We define agency costs as the sum of: - Michael Jensen

A major social problem we face today is how to control the political process that is eroding the free enterprise market system. Although I am pessimistic that we will in fact ever resolve this problem completely, we will surely never solve it unless we develop a viable positive theory of the political process. Such a political theory will not be complete until we also have developed a theory that explains why we get the results we do out of the mass media.

This paper analyzes the relations between knowledge, control and organizational structure both in the market system as a whole and in private organizations. Limitations on the mental capacity of the human mind and the costs of producing and transferring knowledge means that knowledge relevant to all decisions can never be collected in the mind of a single individual or a small body of experts. This means that if the knowledge valuable to a particular decision is to be used in making that decision, there must be a system for partitioning out decision rights to individuals who already have the relevant knowledge and abilities or who can acquire or produce them at the lowest cost. Self interest on the part of individual decision-makers means a control system is required to motivate individuals with the decision rights and the relevant knowledge to use those decision rights appropriately. This control problem is solved in a capitalist economy by a system of alienable property rights.

Most organisations firms are simply legal fictions which serve as a nexus for a set of contracting relationships among individuals.