Professional Documents
Culture Documents
Michael C. Jensen
Harvard Business School
mjensen@hbs.edu
and
William H. Meckling
University of Rochester
Abstract
Understanding human behavior is fundamental to understanding how organizationsfu
nction, whether they are profit-making firms, non-profit enterprises, or governm
entagencies. Much disagreement among managers, scientists, policy makers, and ci
tizensarises from substantial differences in the way we think about human nature a
bout their
strengths, frailties, intelligence, ignorance, honesty, selfishness, and generos
ity. In thispaper 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 ofNeeds) Model, Sociological (or Social Victim) Model, and the Politic
al (or PerfectAgent) Model. We argue that REMM best describes the systematically
rational part ofhuman behavior. It serves as the foundation for the agency mode
l of financial,
organizational, and governance structure of firms.
The growing body of social science research on human behavior has a common messa
ge:
Whether they are politicians, managers, academics, professionals, philanthropist
s, or
factory workers, individuals are resourceful, evaluative maximizers. They respon
dcreatively to the opportunities the environment presents, and they work to loos
enconstraints that prevent them from doing what they wish. They care about not o
nly
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 es
tablish rules ofthe game that tap and direct human energy in ways that increase
rather than reduce the
effective use of our scarce resources.
M. C. Jensen and W. H. Meckling, 1994. All rights reserved.
Journal of Applied Corporate Finance, Summer 1994, V. 7, No. 2, pp. 4 -19.
also published in
Michael C. Jensen, Foundations of Organizational Strategy, Harvard University Pr
ess, 1998.
You may redistribute this document freely, but please do not post the electronic
file on the web. I
welcome web links to this document at http://papers.ssrn.com/abstract=5471. I re
vise my papers
regularly, and providing a link to the original ensures that readers will receiv
e the most recent
version. Thank you, Michael C. Jensen
public interest.
policy disagreement among managers, scientists, policy makers, and citizens aris
es from
substantial, though usually implicit, differences in the way we think about huma
n
nature about the strengths, frailties, intelligence, ignorance, honesty, selfishne
ss,
generosity, and altruism of individuals.
* We use the word man here in its use as a non-gender-specific reference to human
beings. We have
attempted to make the language less gender-specific because the models being dis
cussed describe the
behavior of both sexes. We have been unable to find a genderless term for use in
the title which has the
same desired impact.
The first draft of this paper was written in the early 1970s. Since then it has
been used annually in ourcourse on Coordination and Control and the Management o
f Organizations at both Rochester and Harvard.
We are indebted to our students for much help in honing these ideas over the yea
rs. An earlier version ofsome of the ideas in this paper were published previous
ly in William H. Meckling, Values and the Choiceof the Model of the Individual in
the Social Sciences, Schweizerische Zeitschrift fur Volkswirtshaft und
Statistik Revue Suisse d Economie Politique et de Statistique (December 1976).
This research has been supported by the Managerial Economics Research Center, Un
iversity ofRochester, and the Division of Research, Harvard Business School. We
are grateful for the advice and
comments of many people, including Chris Argyris, George Baker, Fischer Black, D
onald Chew, Perry
Fagan, Donna Feinberg, Amy Hart, Karin Monsler, Kevin Murphy, Natalie Jensen, St
eve-Anna Stephens,
Richard Tedlow, Robin Tish, Karen Wruck and Abraham Zaleznik.
loopholes
in
the development of so-called clubs with private liquor stock in areas where
serving liquor at public bars is prohibited;
the ability of General Dynamics CEO George Anders and his management team,
when put under a lucrative incentive compensation plan tied to shareholder value
,
to quadruple the market value of the company even as the defense industry was
facing sharp cutbacks; and
the growth in the number of hotel courtesy cars and gypsy cabs in cities where
taxi-cab licensing results in monopoly fares.
These examples are typical of behavior consistent with the REMM model, but
not, as we shall see, with other models that prevail in the social sciences. The
failure of
the other models is important because the individual stands in relation to organ
izations as
the atom is to mass. From small groups to entire societies, organizations are co
mposed of
individuals. If we are to have a science of such organizations, it will have to
be founded
on building blocks that capture as simply as possible the most important traits
of humans.
national economic
13 Plato, Laws 739c, ff., and 942a, f, as cited by Karl Popper (1950, p. 102).
109.
Argyris, Chris (1993). Knowledge for Action: A Guide to Overcoming Barriers to O
rganizational Change.
San Fransicso, CA, Jossey-Bass, Inc.
Arrow, Kenneth J. (1971). Control in Large Organizations: Essays in the Theory o
f Risk-Bearing,
Markham Publishing Co.
Baker, George P., Michael C. Jensen and Kevin J. Murphy (1988). Compensation and
Incentives:
Practice vs. Theory. Journal of Finance 43, no. 3 (July): 593-616.
Becker, Gary S. (1968). Crime and Punishment: An Economic Approach. Journal of Pol
itical Economy
76 (March/April).
Becker, Gary S. (1973). A Theory of Marriage: Part I.
82 (July/August).
What Do Firms Do
University of Rochester.
Initiative Committee for National Economic Planning (1975). The Case for Governm
ent Planning. New
York Times.
Jensen, Michael C. (1986). Agency Costs of Free Cash Flow: Corporate Finance and
Takeovers.
American Economic Review 76 (May): 323-329.
Journal of Ec
Jensen, Michael C. (1989a). Active Investors, LBOs, and the Privitization of Bank
ruptcy. Journal of
Applied Corporate Finance 2, no. 1 (Spring): 35-44.
Jensen, Michael C. (1989b).
view 67, no. 5
(September-October): 61-74.
Jensen, Michael C. (1993). The Modern Industrial Revolution, Exit and the Failure
of Internal ControlSystems. Journal of Finance (July): 831-880.
Jensen, Michael C. (1995). Economics, Organizations, and Non-Rational Behavior.
onomic Inquiry .
Ec
Jensen, Michael C. and William H. Meckling (1976). Theory of the Firm: Managerial
Behavior, Agency
Costs, and Ownership Structure. Journal of Financial Economics 3, no. 4 (October)
: 305-360.
Jensen, Michael C. and William H. Meckling (1992). Specific and General Knowledge
, and Organization
Structure . Contract Economics. L. W. a. H. Wijkander. Oxford, Basil Blackwell: 25
1-274.
Jensen, M. C. and Kevin J. Murphy (1990).
ntives. Journal
of Political Economy (April).
Kaitin, Kenneth I., Natalie R. Bryant and Lewis Lasagna (1993). The Role of Resea
rch-Based
Pharmaceutical Industry in Medical Progress in the United States. Journal of Clin
ical
Pharmacology 33 (May): 412-417.
Lang, Larry, Annette Poulsen and Rene M. Stulz (1994). Asset Sales, Firm Performa
nce, and the Agency
Costs of Managerial Discretion. Journal of Financial Economics .
Larrick, Richard P., Richard E. Nisbett and James N. Morgan (1993). Who Uses the
Cost-Benefit Rules
of Choice? Implications for the Normative Status of Microeconomic Theory. Organiz
ational
Behavior and Human Decision Processes 56 (3): 331.
Maslow, A.H. (1943). A Theory of Human Motivation.
y): 370-396.
Meckling, William H. (1976). Values and the Choice of the Model of the Individual
in the Social
Sciences. Schweizerische Zeitschrift fur Volkswirtschaft (December).
Milgrom, Paul and John Roberts (1992). Economics, Organization, and Management.
Englewood Cliffs,
NJ, Prentice-Hall.
Niskanan, William A., Jr. (1971). Bureaucracy and Representive Government. Aldin
e-Atherton, Inc.
Peck, M. Scott (1978). The Road Less Traveled. New York, Simon & Schuster.
Peltzman, Sam (1974). Regulation of Pharmaceutical Innovation, American Enterpri
se Institute.
Popper, Karl (1950). The Open Society and its Enemies. (Second Edition), Princet
on NJ, Princeton
University Press.
Schwert, G.W. (1993). Mark-up Pricing in Mergers and Acquisitions. Rochester, NY
, University of
Rochester.
Stelzer, Irwin M. (1994). Pricing Health Care: There is No Health Care Crisis. W
all Street Journal.
Sykes, Charles J. (1992). A Nation of Victims: The Decay of the American Charact
er, St. Martin s Press.
Wardell, William M. , Mohammed Hassar, Sadanand N. Anavekar, et al. (1978). The R
ate of
Development in New Drugs in the United States, 1963 through 1975. Clinical Psycho
logy and
Therapeutics 24, no. 2 (August).
Williamson, Oliver E. (1970). Corporate Control and Business Behavior. Englewood
Cliffs, NJ, PrenticeHall.
Williamson, Oliver E. (1975). Markets and Hierarchies: Analysis and Antitrust Im
plications. New York,
Free Press.