Michael C. Jensen

Michael Cole Jensen (November 30, 1939 – April 2, 2024) was an American economist who worked in the area of financial economics. Between 2000 and 2009 he worked for the Monitor Company Group,^[1] a strategy-consulting firm which became "Monitor Deloitte" in 2013. Until 2000, he held the position of Jesse Isidor Straus Professor of Business Administration at Harvard University.

Jensen died on April 2, 2024, at the age of 84.^[2] A tribute is available at Promarket.^[3] He was one of the most influential financial economists of all time. Jensen made three major contributions, each of which have had large impacts. First, he is one of the most-cited economists of all time, with over 340,000 citations on Google Scholar as of April 2024, according to the Promarket tribute. Much of his work focused on agency problems within organizations, especially publicly traded corporations. Second, Jensen was also the co-founder and editor for many years of the Journal of Financial Economics. The journal became the top academic finance journal almost immediately after its founding. Among its policies was compensating peer reviewers (referees) for doing a speedy job of evaluating manuscripts. Third, he co-founded the Social Science Research Network in 1994.^[4] SSRN quickly became the leading distributor of academic working papers in many disciplines.

Early life

Born in Rochester, Minnesota, United States,^[5] he received his A.B. in Economics from Macalester College in 1962. He received both his M.B.A. (1964) and Ph.D. (1968) degrees from the University of Chicago Booth School of Business, notably working with Professors Merton Miller (1990 co-winner of the Nobel Prize in Economics) and Eugene Fama (2013 co-winner of the Nobel Prize in Economics).^[6]

Career

After a short stay teaching at Northwestern University, between 1968 and 1988 Jensen^[7] taught finance and business administration at the William E. Simon Graduate School of Business Administration of the University of Rochester, culminating in his 1984-1988 appointment as the LaClare Professor of Finance and Business Administration. In 1974, he co-founded the Journal of Financial Economics. From 1977 to 1988, he served as the founding director of the University's Managerial Economics Research Center. He joined the Harvard Business School on a half-time appointment in 1985 (dividing his time between Rochester and Harvard) before taking a full-time appointment at the latter institution in 1988. Jensen was also forward looking regarding how the internet would reshape how information is disseminated. SSRN was founded in 1994, at a time when few people had heard of the world wide web. In 2000, Jensen retired from academic work, retaining emeritus status at Harvard, upon assuming his position at Monitor.

Jensen was also a visiting scholar at the University of Bern (1976), Harvard University (1984–1985, when he joined the faculty), and the Tuck School of Business at Dartmouth College (2001–2002). In 1992, he was president of the American Finance Association, one of four classmates from the University of Chicago that were elected president of the AFA (the others being Hans Stoll, Richard Roll, and Myron Scholes). He became a member of the American Academy of Arts and Sciences in 1996. Since 2002, he has been a board member of the European Corporate Governance Institute.

In 1974, the first issue of the Journal of Finanical Economics was published. Jensen was the primary editor until about 1990, when he stepped down, partly due to health issues. The Jensen Prize in corporate finance and organizations research at the journal is named in his honor.

Research

Jensen played an important role in the academic discussion of the capital asset pricing model, of stock options policy, and especially of corporate governance.

He developed a method of measuring fund manager performance, the so-called Jensen's alpha.^[8] Based upon his 1968 University of Chicago Ph.D. dissertation, Jensen posited that fund manager abnormal performance should be based upon a fund's average return relative to how much risk it exposed investors to, and how other risky assets had done. As an example, if the annual return on the stock market was 10% in a year when the risk-free rate of interest, as proxied by the return on Treasury bills, was 2%, a fund that was 80% as risky as the overall market should have an expected return of 2% + 0.8 times (10%-2%), or 8.4%, based on the capital asset pricing model referred to above. If the fund had a return of 8.1%, it underperformed by 0.3% relative to its expected return. This measure became known as Jensen's alpha, and became widely used to measure the performance of mutual funds and other investments by both academics and practitioners.

Jensen's best-known work is the 1976 paper he co-authored with William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.^[9] One of the most widely cited economics papers of the last 50 years, it implied the theory of the public corporation as an ownerless entity, made up of only contractual relationships, a field pioneered by Ronald Coase. The paper noted that if a manager only receives a fraction of the benefits that he or she adds to the firm, the manager will not work as hard to maximize value as he or she would if 100% of the incremental benefits flowed to the manager. The paper hypothesized that an advantage of debt financing was that with a smaller amount of equity financing, a manager could own a larger percentage of the equity, and thus have better incentives to maximize firm value. The paper also hypothesized that outside investors would be aware of these incentive effects, and thus would be willing to assign a higher valuation to a firm that had higher managerial equity ownership.

His 1983 paper Reflections on the Corporation as a Social Invention argued that corporations' sole responsibility was to maximize shareholder value, based on the assumption that the stock market accurately reflected a company's value, the assumption of the efficient markets hypothesis.^[10]

In 1986, Jensen published a short article, "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers" in the American Economic Review^[11] that sought to explain the buyout boom that was occurring. At the time, buyouts were referred to as leveraged buyouts (LBOs) because they frequently involved high amounts of debt financing. The paper argued that the managers of some profitable publicly traded firms were not maximizing shareholder value because managers were overinvesting or sitting on retained earnings. Jensen argued that if the company substituted debt for equity financing, the managers would be forced to pay out profits as interest and principal to debtholders, and in so doing would incentivize managers to make sure that there were enough profits to meet the debt payments, and in the process increase firm value.

It was a 1990 Harvard Business Review article, CEO Incentives: It's Not How Much You Pay, But How^[12] by Jensen and Kevin J. Murphy, that prescribed executive stock options as a mechanism to incentivize executives to maximize shareholder value. The justification they gave was that shareholders were the "residual claimants" of the corporation so they had the sole right to profits. The idea that shareholders are the sole residual claimants was later challenged by some legal scholars, and some (such as Stout 2002^[13]) actively reject it, in favor of other arguments for shareholder primacy. However, recent literature (such as Rojas 2014^[14]) builds upon Jensen's work arguing in favor of a dynamic model of the corporation and theory of corporate governance.

After Jensen and Murphy (1990), Congress passed Section 162(m) of the U.S. Internal Revenue Code (1993), making it cost effective to pay executives in equity. As a result, executives had increased financial incentives to focus their efforts on increasing the company's stock price. In the short run, some executives even manipulated accounting numbers (Enron, Global Crossing) to achieve the goal.^[15] Others focused on long-term value creation, even if it negatively affected short-term earnings per share (EPS).

Jensen acknowledged that market prices were not always right. In 2005 he published "Agency Costs of Overvalued Equity" In Financial Management.^[16]

Jensen collaborated several times with Werner Erhard.^[17] The backbone of their study was an ontological/phenomenological model.^[18] He also collaborated with Eugene Fama on two articles that were published in the 1983 Journal of Law and Economics dealing with agency problems, that is, conflicts in the goals of managers and shareholders.^[19][20]

References

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• Personal page at the Harvard Business School website
• Author page at the SSRN (Social Science Research Network) website
• BEING A LEADER & THE EFFECTIVE EXERCISE OF LEADERSHIP: An Ontological/Phenomenological Model Archived 2014-02-02 at the Wayback Machine