This paper integrates elements from the theory of agency, the theory of property rights
and the theory of finance to develop a theory of the ownership structure of the firm. We
define the concept of agency costs, show its relationship to the ‘separation and control’
issue, investigate the nature of the agency costs generated by the existence of debt and
outside equity, demonstrate who bears costs and why, and investigate the Pareto
optimality of their existence. We also provide a new definition of the firm, and show
how our analysis of the factors influencing the creation and issuance of debt and equity
claims is a special case of the supply side of the completeness of markets problem.
The directors of such [joint-stock] companies, however, being the managers rather of
other people’s money than of their own, it cannot well be expected, that they should
watch over it with the same anxious vigilance with which the partners in a private
copartnery frequently watch over their own. Like the stewards of a rich man, they are apt
to consider attention to small matters as not for their master’s honour, and very easily
give themselves a dispensation from having it. Negligence and profusion, therefore, must
always prevail, more or less, in the management of the affairs of such a company.