How ‘Shareholder Value’ Became a Wall Street Mantra

Michael Jensen, who died on April 2, did as much as any single thinker to shape modern financial capitalism, particularly as it is practiced in the Anglo-Saxon world. To his critics, he was the high priest of the greed-is-good era who justified exorbitant executive pay and vulture capitalism: Gordon Gekko with a doctorate. To his admirers, he was the surgeon who gave Anglo-Saxon capitalism a new lease of life by slicing off the fat, removing the malignant tumors and prescribing a strict exercise regime.

Nobody can deny his extraordinary influence. His elective at Harvard Business School was the most popular in the institution’s history, enrolling more than 600 students, two-thirds of each year’s class, many of whom went on to restructure American capitalism during one of its most excited phases. And nobody can deny the rigor of his ideas about the central issues in business theory: the proper boundaries of the firm, the ideal incentive structure, the market for corporate control and the advantages and disadvantages of public versus private companies. His groundbreaking article, co-written with William Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” has earned more than 130,000 Google citations, more than any other article in financial economics.

Jensen’s central idea was that the people hired to run companies (“agents”) will shortchange the people who own the companies (“principals”) unless they are motivated by the right mixture of sticks and carrots. This is particularly true of public companies where ownership is dispersed and monitoring mechanisms weak. The giant companies that dominated the US economy are monuments to the so-called “agency problem”: a bloated class of managers produced dismal returns for shareholders while living a comfortable life of perks and lifetime tenure, low risk and low return.

The solution was to apply the magic of shareholder value to change incentives: Pay the CEOs and senior managers of public companies like owners with share options — or better still take the companies private through leveraged buyouts. The more you turn “agents” into “principals,” the more you will give them an incentive to squeeze the maximum value out of the companies that they were hired to run.