Jensen Corporate Objective Function

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V O LU M E 2 2 | N U M B E R 1 | W iNtER 2 0 1 0

Journal of

APPLIED CORPORATE FINANCE
A MO RG A N S TA N L E Y P U B L I C AT I O N

In This Issue: Honoring Michael Jensen
Baylor University Roundtable on
the Corporate Mission, CEO Pay, and improving the Dialogue with investors

8

Panelists: Michael Jensen, Harvard Business School;
Ron Naples, Quaker Chemical Corporation; Trevor Harris,
Columbia University; and Don Chew, Morgan Stanley.
Moderated by John Martin, Baylor University.

Value Maximization, Stakeholder theory, and the
Corporate Objective Function

32

Michael Jensen, Harvard Business School

the Modern industrial Revolution, Exit, and
the Failure of internal Control Systems

43

Michael Jensen, Harvard Business School

Just Say No to Wall Street: Putting a Stop to the Earnings Game

59

Joseph Fuller, Monitor Group, and Michael Jensen,
Harvard Business School

CEO incentives—it’s Not How Much You Pay, But How

64

Michael Jensen, Harvard Business School, and
Kevin Murphy, University of Southern California

Active investors, LBOs, and the Privatization of Bankruptcy

77

Michael Jensen, Harvard Business School

Venture Capital in Canada: Lessons for Building (or Restoring) National Wealth

86

Reuven Brenner, McGill University, and
Gabrielle A. Brenner, HEC Montreal

How to tie Equity Compensation to Long-term Results

99

Executive Compensation: An Overview of Research on Corporate Practices and Proposed Reforms

107

Promotion incentives and Corporate Performance:
is there a Bright Side to “Overpaying” the CEO?

119

Lucian Bebchuk and Jesse Fried, Harvard Law School
Michael Faulkender, Dalida Kadyrzhanova, N. Prabhala,
and Lemma Senbet, University of Maryland
Jayant Kale, Georgia State University, Ebru Reis,
Bentley University, and Anand Venkateswaran,
Northeastern University

Are incentives the Bricks or the Building?

129

Ron Schmidt, University of Rochester

Value Maximization, Stakeholder Theory,
and the Corporate Objective Function
by Michael C. Jensen, The Monitor Group and Harvard Business School1

n most industrialized nations today, economists,
management scholars, policy makers, corpo rate executives, and special interest groups are engaged in a high-stakes debate over corpo rate governance. In some scholarly and business circles, t he discussion focuses mainly on questions of policies and

procedures designed to improve oversight of corporate
managers by boards of directors. But at the heart of the
c urrent global corporate governance debate is a remarkable division of opinion about the fundamental purpose of t he corporation. Much of the discord can be traced to the
complexity of the issues and to the strength of the conflicting interests that are likely to be affected by the outcome. But also fueling the controversy are political, social, evolutionary, and emotional forces that we don’t usually think of as operating in the domain of business and economics. These

forces serve to reinforce a model of corporate behavior that draws on concepts of “family” and “tribe.” And as I argue in this paper, this model is an anachronism—a holdover
from an earlier period of human development that nevertheless continues to cause much confusion among corporate managers about what it is that they and their organizations
a re supposed to do.
At the level of the individual organization, the most basic
issue of governance is the following. Every organization has to ask and answer the question: What are we trying to accomplish? Or, to put the same question in more concrete terms: How do we keep score? When all is said and done, how do

we measure better versus worse?
At the economy-wide or social level, the issue is this: If
we could dictate the criterion or objective function to be
maximized by firms (and thus the performance criterion by
which corporate executives choose among alternative policy
options), what...
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