' Institutional Investor, (June, 1989), p. 8.

*** Abstract not available at this time.***

Michael C. Jensen, 'LBOs and the Reemergence of Institutional Monitoring of Managers,' Leveraged Management Buyouts: Causes and Consequences, Yakov Amihud, ed. (Dow Jones Irwin, Homewood, IL, 1989), pp. 263-268.

*** Abstract not available at this time.***

Michael C. Jensen, 'Is Leverage an Invitation to Bankruptcy?,' Wall Street Journal , p. A 14, (February 1, 1989).

*** Abstract not available at this time.***

Michael C. Jensen, 'Arbitrage, Information Theft, and Insider Trading,' New Palgrave Dictionary of Money and Finance (London, 1992); an earlier version appeared as 'Arbitrage, Information Theft, and the Mistaken Attack on Insider Trading,' in Chief Financial Officer U.S.A., John Thackay, ed. (Sterling Publications, London: 1988), pp. 114-115.

*** Abstract not available at this time.***

Michael C. Jensen, 'The Takeover Controversy,' Executive Speeches, Vol. 2, No. 10 (May, 1988).

*** Abstract not available at this time.***

Michael C. Jensen, 'Characteristics of Hostile and Friendly Takeover Targets: Comment,' Proceedings of Conference on Corporate Takeovers: Causes and Consequences, Alan Auerbach, ed., (University of Chicago Press, May 1988).

*** Abstract not available at this time.***

Michael C. Jensen, 'A Helping Hand for Entrenched Managers,' Wall Street Journal (November 4, 1987).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Takeover Controversy, the Restructuring of Corporate America,' reprinted in From the Podium, Beta Gamma Sigma, (September 1987).

*** Abstract not available at this time.***

Michael C. Jensen, 'Don't Freeze the Arbs Out,' Wall Street Journal , p. 22 (December 3, 1986).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Takeover Controversy: Shareholders vs. Managers,' Cato Policy Report, Vol. VIII, No. 3 (May/June, 1986).

*** Abstract not available at this time.***

Michael C. Jensen, 'How to Detect a Prime Takeover Target,' New York Times, (March 9, 1986).

*** Abstract not available at this time.***

Michael C. Jensen, 'When Unocal Won Over Pickens, Shareholders and Society Lost,' Financier (November, 1985), pp. 50-52. Reprinted in The Rochester Management Review(Fall, 1986).

It is now difficult to launch a takeover against a Board willing to use the powers granted by the Unocal court to discriminate among shareholders. A determined Board could, in the extreme, pay out all the corporation's assets and leave the acquirer holding a worthless empty shell.

The Unocal 'victory' over Mesa cost the Unocal shareholders $1.1, the amount by which the Mesa offer exceeded the $8.3 billion value of Unocal's 'victory.' This loss is 26% of Unocal's pre-takeover value of $6.2 billion. As of October 11 Unocal's value had declined by another $754 million.

The $2.1 billion net increase in value to Unocal shareholders during the battle resulted from Unocal's $4.2 billion debt issue which, contrary to assertions, benefits its shareholders. It does so by bonding Unocal to pay out a substantial fraction of its huge cash flows to shareholders rather than to reinvest them in low-return projects, and by reducing taxes on Unocal and its shareholders.

For his services in generating this $2.1 billion gain for Unocal shareholders, T. Boone Pickens has been vilified in the press, and Mesa Partners II has incurred net losses, before taxes. In addition to Mesa's losses, shareholders of all Delaware corporations lose because the court's decision gives management a weapon so powerful it essentially guarantees that no Delaware corporation that uses it will be taken over by a tender offer.

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Michael C. Jensen, 'Mergers Benefiting Oil Patch,' Dallas Morning News (September 3, 1985).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Efficiency of Takeovers,' The Corporate Board, (September/October 1985), pp. 16-22.

The market for corporate control that has arisen in the last two decades is generating large benefits for shareholders and for the economy as a whole. The corporate control market generates these gains by loosening the control over vast amounts of resources and making it possible for those resources to move more quickly to their highest-valued use. This occurs through takeovers (both hostile and friendly), divestitures, spin-offs, split-ups, leveraged buyouts, and going-private transactions.

We are seeing a normal healthy market in operation, both on the takeover side and on the divestiture side. The total benefits have been huge as reflected in gains of $40 billion to stockholders of acquiring firms in 260 tender offers alone in the last four and a half years (as estimated by the office of the chief economist of the SEC).

The market for corporate control is best viewed as a major component of the managerial labor market. It is the arena in which alternative management styles compete for the rights to manage corporate resources. Understanding this is crucial to understanding much of the rhetoric that takes place about the effects of hostile takeovers.

Managers formerly protected from competition for their jobs by antitrust constraints that prevented takeover of the nation's largest corporations are now facing a much more demanding environment and a more uncertain future. It is not surprising that many of them would like relief from this competition.

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Michael C. Jensen and Jerold L. Zimmerman, 'Management Compensation and the Managerial Labor Market,' Journal of Accounting and Economics, Vol. 7, Nos. 1-3 (April, 1985).

*** Abstract not available at this time.***

Michael C. Jensen and Kevin J. Murphy, 'Beware the Self-Serving Critics,' New York Times(May 20, 1984).

*** Abstract not available at this time.***

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Michael C. Jensen, 'Capital Structure Change and Decreases in Stockholders' Wealth: Comment,' National Bureau of Economic Research Proceedings of Conference on Corporate Capital Structures in the United States (University of Chicago Press, 1984).

*** Abstract not available at this time.***

Michael C. Jensen, 'Corporate Financial Reporting: A Methodological Review of Empirical Research: Comment,' Journal of Accounting Research, Supplement to Vol. 20 (1982).

It is important to avoid using 'perfection' as a criterion to judge scientific papers. Virtually all papers that make important contributions leave many questions unanswered and many even contain errors. It is also important to distinguish the criterion used to judge the scientific process as a whole from that used to judge individual papers. Complex phenomenon are mastered by the gradual development and linkage of models of sub-components of the system that of necessity are oversimplified and therefore only approximations to reality. Mathematics plays an important role in this process but much analysis and progress has to be accomplished in a new area before mathematics can be useful. Mathematics is not the same as 'rigor' and 'analysis' but it is often mistakenly identified as such. The tautologies or definitions chosen by scholars have important effects on the productivity of research efforts; yet these effects are generally unrecognized and unstudied. Indeed, in many quarters it is considered unscientific, or useless or even embarrassing to devote efforts to the consideration of tautologies.

Download a copy of Corporate Financial Reporting: A Methodological Review of Empirical Research: Comment readable with Adobe Acrobat Reader

Michael C. Jensen and William H. Meckling, 'Freedom and the Role of the Government,' The Texas Forum, Vol. 2, No. 3 (January, 1978).

*** Abstract not available at this time.***

Michael C. Jensen and William H. Meckling, 'Between Freedom and Democracy,' The Banker, Vol. 127, No. 620 (October, 1977).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Sorry State of News Reporting and Why It Won't be Changed,' The Bulletin of the American Society of Newspaper Editors, No. 604 (April, 1977).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Debasement of Contracts and the Decline of Capital Markets,' in The World Capital Shortage (Bobbs-Merrill Co., Inc.: Indianapolis, Indiana, 1977).

*** Abstract not available at this time.***

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Michael C. Jensen, 'A Theory of the Press: Entertainment, Bad Guys, and a Search for Certainty,' in The Money Manager(July, 1976).

*** Abstract not available at this time.***

Michael C. Jensen, 'The Time Series Behavior of Earnings: Discussion,' in Empirical Research in Accounting: Selected Studies (The Institute of Professional Accounting, Graduate School of Business, University of Chicago, 1970).

*** Abstract not available at this time.***

Michael C. Jensen, 'Comment,' in Economic Policy and the Regulation of Corporate Securities, Henry Manne, Editor (Washington, D.C.: American Enterprise Institute for Public Policy Research, 1969).

*** Abstract not available at this time.***

Michael C. Jensen, 'Random Walks: Reality or Myth -- Comment,' Financial Analysts Journal (November-December, 1967).

*** Abstract not available at this time.***

Teaching Cases

HBS Case materials can be obtained from Harvard Business School Publishing .

Michael C. Jensen, and Kevin Murphy, 'Compensation at Lexerd Systems.' Harvard Business School Case N2-494-066, 1994.

*** Abstract not available at this time.***

Michael C. Jensen, Willy Burkhardt, and Brian K. Barry, Jay Dial, 'Wisconsin Central Ltd. Railroad and Berkshire Partners (A): Leveraged Buyouts and Financial Distress,' Harvard Business School Case 9-190-062, 11/13/92, and Michael C. Jensen, Jay Dial and Brian K. Barry, 'Wisconsin Central Ltd. Railroad and Berkshire Partners (B): LBO Associations and Corporate Governance,' Harvard Business School Case 9-190-070, 11/13/92.

These cases provide an opportunity for students to understand the structure and operation of an LBO Association. Wisconsin Central Limited (WCL), formed in a 1987 leveraged buyout of 2,000 miles of unprofitable track from the Soo Line Railroad, is a regional railroad operating throughout Wisconsin and in parts of Minnesota, Illinois, and Michigan. For many years WCL has been the most profitable railroad in the country.

In the first case, there is conflict between the board of directors and the management of WCL over WCL's response to the startup losses that caused its technical default. The policy disagreement is over whether WCL should try to grow its way out of the unexpected difficulties or respond by cutting costs. The main issues in the case, therefore, are: the nature of the conflict between WCL's board and its management; and the role of WCL's capital structure and division of equity holdings in resolving the conflict.

The second case describes the resolution of the default situation. It further examines the internal control mechanisms and distinct role of the board of directors of a typical LBO association.

The teaching note provides instructors with detailed analysis of both the (A) and (B) cases, exploring the WCL buyout transaction, including strategy, valuation and capital structure, and the incentives of the major players in creating and resolving the conflict. The note includes cash flow projections for WCL, a suggested lesson plan for teaching the cases, and a transcript of a videotaped session held at Harvard Business School with WCL's president and CEO, and a general partner of Berkshire Partners. Through the videotape, which serves as companion to the (A) case and is accompanied by a short viewing guide, students learn how differently these participants viewed the crisis at WCL, and how they were able to resolve the conflict in spite of their divergent views.

This case series offers students an excellent opportunity to witness the control function of debt in action and highlights the important differences between traditional boards of directors, where equity ownership by directors is small, and LBO boards, whose members own significant amounts of stock. The series may be taught in conjunction with 'Eclipse of the Public Corporation,' by Michael C. Jensen (Harvard Business Review Reprint No. 89504). These cases are currently taught in 'Coordination and Control in Markets and Organizations,' an elective course in the second year of the Harvard MBA program.

Ted Clark, Michael C. Jensen, James Cash, 'Newhall Land and Farming, (A) and (B),' Harvard Business School Cases, 11/91.

(A): The Newhall Land and Farming Co. is the largest real estate master limited partnership in the world. In several restructurings during the 1980s, the company liquidated a large portion of its assets and distributed more than twice as much cash to investors as the entire company had been valued at prior to restructuring. While the restructuring was voluntary, significant organizational tension resulted from the actions. Demonstrates the financial benefits of voluntary restructuring and releveraging, while identifying some of the organizational tensions that result. May be used with Newhall Land and Farming Co. (B).

(B): Information systems played a key role in enabling the restructuring of Newhall. In 1991, Newhall was considering rewriting the highly successful accounting software developed to support master limited partnership reporting needs, and converting all mainframe applications to PC-based systems. Demonstrates the role of information technology in facilitating and enabling business strategy. Explores the issues of concern to business and MIS executives in downsizing information systems. May be used with Newhall Land and Farming Co. (A).

Michael C. Jensen and Brian Barry, 'Gordon Cain (A)' and 'Gordon Cain (B)'. Harvard Business School Cases 9-492-021 and 9-492-022, 1991.

The Sterling Group, a Houston-based LBO firm led by entrepreneur Gordon Cain, forms Sterling Chemicals Inc. to purchase an ailing commodity chemicals plant from corporate giant Monsanto. Because of dramatically increased organizational performance and rising styrene prices, the firm generates huge increases in value. Sterling's success bred conflict, however, in the form of pressure from employees to liquefy their large, undiversified equity holdings. This pressure threatens to undo the very structure that led to success.

As background, the (A) case recounts the story of Cain Chemical Inc., also created by Sterling through a series of leveraged acquisitions of petrochemical plants and pipelines along the Texas Gulf Coast. The case explores the relative contributions of rising chemicals prices and organizational changes to value creation, the wealth effects of the value change to employees, and Cain's eventual decision to sell the company to a conglomerate to gain the desired liquidity.

The follow-up (B) case reveals Sterling Chemicals' decision to go public, and provides a brief synopsis of its IPO, and post-IPO performance. The companion videotape shows Gordon Cain discussing his experiences at Sterling and Cain Chemical with Harvard MBA students.

This case series allows students to examine the causes of organizational change, the difficulties of managing success in closely held LBO companies, and the relative merits of various exit strategies.

Michael C. Jensen, Karen H. Wruck, and Brian Barry, 'Fighton, Inc. (A) and (B)' Harvard Business School Case 9-391-056, 3/20/91.

The objective of this case is to sensitize students to the problems that arise when an organization has multiple conflicting objectives. It also provides an opportunity to discuss the critical role of theory in analyzing and solving business problems, and the nexus of contracts definition of the firm.

Fighton, Inc. is a unique organization. Located in Rochester, New York, Xerox Corporation supported its founding in 1968 following that city's race riots. The express purpose of the organization was to be a self-supporting source of employment and training for black members of the community. The case ends with the company in crisis. It is hemorrhaging cash and constantly turning to Xerox for assistance. Fighton is also having trouble retaining competent employees.

The class discussion focuses on how the organization got into this situation and what actions can be taken to help it survive. Contrary to the forecasts many students will make in class discussion, the organization did change and survive. Today it is called Eltrex Corporation, and the CEO and largest shareholder is Matthew Augustine, a Harvard Business School graduate. At 1989 year-end, Eltrex had 110 employees, $7.6 million in sales, and $.5 million in pre-tax profits.

Karen H. Wruck, Michael C. Jensen and Brian Barry, 'Fighton, Inc., (A) and (B) Teaching Note', 5-491-111, 6/1/91.

Teaching Notes to Fighton (A) and (B) cases.

Karen H. Wruck and Michael C. Jensen, with the assistance of Adam M. Berman, Mark Wolsey-Paige and Brian Barry, 'Revco D.S., Incorporated,' Harvard Business School Case 9-190-202, 6/1/91.

Amid controversy and criticism, Revco filed Chapter 11 less than two years after going private in a $1.5 billion leveraged buyout. During its four years in Chapter 11, the company received multiple third-party takeover offers and creditor reorganization plans. A 'vulture' capital group, Zell/Chilmark Fund, L.P., played an active role in successfully reorganizing Revco by committing capital to pay dissenting junior creditors in cash. This case begins with Revco's LBO and ends with its Chapter filing. Teaching Purpose: Motivates a discussion of bankruptcy and financial distress, the critical role played by LBO sponsors, and the incentives to overpay created by upfront fee structures. Students sort out the relative influence of operating decisions, financing decisions, governance structures, and transaction prices on Revco's pre- and post-bankruptcy performance. Students conduct their own due diligence to determine whether the LBO price was appropriate and whether the post-LBO financial ownership and governance structure created or destroyed value. May be used with Revco D.S., Inc. (B) and Zell/Chilmark Fund, L.P.

Unpublished Papers and Papers in Progress

Michael C. Jensen, 'Paying People to Lie: The Truth About the Budgeting Process,' Harvard NOM Research Paper No. 01-01, and HBS Working Paper No. 01-072 (April 2001).

This paper analyzes the counterproductive effects associated with using budgets or targets in organizational performance measurement and compensation systems. Paying people on the basis of how their performance relates to a budget or target causes people to game the system and in doing so to destroy value in two main ways: 1. both superiors and subordinates lie in the formulation of budgets and therefore gut the budgeting process of the critical unbiased information that is required to coordinate the activities of disparate parts of an organization, and 2. they game the realization of the budgets or targets and in doing so destroy value for their organizations.

My purpose in this paper is to explain exactly how this happens and how managers and firms can stop this counterproductive cycle. The key lies not in destroying the budgeting systems, but in changing the way organizations pay people. In particular to stop this highly counterproductive behavior we must stop using budgets or targets in the compensation formulas and promotion systems for employees and managers. This means taking all kinks, discontinuities and non-linearities out of the pay-for-performance profile of each employee and manager. Such purely linear compensation formulas provide no incentives to lie, or to withhold and distort information, or to game the system.

While the evidence on the costs of these systems is not extensive, my belief is that solving the problems could easily result in large productivity and value increases-sometimes as much as 50 to 100% improvements in productivity. I believe the absence of such budget/target systems is an important part of the increased productivity of entrepreneurial firms and LBO firms. Moreover, eliminating this budget/target-induced gaming from the management system will eliminate one of the major forces leading to the general loss of integrity in organizations.

Download a copy of Paying People to Lie: The Truth About the Budgeting Process readable with Adobe Acrobat Reader.

Michael C. Jensen, William H. Meckling and Clifford G. Holderness, 'The Logic of the First Amendment,' Harvard Business School Working Paper # 00-064 (March 2000).

We develop a framework that is applicable to all freedom of expression disputes. Our framework is based on the meaning of freedom which is based on the meaning of scarcity, and which, in turn, is based on the existence of physical incompatibilities. To maximize freedom, one must differentiate between scarce and non-scarce rights. Scarce rights can not be granted to everyone because of natural limitations caused by physical incompatibilities. If one person burns a tree for warmth, another cannot use the tree to build a house. Conflicts caused by such physical incompatibilities are resolved peacefully by giving exclusionary rights in the physical use of the tree to a single, private party. These are scarce rights because more than one person cannot use the tree when there are physical incompatibilities. Non-scarce rights, in contrast, can be granted to everyone. The contents of ones speech, for example, in no way limits what other people can say or do. To maximize freedom, each scarce right must be assigned to some individual person, and all non-scarce rights should be assigned to everyone. We use this framework to provide an integrated and consistent analysis of prominent Supreme Court rulings on free speech issues including public access to government and private property, symbolic speech (including flag burning), libel, and obscenity.

Download a copy of  The Logic of the First Amendment  readable with Adobe Acrobat Reader 

Michael C. Jensen, 'Toughmindedness, Courage and Change,' unpublished manuscript (May 1993).

*** Abstract not available at this time.***

Download a copy of Toughmindedness, Courage and Change readable with Adobe Acrobat Reader

Michael C. Jensen, 'The Case Method and Science,' unpublished manuscript (May 1993).

*** Abstract not available at this time.***

Download a copy of The Case Method and Science readable with Adobe Acrobat Reader

Michael C. Jensen, 'Takeovers and the Business Judgment Rule,' unpublished manuscript (April, 1986).

*** Abstract not available at this time.***

Jensen, Michael C. and William H. Meckling, 'Divisional Performance Measurement,' in Michael C. Jensen, Foundations of Organizational Strategy. (Harvard University Press, 1998), pp. 345-361.

Our purpose in this paper is to examine divisional performance measurement methods and related aspects of the rules of the game that govern the behavior of managers. Performance measurement is one of the critical factors that determine how individuals in an organization behave. It is one aspect of what we call the organizational rules of the game, which consist of (1) the performance measurement and evaluation system, (2) the reward and punishment system, and (3) the system for partitioning decision rights among individuals in an organization.

Performance measurement includes the objective and subjective assessments of the performance of both individuals and subunits of an organization such as divisions or departments. Performance evaluation is the process of attaching value weights to various measures of performance to represent the importance of achievement on each dimension.

The reward and punishment system relates the rewards granted to individuals to results measured by the performance measurement system. Rewards and punishments include nonmonetary factors such as honor, attention, and rank, as well as monetary factors such as salary changes and bonuses.

A manager is said to have a decision right if the enforcement and disciplinary powers of the top-level executive office will be used to enforce his ability to take an action. In large organizations, decision rights are more complex than the simple phrase suggests. For example, it is common in such organizations for no single individual to have all the decision rights necessary to undertake a major project. Instead, there is a complex process that brings many people into the decision-making function, a process that breaks the simple notion of a decision right into many components that are allocated to various decision agents. The following is a common breakdown:

    1. Initiation right-the right to initiate resource allocation proposals.
    2. Notification right-the right to be notified of the actions or proposed actions of others in the organization and the right to provide information or recommendations to the decision process regarding those proposals.
    3. Ratification right-the right to review and ratify or veto the resource allocation recommendations of others.
    4. Implementation right-the right to implement the ratified resource allocation proposals.
    5. Monitoring right-the right to monitor the implementation of ratified proposals, including the rights to measure and evaluate performance and to determine rewards and punishments.

Notification rights differ from ratification rights because the individual does not have veto power over the decisions at issue. Coordination of the individuals who have input into a decision is accomplished through a set of procedures that makes up a large part of what is generally thought of as the management process in an organization. Committees play an important role in coordinating and focusing the input of information into the decision making process and provide an appeal process to resolve differences of opinion regarding aspects of any decision or project. This process takes on many of the characteristics of an internal court system with its own rules and procedures. Further consideration of the complexity of decision rights and the decision process is left to future work to concentrate here on analysis of performance measures.

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Michael C. Jensen, 'The Role of the Press in Shaping the Economy and Society,' unpublished manuscript (February, 1983).

*** Abstract not available at this time.***

Michael C. Jensen, William H. Meckling and Clifford G. Holderness, 'The Case for Restricting Access to Courts,' Graduate School of Management, University of Rochester, Managerial Economics Research Center Working Paper No. MERC 81-06 (May, 1981).

*** Abstract not available at this time.***

Michael C. Jensen and William H. Meckling, 'Conflict Between the Political and Private Sectors,' Study of World Economic Change (Booz, Allen & Hamilton, Inc., November, 1978).

*** Abstract not available at this time.***

Michael C. Jensen, 'Freedom and the Role of the Government,' debate with J. K. Galbraith, Graduate School of Management, University of Rochester, Center for Research in Government Policy in Business Public Policy Working Paper No. 77-10 (November, 1977).

*** Abstract not available at this time.***

John P. Gould and Michael C. Jensen, 'Toward a Positive Theory of Public Debt,' unpublished manuscript (May, 1977).

*** Abstract not available at this time.***

Michael C. Jensen, 'Efficient Management of Computing Resources,' National Science Foundation Report under Grant No. NM-44241 (May, 1977).

*** Abstract not available at this time.***

David Goldstein, Michael C. Jensen and David Smith, 'Report of the University of Rochester President's Committee on Computing Problems and Opportunities' (January, 1973).

*** Abstract not available at this time.***

William H. Meckling and Michael C. Jensen, 'Analysis of University Endowment Expenditure Policies,' University of Rochester (January, 1970).

*** Abstract not available at this time.***

Michael C. Jensen, 'Determinants of Mutual Fund Performance,' Proceedings of the Seminar on the Analysis of Security Prices (University of Chicago, November, 1967).

*** Abstract not available at this time.***


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Updated November 2002