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Jensen's Theory of the Firm

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PPGPortal > Home > Concept Dictionary > I, J > Jensen's Theory of the Firm

Jensen's Theory of the Firm 

A theory which holds that the effectiveness of capitalist, private sector organizations can be justified solely because they are organized around the maximization of a single bottom-line variable: profit.

(Jensen, Michael C. 2003. A Theory of the Firm: Governance, Residual Claims and Organizational Forms, Cambridge, Massachusetts: Harvard University Press, p 287.)


The effectiveness of the capitalist, private sector organizations can be justified solely because it possesses a single bottom-line variable to maximize – profit. It disciplines managers, limits discretion and allows for performance incentives.

Conversely, the multiple objectives for public sector organizations eliminate the ability to measure performance, creating a major problem. Despite the public sector’s inherently unobservable outcomes, observable and quantifiable proxies are often used to measure success that can sometimes produce adverse outcomes (such as with test scores and education). It is also difficult to generate individual or organizational performance incentives, which, when imposed, can distort or even diminish moral incentives.


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School of Public Policy and Governance