Analytical Framework

Abstract

In perfect capital markets without taxes and transaction costs the source of finance and the resulting ownership structure are irrelevant to the costs of capital, as proven by Modigliani and Miller (1958). In their seminal paper, however, Jensen and Meckling (1976) show that the separation of ownership and control that is associated with corporate finance produces agency costs. Classical agency costs arise from asymmetric distribution of information between the party (the agents) that takes some action on behalf of outsiders (principals), combined with the fact that results are not perfectly correlated with efforts of the insiders. Depending on the timing of contracting, action of the agent, and random influences of nature, one distinguishes between moral hazard or hidden action and hidden information, as well as adverse selection.