Accepted Manuscript

AGENCY COSTS WHEN AGENTS PERFORM BETTER THAN

OWNERS

Oscar Varela

PII: S1544-6123(17)30037-5
DOI: 10.1016/j.frl.2017.07.019
Reference: FRL 753

To appear in: Finance Research Letters

Received date: 14 January 2017

Revised date: 18 April 2017
Accepted date: 31 July 2017

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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 ACCEPTED MANUSCRIPT

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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AGENCY COSTS WHEN AGENTS PERFORM BETTER THAN

OWNERS
Oscar Varela
Department of Economics and Finance University of Texas at El Paso 500 West University Avenue El PasoTexas 79968
United States

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.

JEL Classification: G3, G30, G32

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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

owner-manager becomes an agent. Non-pecuniary benefits to the agent (owner-

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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.

This incompleteness in the Jensen and Meckling theory of agency costs

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,

including entrepreneurship, and they claim that these must be overcome if it is to

remain a prominent theory. Entrepreneurship literally from the French for

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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agency costs, and create benefits, generating agency anti-costs.

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

agency anti-costs and the latter to agency costs.1

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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

tantamount to an owner-manager in Jensen and Meckling (1976) receiving a salary for

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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.

This paper is organized as follows. Section 2 presents relevant literature and

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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

We should refrain from thinking of competition and cooperation as mutually exclusive.

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(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

arrangements, e.g. corporations, partnerships, nonprofit corporations, licenses,

bailments, nonvoting common stock, trusts, agencies, employee-employer

relationships, and marriages. (p. 821)

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paper are summarized in Appendix A and other anecdotal evidence of agency anti-

costs are presented in Appendix B.

2. LITERATURE AND FRAMING OF STUDY

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

performance due to ownership dispersion to differences between ownership and

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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

traded firms executives enjoy excessive perquisites.

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2
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

management to seek outside capital.

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Smith (1776), however, also describes benefits of specialization and its more

efficient production, and Ricardo (1817) relates these to comparative advantage.

Alchian (1961) states that the different skills of different people as owners make

pertinent the principle of comparative advantage through specialization in ownership.

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

with those of stockholders the greater the executives holdings of stock.

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

advantage and self-interest.

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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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compared to agency costs, as growth in pecuniary benefits from employment of an

owner-manager can via trade produce more non-pecuniary benefits than previously
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possible.

3. AGENCY ANTI-COST THEORY

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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).
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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

returns around the announcement date, whereas resignations due to normal

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

management has incentives to improve performance as the owners agents.

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The major contribution of this research is therefore to show in the Jensen and
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Meckling (1976) paradigm the case where agents improve performance, and the

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

impossible if management is able to re-negotiate them.

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needing to shift the owner-managers agency costs to outside parties are, parallel with

the owner-manager, beneficiaries of agency anti-costs. As in Barzel (1987) the

entrepreneur curtails his incentive to gain at the expense of his partners, and the net

gain from the collaboration is then maximized. (p. 103) 9

Jensen and Mecklings methodology can, under these circumstances, be

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

to employ an agent who is given ownership interest. This person is fundamentally

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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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shirked their pulling of a riverboat.

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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

for the firms value are discussed in the next section.

3.2. Agency Anti-Costs

3.2.1. Agency Anti-Costs and Jensen and Meckling

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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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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good performance, avoiding an overreaction to ex-post poor performance driven by bad

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)
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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.

Insert Figure 1 here

When the owner-manager relinquishes sole ownership by selling equity, we

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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separate manager (p. 640)

The owner-manager-agent, because of the gains from specialization (agency

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anti-costs), finds it advantageous to reduce expenditure on non-pecuniary benefits

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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

benefits directly through the firm. The owner-manager-agent has comparative

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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that the owner-manager-agent promotes, as in Alchian (1984) a group of people can

by joint action achieve more than the sum of their separate results (p. 35)

3.2.2. Enhancing firm value employing a manager-agent with ownership interest

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

proportional to the sole owners divestment of the firm. Then if an owner-manager-

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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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relation to the less such knowledge it employs.14 In addition, employing a manager-

agent who also has an ownership interest is agency cost neutral if such employment
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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

owner with the talent of a specialized agent.

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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.

Assume the owner-manager-agent has 30 percent ownership ( is 0.30), and

that the improvement in firm value (relative to when this owner had 100 percent

ownership interest) is proportional to this ownership interest. Then the budget

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

traditional Jensen-Meckling framework, with the added benefit that non-manager

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owners are also better off than before.

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

(1997) comment concerning the large impact of executives actions on values of

firms... (p. 774)

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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.

3.2.3. The Alchian-Demsetz AD-Factor

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If the budget constraints slope is steeper (in absolute value) by more than -1/,
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then the creation of an agency relationship produces a gain in the firms value that is

higher than an owner-manager-agents consumption of non-pecuniary benefits.

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Assume as before that the owner-manager retains 30 percent ownership ( is 0.30). If

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

as representing a monitors ability to meter production and constrain shirking beyond

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the agency cost neutral point. The owner-manager-agent receives pecuniary benefits

16
The AD-Factor must be bounded such that it must be less than to rule out positive

sloped budget constraints.

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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.

The major implication of this discussion is that the consumption of non-pecuniary

benefits occurs in a roundabout way. The owner-manager-agent as an employee of the

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.

Using the Jensen and Meckling paradigm, the owner-manager incorporates

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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

in absolute value increases at an increasing rate.

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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.

Insert Figure 2 here

The owner-managers trade-off after the (1 ) sale of the firm is line V2 P2 in

Figure 2, with slope - 1/( AD), with the AD-Factor accounting for the higher slope (in

absolute value) in budget constraint V2 P2 compared to V1 P1. The optimal

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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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exchange the greater value of the firm.

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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therefore, an owner-manager-agent. It is the employment of this owner-manager-agent

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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

critical to the outcome.

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steeper line V2 P2.19 The owner-manager-agent gains by increasing value as a team

manager with the flexibility to trade for non-pecuniary benefits, and possibly retain a

surplus. This result is Pareto optimal.

4. CONCLUSION

This paper introduces agency anti-costs as a concept that generalizes Jensen

and Mecklings (1976) work on agency costs, while it simultaneously complements and

T
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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

CR
projects, increasing the firms value above the pure owners capability. These agents as

US
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

also be thought of as having less incentive to expropriate firm value as owner-

M

managers. Their management ability via their comparative advantage or teamwork skills

to increase firm value allows them to obtain non-pecuniary benefits in a roundabout

ED

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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most specialists do for non-pecuniary benefits in the open market.

CE

An Alchian-Demsetz AD-Factor is introduced that formalizes this result in the

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

non-pecuniary benefits as agents of the firm. A positive AD-Factor can represent a

19
Turner and Muller (2004) suggest that this result is more likely the better the

communication between owners and agents.

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monitors ability at metering production and constraining shirking. Owner- or team-

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

benefits via trade as in Alchian and Demsetz.

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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Being Too Good at Your Job [Lublin (2017)].

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AC

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Figure 1

Firm value and wealth

V1

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IP
CR
Vmax

V0
A
US
AN

U1
M

D
V*
ED

U2
PT

Slope = -1
Slope = -1/
F0 F* P1 Fmax Market value of the stream of managers
CE

expenditures on non-pecuniary benefits

Note: Indifference curves are drawn out as a convention, and are assumed not to intersect,
AC

even if this seems possible from the drawings. The only relevant point to be considered on the

indifference curve is its tangency point with the budget constraint.

20
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Figure 2

Firm value and wealth

V2

V1

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IP
V B

CR
Vmax
US
AN
A
V0

U1
M

D
V*
ED

U2
PT

Slope =-1/(-AD)
Slope = -1
CE

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,
AC

even if this seems possible from the drawings. The only relevant point to be considered on the

indifference curve is its tangency point with the budget constraint.

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APPENDIX 1

AGENCY THEORY: JENSEN AND MECKLING

Jensen and Meckling (1976) show a firms sole owner-managers tradeoff

between the value of the firm and consumption of non-pecuniary benefits. The optimal

combination occurs when the owner-managers indifference curve is tangent to the

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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

CR
than before, as these are partly financed by the new (non-manager) owner. As the new

US
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
AN
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
ED

the slope of the constraint line Vmax - Fmax, is -1; the sole owner-manager can only

extract non-pecuniary benefits at his/her own cost.

PT

Insert Figure A.1 here

CE

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
AC

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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owner-manager, thereafter, able to consume non-pecuniary benefits along this new

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

non-pecuniary benefits as before.

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-

CR
0
pecuniary benefits rise from F* to F . The new owner may (as Jenson and Meckling

US
make clear) anticipate this behavior in its bid for an equity stake in the firm, and revise

V* to reflect the former sole owner-managers new level of non-pecuniary benefits,

AN
bidding instead (1 ) times the revised value of V*. Figure A.2 shows that the owner-

managers trade-off after the (1 ) sale of the firm is line V2 P2, the optimal
M

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
PT

former sole owner.

CE

Insert Figure A.2 here

AC

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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
AN
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,
M

even if this seems possible from the drawings. The only relevant point to be considered on the
ED

indifference curve is its tangency point with the budget constraint.

PT
CE
AC

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Figure A.2

Firm value and wealth

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
M

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
ED

indifference curve is its tangency point with the budget constraint.

PT
CE
AC

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APPENDIX 2

ANECDOTAL EVIDENCE OF AGENCY ANTI-COSTS

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

US
the New York Yankees) are sometimes accused of over-involvement in the franchise

operations to the detriment of the teams performance (and value).

AN
In these instances, the owners employment of specialized agents (centralized

contractual agents in the words of Alchian and Demsetz, 1972, p. 778) that elevate the
M

work level necessary for profit maximization can increase the value of the firm,
ED

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,
PT

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
CE

comparative advantages. (Alchian and Demsetz, 1972, p. 778).

AC

Many of the anecdotal stories related to agency anti-costs concern operations in

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

owner/general manager title, the Cowboys future might be different. (p 68).

US
The Boston Red Soxs professional baseball team was more successful when
AN
the owner, Tom Yawkey, was uninvolved, according to Chen (2011). As Chen states,

Most baseball owners at the time ruled like dictators, making every decision. Yawkey
M

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
ED

"general manager". This situation was different for George Steinbrenner, the late

principal owner of the New York Yankees professional baseball team, who according to
PT

Kaplan and Reiss (1990) had recurring blind spots in running this most valuable of
CE

franchises, including 19 managerial changes in 17 years. Similarly, Walter Briggs,

owner of the Detroit Tigers professional baseball team, managed his players salaries
AC

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,

because their jobs were safe. (p 118).

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.

791). It appears that when shirking is controlled by team members themselves, a

specialist agent can produce significantly better results. It is striking therefore that even

in the professional sports atmosphere of reverse shirking, anecdotal evidence suggests

that value is imperiled when owners refuse to employ agents.

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

IP
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

US
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
AN
too long to delegate can have dire consequences, anxiety (including financial fears,

where owners cannot imagine handing out equity to their company, even when
M

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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my company to grow, I have to give up something.).

Jerry Yang, one of the founders of Yahoo, indeed learned that founders do not
PT

always make the best CEOs. According to the Economist (2008), Yang has been
CE

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.
AC

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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Wearhouse, was dismissed abruptly and subsequently resigned, because of

disagreement with the companys direction, according to Kapner and Lublin (2013).

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