Economists have long been concerned with the incentive problems that arise when decision making in a firm is the province of managers who are not the firm's security holders. One outcome has been the development of “behavioral” and “managerial” theories of the firm which reject the classical model of an entrepreneur, or owner-manager, who single-mindedly operates the firm to maximize profits, in favor of theories that focus more on the motivations of a manager who controls but does not own and who has little resemblance to the classical “economic man.” Examples of this approach are Baumol (1959), Simon (1959), Cyert and March (1963), and Williamson (1964b).

More recently the literature has moved toward theories that reject the classical model of the firm but assume classical forms of economic behavior on the part of agents within the firm. The firm is viewed as a set of contracts among factors of production, with each factor motivated by its self-interest. Because of its emphasis on the importance of rights in the organization established by contracts, this literature is characterized under the rubric “property rights.” Alchian and Demsetz (1972) and Jensen and Meckling (1976b) are the best examples. The antecedents of their work are in Coase (1937, 1960).

The striking insight of Alchian and Demsetz (1972) and Jensen and Meckling (1976b) is in viewing the firm as a set of contracts among factors of production.