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Varela 2017
Varela 2017
Oscar Varela
PII: S1544-6123(17)30037-5
DOI: 10.1016/j.frl.2017.07.019
Reference: FRL 753
Please cite this article as: Oscar Varela , AGENCY COSTS WHEN AGENTS PERFORM BETTER
THAN OWNERS, Finance Research Letters (2017), doi: 10.1016/j.frl.2017.07.019
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Highlights
Agency anti-costs complements and extends Alchian and Demsetzs work on the
firm
It also generalizes Jensen and Mecklings work on agency costs
A special case of agency anti-costs is presented via an Alchian-Demsetz A-factor
Then, it is sub-optimal to expropriate non-pecuniary benefits through the firm
Rather, trading firm value in market for non-pecuniary benefits is Pareto optimal
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Abstract
This paper extends Jensen and Mecklings agency cost theory. A clockwise rotation of
their budget constraint represents better performance by agents compared to owners
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and higher firm values. This extension incorporates Alchian and Demsetzs view of the
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firm, wherein firm values increase when managers are employed. It is then sub-optimal
for owner-managers to directly expropriate non-pecuniary benefits through the firm as in
Jensen and Meckling. It is instead Pareto optimal that owner-managers who seek to
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expropriate non-pecuniary benefits do so using the firms higher value, and trading it for
the non-pecuniary benefits they desire in the open market.
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Key words: Agency Theory; Agency Costs; Value of Firms
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Acknowledgement: information omitted for blind review
1. INTRODUCTION
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Jensen and Mecklings (1976) seminal work on agency theory shows that the firms
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value decreases when a sole owner-manager divests ownership, in which case the
manager) are then partly borne by the outside owners, who may control these by
monitoring or bonding the agent. Agency costs are measured by the loss in the firms
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value in the presence of agency costs, and the bonding and monitoring costs. Not
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considered by Jensen and Meckling is the situation where agents perform better than
owners.
motivates this paper. The objective is to formalize the possibility that agents perform
better than owners within their paradigm in order to complete it. Indeed, Bendickson,
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et. al. (2016) suggests that agency theory has fallen short in various areas,
undertaker involves undertaking and managing the risk of a new enterprise through
creativity in business, aimed at adding value in the use of capital. The focus of the
present research therefore aligns with Bendickson, et. al. in broadening the scope of
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agency theory to include the case where agents perform better than owners.
The case for agents performing better than owners is certainly plausible, as
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illustrated by the following unusual anecdote. When Albert Einstein emigrated from
Germany to the United States in 1933 as the first great acquisition by The Institute for
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Advanced Study at Princeton, he suggested a salary of $3,000 a year. Only because
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his wife and Abraham Flexner negotiated a better deal for him did he end up with
$15,000 a year (Rhodes, 1986, p. 186-187). The agents for one of the most brilliant
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persons in history performed five times better than he as the principal and owner of his
most valuable asset himself! Agents can improve performance for principals, mitigate
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When agents perform better than owners, then Jensen and Meckling (1976)
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complements and extends Alchian and Demsetz (1972), who argue that the firms value
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can be increased when managers are employed. Alchian (1983) presents a situation in
which an owner-manager cooperates with other owners to increase values while at the
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same time competing with them to enlarge his/her share. The former is analogous to
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Alchian (1983) suggested that Cooperation means action to increase the wealth
capable of being partitioned among the cooperators, who are also competing in trying to
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The present paper shows, assuming an all equity firm, that a clockwise rotation
of the Jensen and Meckling budget constraint is consistent with better performance by
agents compared to owners, and higher firm values. This extension, representative of
Alchian and Demsetzs view of the firm, serves to complete agency theory.
The monitor rewarded with residual income in Alchian and Demsetz (1972) is
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managing the firm and residual income related to his/her performance. The monitor, in
metering production and constraining shirking by team members, adds value to the firm,
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tantamount to an agent performing better than owners, producing agency anti-costs. An
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Alchian-Demsetz AD-Factor is postulated in the present paper that when positive leads
through trade to Pareto optimal non-pecuniary benefits via agency anti-costs compared
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to the traditional Jensen-Meckling framework.
frames this study. Section 3 presents the theory of agency anti-costs. Section 4
provides the conclusions. Aspects of Jensen and Mecklings theory relevant to this
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enlarge their obtained portion of the larger total. (p. 266) He admonished however that
(p. 267) Rather, Alchian (1965) thought of cooperation as paramount to the agency
anti-cost result, stating that The ability of individuals to enter into a mutually agreeable
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sharing of the rights they possess is evident from the tremendous variety of such
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paper are summarized in Appendix A and other anecdotal evidence of agency anti-
Smith (1776) points to dilution of the owners objectives for the firm when it is
managed by others.2 Berle and Means (1932) relate their findings about firm
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control, leading to agency costs. This early literature on agency costs was formalized by
Jensen and Meckling (1976). They argue that agency costs include the loss in the
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firms value as non-pecuniary benefits are expropriated by agents (owner-managers),
as well as bonding and monitoring costs.3 Empirical studies in support of agency theory
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include Denis, Denis and Sarin (1999) who show that managers pursue diversification
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in order to gain non-pecuniary benefits, and Edgerton (2012) who shows that publicly
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See Smith (1776), Book V, Chapter III, Paragraph 57.
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In this regard, Williamson (1988) argues that agency costs consist mostly of the loss
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in firm value due to non-pecuniary expenditures. In contrast, Fama (1980) argues that
internal devices and market discipline control the agency problem. Fama and Jensen
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(1983) also argue that segregation of decision (senior) and control (board) management
helps bond managers to owners, reducing agency costs. Moh'd, Perry and Rimbey
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(1995) find support for the argument that cash dividend payments reduce agency costs.
The incentive to reduce agency costs from such distributions is that they pressure
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Smith (1776), however, also describes benefits of specialization and its more
Alchian (1961) states that the different skills of different people as owners make
He suggests that ownership ability includes attitude toward risk bearing, knowledge
of different peoples productive abilities, foresight, and judgment. (p. 38) Alchian and
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Demsetz (1972), extending these arguments, posit a theory of the firm wherein a team
manager produces gains from team production by addressing metering and shirking
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problems. The team manager is motivated in part by self-interest as the recipient of
residual income.
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Ang, Cole, and Lin (2000) find higher agency costs when outsiders as opposed
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to insiders manage the firm, when the managers ownership share is smaller, and when
the number of shareholders who are not managers are higher. The second conclusion
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is of particular interest, as it suggests that agency costs fall as the managers ownership
share rises. Our theory suggests that the improvement in firm value has decreasing
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returns as the managers ownership share rises, and is in a dual way consistent with
Ang et al who find that agency costs fall as the ownership share rises.
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Eisenhardt (1989) elaborates that shirking by agents may result from moral
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hazard wherein agents expropriate the firms value when not monitored and adverse
selection wherein principals cannot verify the value of the agents work due to their own
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lack of expertise in evaluating it. She suggests that an outcome-based contract can
coalign the agents preferences with the principals. Such a coalignment in our
judgement is very possible when the agent-manager is also an owner, minimizing moral
hazard and adverse selection and maximizing the value of the agents work. Indeed,
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Argawal and Mandelker (1987) find that the managerial preferences are more aligned
This literature in its totality points to agency problems related to the dispersion of
ownership and control in the corporation, where agency costs include a loss in the
firms value, bonding and monitoring costs. There is support for this theory, especially
as it relates to the loss in firm value due to non-pecuniary benefits. Yet, the literature
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also presents counter-arguments related to the benefits of specialization, comparative
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A corollary to the specialization by an Alchian and Demsetz (1972) team
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manager or Jensen and Meckling (1976) owner-manager is trade, as specialists must
trade for things not specialized in. Managers with an ownership stake who add value to
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the firm can trade for a higher level of non-pecuniary benefits rather than expropriating
these from the firm.4 A Pareto optimal result is possible with agency anti-costs, when
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owner-manager can via trade produce more non-pecuniary benefits than previously
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possible.
3.1. Background
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Alchian and Woodward (1987) point to gains from trade which arise as a result of
cooperation not directed by market prices but by management. (p. 110), and Alchian
(1991) that cooperative activity with a firm yields an output greater than could
otherwise be achieved and that the source of gain in the firm is teamwork (p.
233)
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A result in Jensen and Meckling (1976)5 is that agency costs are borne by
offering investors as bidding investors modify cash flows to reflect the firms anticipated
lower value. This result is questionable given that market timing of equity issues and
merger activity create doubt as to whether investors correctly price the firms securities,
in which case agency costs are offset.6 Another more significant offset to agency costs
as proposed in the present paper is agency anti-costs where agents perform better than
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owners.
Agents naturally aim to mitigate the probability of being fired for inadequate
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performance. In Denis and Denis (1995) firm performance improves following forced
(non-retired) resignations.7 These results are consistent with Coughlan and Schmidt
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(1985) and Warner, Watts, and Wruck (1988) who find an inverse relation between
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5
See Appendix 1 for a more formal summary of Jensen and Meckling (1976).
6
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For example, Chernenko, Foley and Greenwood (2012) find that overvalued equity
can offset agency costs as related to market timing. They suggest that the Baker and
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Wurgler (2000), Graham and Harvey (2001), and Loughran and Ritter (1995) findings
that firms time security issuances have implications for offering investors to possibly
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offset agency costs. Recent findings of Elliott, Koeter-Kant and Warr (2008) also
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support this view. Chemenko et al. (2012) suggest that merger activity, driven in part by
mispricing as suggested by Bekkum, Smit, and Pennings (2011), Loughran and Vijh
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(1997), Rhodes-Kropf and Viswanathan (2004), Savor and Lu (2009), and Shleifer and
Vishny (2003) can also offset the offering investors bearing of agency costs.
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The announcement of a forced resignation produces positive and significant abnormal
retirements do not.
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stock price performance and management change. Weisbach (1988) finds that
performance improves even more following a management change the greater the
proportion of outsiders on the board, as they may be more involved in monitoring the
firm. Mukherjee and Varela (1992, 1993) also find similar improvements in operating
performance following successful control proxy contests. Lublin (2013) points out that
a growing number of U.S. companies are limiting the upside for top leaders in down
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years for stock prices, restricting certain compensation when total shareholder return is
negative. Thurm (2013) similarly points to evidence that directors are now more
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frequently paying CEOs for performance. This literature overall suggests that
agency costs implications when this occurs. We assume that the owners hiring of an
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owner-manager (agent) is a positive net present value (NPV) project and consistent
with the view of a team manager in Alchian and Demsetz (1972). 8 Owners rather than
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Other literature exists that suggests that agents may invest sub-optimally and reject
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positive NPV projects. Our approach differs from this literature some of which is
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mentioned below - insofar as we assume that equity issues are not undertaken for
employment of managers. This other literature includes Myers and Majluf (1984) who
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suggest that managers acting in the best interest of current stockholders may reject
positive NPV projects when underpriced equity financing is required. Dybvig and Zender
(1991) argues that this sub-optimal investment problem occurs when management has
a sub-optimal contract with owners. Persons (1994) argues that optimal contracts are
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needing to shift the owner-managers agency costs to outside parties are, parallel with
entrepreneur curtails his incentive to gain at the expense of his partners, and the net
extended. The budget constraint would be steeper instead of flatter as in their analysis.
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This reflects the fact that agents performing better than owners invest funds for higher
returns that were previously used to finance non-pecuniary benefits (at a cost equal to
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the WACC). Incentives change because the gain in the firms value and its proportion
thereof to the current owner-manager (agent) the former sole owner-manager before
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sole ownership is divested - is greater than the loss in his/her non-pecuniary benefits.
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The direction from which to consider the creation of the former sole owner-
manager needs elaboration to add clarity to our discussion. In Jensen and Meckling,
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the sole owner evolves into the former sole-owner manager as ownership is divested.10
The former sole owner-manager can be expected to engage in management of the firm
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more like an agent than before. In contrast, the present analysis considers the owners
different than the former sole owner-manager in Jensen and Meckling, behaving more
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9
In Cheung (1983) this posture was extreme when a group of workers in China
actually agreed to the hiring of a monitor to whip them (p. 8) presumably if they
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10
Although not discussed by them, such an evolution is not management neutral, as a
lower ownership stake is associated with less absolute risk aversion, leading this
manager to possibly place less weight on the risk of projects under consideration.
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like an Alchian and Demsetz team manager.11 The technical aspects of this difference
Assume that an owner-manager has ownership interest in the firm. The other
owners who are not managers own (1 ) of the firm. They employ the owner-
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manager as an agent for whom compensation includes ownership interest. The
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owner-manager-agent with specialized knowledge in efficiently managing the firm
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improves its value in some proportion to its ownership interest. Then, using the Jensen-
Meckling paradigm, the V1 P1 budget constraint in Figure 1 is steeper than the Vmax
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Pmax constraint for a sole owner. This constraint passes through point D, conceptually
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providing the same combination of pecuniary (vertical axis) and non-pecuniary
(horizontal axis) benefits as to a sole owner (with indifference curve U2).12 This
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11
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In this regard, Cornelli, Kominek and Ljungqvist (2013) find that when a firm has
sufficiently large shareholders who are board members, more active and effective
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monitoring occurs, and the firing of CEOs does not occur by mistake. This monitoring
employs use of more costly soft information on the CEOs ability (inability) to produce
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luck or honest mistakes. In the sense that agents can be effectively monitored by large
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shareholders, these empirical results support the theoretical constructs developed here.
In Alchian (1984) even directors earning high salaries in other primary jobs will
have an incentive to effectively monitor the CEO because failure to do so may cause
loss of reputability that could affect their salaries in their primary jobs. (p. 46)
12
This conclusion presumes that the sale price for (1 ) of the firm equals (1 ) V*.
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illustrates that the owner-manager-agent, while conceptually the same as the former
sole owner, behaves in a manner that adds rather than subtracts value for the firm.
would as in Jensen and Meckling (1976) not expect the new owner to be able to
enforce identical behavior on the old owner (p. 317) Alchian (1978) agreed noting
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that, If an employee-manager, despite the best monitoring controls of the stockholder,
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is expected to divert corporate value to himself, the stockholder will take that into
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account by a lower wage paid to the employee. The stockholder will not suffer a loss.
(p. 640) But then he deviated from Jensen and Meckling by noting that To offset that
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agency monitoring cost, there must be more than compensating advantage in having a
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separate manager and stockholders. If, for example, the manager can operate the
enterprise better than the investor, then the gains from that specialization can more
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than offset the monitoring costs. In this case the investor and the manager both gain
from specialization despite the costs of monitoring potential diversionary tactics of the
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(from point D to point A, or value F* to F ) and increase the value of the firm (from value
V* to V0). This change enables the owner-manager-agent to benefit by trading for non-
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pecuniary benefits using the firms higher value, instead of expropriating non-pecuniary
advantage in increasing the value of the firm, specializes in this management activity,
and via trade obtains non-pecuniary benefits. This gain may be a result of the teamwork
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by joint action achieve more than the sum of their separate results (p. 35)
The implications of this alternative view of Jensen and Meckling for the slope of
V1 P1 are the following. Assume that the rate of improvement in the firms value is
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agent has an ownership interest, the slope of V1 P1 is - 1/, such that the rate of
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change in the value of the firm equals 1/. This proportionality of the owner-manager-
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agents ownership of the firm with respect to the value of the firm implies in absolute
value terms decreasing returns with respect to ownership interest.13 The specialization
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benefits of the owner-manager-agent diminish, with this individual behaving more like
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an owner who is not a manager, as its ownership interest rises. That is, the premium in
value that the firm gains from employing an agents specialized knowledge declines in
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agent who also has an ownership interest is agency cost neutral if such employment
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13
That is, (1/) / = - (1/ 2).
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This idea defines a technical difference between owners and owner-managers who
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are agents. The manager who when employed is compensated with an ownership
interest should increase firm value significantly given his/her managerial expertise,
even though they own a small percentage of the firm. The owner when a sole owner
gains no such value from expertise, unless this individual can dually serve as a sole
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improves firm value by 1/, as any steeper slope for V1 P1 leads to a net gain for the
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owner-manager-agent, as well as for owners who are not managers.
that the improvement in firm value (relative to when this owner had 100 percent
constraints slope is -1/0.30 or -3.33, such that the value of the firm improves by 233%
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(that is, 3.33 1). The owner-manager-agent receives pecuniary benefits equal to 1.0
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(that is, its ownership interest times the firms value, or 0.30 x 3.33). This means that
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the owner-manager-agent can trade for non-pecuniary benefits at a 1 to 1 ratio, being
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just as well off as before. In this case, employing an owner-manager-agent is agency
cost neutral as agency costs are just offset by agency anti-costs. The higher value of
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the firm from employing specialized agents substitutes for agency costs in the
If the budget constraints slope changes between - and - 1/ (that is, between
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- 0.30 and - 3.33 in our example), then some agency anti-costs benefits from a gain in
value are obtained from employing an agent, although these are not high enough to
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completely offset agency costs. Agency costs are partially absorbed by the firm and
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partially by the gain in the firms value. For example, assume that the owner-manager-
agent still has 0.30 ownership interests but that the improvement in firm value is less
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than proportional to 1/. Assume that the budget constraints slope is -1.67 (half of
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This generalization of Jensen and Meckling (1976) makes clear Shleifer and Vishnys
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the -3.33 in the prior example) and the firms value accordingly improves by 0.67%.
The owner-manager-agent then receives pecuniary benefits equal to 0.50 (that is, 0.30
x 1.67). The new value of the firm is only capable of compensating for non-pecuniary
benefits at a rate of 50 cents on the dollar, and agency costs are not totally absorbed by
the increase in the firms value from agency anti-costs. When the change in the firms
value is less than proportional to the ownership interest of a manager-agent who is also
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compensated with ownership, then employing an owner-manager-agent is not agency
cost neutral, although some (but not all) agency costs can be absorbed by an
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improvement in firm value.
the improvement in firm value is more than proportional to this ownership interest, the
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steeper budget constraint V1 P1 has slope - 1/( AD). Define AD as the Alchian-
Demsetz Factor reflecting improvements in firm value beyond the agency cost neutral
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point.16 If the AD-Factor is 0.10, then the slope of V1 P1 is 5.0000 (that is, - 1/(0.30
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0.10). The value of the firm improves by 400%, and the AD-Factor may be thought of
the agency cost neutral point. The owner-manager-agent receives pecuniary benefits
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The AD-Factor must be bounded such that it must be less than to rule out positive
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equal to 1.50, i.e. 0.30 x 5.0000, and can trade them for non-pecuniary benefits at a
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1.50 to 1 ratio, being better off than before.
owners has expertise in managing the firm and leading its team. This expertise is used
to increase the value of the firm, such that more than a one-to-one correspondence
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exists between its increased pecuniary value and non-pecuniary benefits. The owner-
manager-agent may trade higher pecuniary value in the open market for non-pecuniary
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benefits, and by retaining a financial surplus is better off than before. The owner-
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manager-agent, as in Jensen and Meckling, no longer finances the entire cost of non-
pecuniary benefits, except that the difference is that this financing occurs via the
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increase in the firms value and the surplus that the owner-manager-agent retains.
these expectations into the sale price of its divestment, increasing the value that is
retained. The old sole owner could anticipate that the firms value will increase once
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divestment occurs, as the benefits of managerial specialization take hold, and use this
information in determining the offer for an equity stake in the firm. This individual will not
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Since V1 P1 = - 1/( AD), it follows that (V1 P1) / AD = -1 / ( AD), and 2 (V1
P1) / AD2 = -2 / ( AD)3. Thus in absolute value terms, the first derivative of the
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value of the firm (as reflected in its budget constraint) shows that its value increases as
AD rises. Better monitoring and metering constrain shirking and increase firm value
beyond the agency cost neutral point. The second derivative shows that this increase
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offer a price of (1 ) V* for (1 ) of the firm, but instead will revise V* to reflect the
owner-managers revised V value for the firm. Figure 2 shows these adjustments.
Figure 2, with slope - 1/( AD), with the AD-Factor accounting for the higher slope (in
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pecuniary and non-pecuniary combination is at tangency point B, and the value of the
firm is V. The governing principle for the new combination in terms of the firms value is
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that it must be higher than that corresponding to line Vmax Fmax, and V1 P1, and that
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point B correspond to a higher indifference curve than that pertaining to point A. After
divestment, the value of the firm rises from V* to V. The former sole owner and now
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owner-manager-agent consumes less non-pecuniary benefits through the firm, and has
the flexibility of trading for higher non-pecuniary benefits using as the medium of
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An appropriate Alchian and Demsetz interpretation for this scenario is that the
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firms initial owners have employed an agent with an expertise to better manage the
firm and increase its value.18 This agent has been given an ownership interest and is,
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that through its positive net present value increases the firms value and produces the
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18
Levitt and Syverson (2008) point out that Agents are often better informed than the
clients who hire them (p. 599) and that This information is helpful to those who hire
them (p. 609). While the net consequences may be either positive or negative, it
appears according to Fernie and Metcalf (1999) that the payment system may be
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manager with the flexibility to trade for non-pecuniary benefits, and possibly retain a
4. CONCLUSION
and Mecklings (1976) work on agency costs, while it simultaneously complements and
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extends Alchian and Demsetzs (1972) work on the firm. Agency anti-costs result when
specialized agents or team managers perform better than pure owners as positive NPV
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projects, increasing the firms value above the pure owners capability. These agents as
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owner-managers in Jensen and Meckling (1976) or team managers in Alchian and
Demsetz (1972) can be thought of as receiving a salary for managing and residual
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income as owners, with the latter particularly related to agency anti-costs. They can
managers. Their management ability via their comparative advantage or teamwork skills
way. They first obtain greater pecuniary value for the firm through agency compared to
what the pure owners could otherwise obtain, and second, they trade such value as
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Jensen and Meckling paradigm that equivalently complements Alchian and Demsetz.
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This variable must be positive for owner- or team- managers to obtain Pareto optimal
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Turner and Muller (2004) suggest that this result is more likely the better the
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managers interested in non-pecuniary benefits subsidized by the firm can gain these
benefit in multiple ways. One way is through the traditional Jensen-Meckling approach.
Another is to use agency to increase firm value to gain Pareto optimal non-pecuniary
Future studies in agency theory could attempt to show more clearly the multiple
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roles of agents in the business enterprise. Such an effort should balance the benefits of
agents against their costs with rationale expectations suggesting net benefits. Certainly,
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agency costs wherein agents expropriate value from the firm necessitating monitoring
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and bonding costs is not disputable, but at the same time the enhanced value to the
firm that they bring owing to their expertise should not be discounted. On a net basis,
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the net benefits to the firm from the employment of agents may be more along the lines
described in the present paper. Future empirical research should try to study both the
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costs and benefits of agents, and address this question concerning their net effects.
Agents who are exceptionally good at adding value may indeed even bond the owner to
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their agent, wherein owners give their agents a free hand because of their expertise
and experience. An extreme view of such added value can be found in The Danger of
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Figure 1
V1
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Vmax
V0
A
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AN
U1
M
D
V*
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U2
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Slope = -1
Slope = -1/
F0 F* P1 Fmax Market value of the stream of managers
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Note: Indifference curves are drawn out as a convention, and are assumed not to intersect,
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even if this seems possible from the drawings. The only relevant point to be considered on the
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Figure 2
V1
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V B
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Vmax
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AN
A
V0
U1
M
D
V*
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U2
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Slope =-1/(-AD)
Slope = -1
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F0 *
F P2 P1 Fmax Market value of the stream of managers
expenditures on non-pecuniary benefits
Note: Indifference curves are drawn out as a convention, and are assumed not to intersect,
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even if this seems possible from the drawings. The only relevant point to be considered on the
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APPENDIX 1
between the value of the firm and consumption of non-pecuniary benefits. The optimal
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budget constraint. They then show, assuming the sole owner-manager now divests
some ownership interest, that the consumption of non-pecuniary benefits is less costly
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than before, as these are partly financed by the new (non-manager) owner. As the new
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budget constraint is shallower, the former sole owner-manager finds a new optimum
tangency to the right and below the prior optimum, and the value of the firm falls by the
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cost of the increased non-pecuniary expenditures to the firm.
Figure A.1 shows as in Jensen and Meckling that V max is the maximum value of
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the firm with a sole owner-manager and Fmax is the maximum value that this owner-
manager could obtain from the firm in non-pecuniary benefits. Their tradeoff, shown by
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the slope of the constraint line Vmax - Fmax, is -1; the sole owner-manager can only
The optimal position for the sole owner-manager is at tangency point D, where
U2 is the indifference curve, and the optimal value of the firm is V* and non-pecuniary
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benefits is F*. The sole owner-manager may sell (1 ) percent of the firm, while
retaining percent. Then the cost of non-pecuniary benefits to the former sole owner-
manager equals percent of the post-sale non-pecuniary benefits consumed and the
slope of the new budget constraint is - . The new constraint, shown by V1 - P1,
presumes that the new owner pays (1 - ) V* for its equity share, with the former sole
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constraint. The new constraint also passes through point D, because the former sole
owner-manager, given the divestment proceeds, can have the same wealth level and
The former sole owner-manager will most likely consume higher levels of non-
pecuniary benefits with one possibility at point A with a higher level of utility from U1.
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The value of the firm consequently falls from V* to V 0, representing the cost of the new
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level of non-pecuniary benefits to the firm as the level of the owner-managers non-
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0
pecuniary benefits rise from F* to F . The new owner may (as Jenson and Meckling
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make clear) anticipate this behavior in its bid for an equity stake in the firm, and revise
managers trade-off after the (1 ) sale of the firm is line V2 P2, the optimal
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pecuniary and non-pecuniary combination is at tangency B, and the value of the firm is
V (as the tangency must be on line Vmax Fmax). The firms value falls from V* to V, as
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the owner-manager consumes more non-pecuniary benefits after the sale, which the
buyer factored into the final offer price. The loss in the firms value is absorbed by the
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Figure A.1
Firm value and wealth
Vmax
V1
V* D
T
A
U1
IP
0 U2
V
Slope = -
CR
P1
US Slope = - 1
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F* F0 Fmax Market value of the stream of managers
expenditures on non-pecuniary benefits
Note: Indifference curves are drawn out as a convention, and are assumed not to intersect,
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even if this seems possible from the drawings. The only relevant point to be considered on the
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Figure A.2
Vmax
V1
V* D
T
A
V2 U1
IP
0 U2
V
Slope = -
CR
V B
P1
US Slope = - 1
P2
AN
F* F0 Fmax Market value of the stream of managers
expenditures on non-pecuniary benefits
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Note: Indifference curves are drawn out as a convention, and are assumed not to intersect,
even if this seems possible from the drawings. The only relevant point to be considered on the
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APPENDIX 2
Situations in which agents perform better than owners occur when (a) agents
have greater expertise than owners in managing a firm, (b) owners are motivated
toward ownership for reasons other than profit maximization, possibly including owners
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of some sports franchises, and (c) wealthy owners lose the desire to perform the hard
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work necessary for profit maximization, as the backward bending supply curve for labor
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applies to owners as well as employees. Indeed, in the sports franchise area, some
owners (such as Jerry Jones of the Dallas Cowboys or the late George Steinbrenner of
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the New York Yankees) are sometimes accused of over-involvement in the franchise
contractual agents in the words of Alchian and Demsetz, 1972, p. 778) that elevate the
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work level necessary for profit maximization can increase the value of the firm,
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producing agency anti-costs. Such agents, who may also be owner-managers (The
specialist who receives the residual rewards in the words of Alchian and Demsetz,
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1972, p. 782), have less absolute risk aversion than sole owners, and are possibly freer
to engage in more effective and objective management to make better use of their
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professional sports teams, including baseball, football and automobile racing. The
owner of Racing Team Petty realized that he could not run the team efficiently, and
hired a car specialist and a coach for this purpose, according to Spencer (2002).
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The Indianapolis Colts professional football team became very successful when
its owner, Jim Irsay, decided to be less involved in the teams operations, according to
Wertheim (2010). In contrast, the Dallas Cowboys professional football team performed
dismally when its owner, Jerry Jones, became more involved in the teams operations,
according to Cartwright (2001). Cartwright writes regarding the Cowboys abysmal dive,
Blame the man behind the grin. Blame his dictatorial arrogance, his obsessive need to
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prove that he too is a real football guy, his stubborn refusal to hire the real article to run
this operation. (p. 80). This opinion is supported by Attner (2001), who writes that If,
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for the next five years or so, Jones would drop the general manager duties from his
Most baseball owners at the time ruled like dictators, making every decision. Yawkey
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was smart enough to know that though he was a passionate fan, he wasn't equipped to
make personnel decisions, creating a new position at the time, that of the teams
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"general manager". This situation was different for George Steinbrenner, the late
principal owner of the New York Yankees professional baseball team, who according to
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Kaplan and Reiss (1990) had recurring blind spots in running this most valuable of
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owner of the Detroit Tigers professional baseball team, managed his players salaries
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and created a complacent team, running his team like a hobby, according to Frank
(1953), playing favorites with players that didnt break their necks trying to win,
The anecdotal evidence that owners who are too involved in the teams
operations have worse outcomes is instructive, especially as sports teams are more
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likely to engage, according to Alchian and Demsetz (1972), in reverse shirking (p.
specialist agent can produce significantly better results. It is striking therefore that even
Outside the realm of sports, it is also clear that a good owner cannot do
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everything, a basic message for agency anti-costs. Greco (1996), in the article Replace
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yourself, discusses how hiring a professional manager--whether a chief financial
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officer or an information-systems director--is never easy. And yet, there are often times
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when this must be done to enhance value. Greco discusses the four stages that owners
of growing businesses must typically navigate in letting go, including denial (But waiting
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too long to delegate can have dire consequences, anxiety (including financial fears,
where owners cannot imagine handing out equity to their company, even when
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necessary to attract resources), sadness (in missing a job dealing with customers who
have become friends, in order to handle more critical issues), and acceptance (If I want
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Jerry Yang, one of the founders of Yahoo, indeed learned that founders do not
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always make the best CEOs. According to the Economist (2008), Yang has been
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unable to devise a business strategy which will allow Yahoo to compete with rival Web
search engine Google. His decision to reject a takeover offer from Microsoft Corp.
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closed one possible escape route. Yahoo's situation continues to deteriorate. Lyon
(2008) suggests that Yang's personal connection to the company may have
prevented him from selling to the computer technology company Microsoft in February,
2008. And most recently, George Zimmer, founder and executive chairman of Mens
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disagreement with the companys direction, according to Kapner and Lublin (2013).
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