Neoclassicism and the Separation of Ownership and Control

"Separation of ownership and control" is a phrase whose history will forever be associated with Adolf A. Berle and Gardiner C. Means' The Modern Corporation and Private Property (1932), as well as with Institutionalist economics, Legal Realism, and the New Deal. Within that milieu the large publicly held business corporation became identified with excessive managerial power at the expense of stockholders, social irresponsibility, and internal inefficiency. Neoclassical economists both then and ever since have generally been critical, both of the historical facts that Berle and Means purported to describe and of the conclusions that they drew. In fact, however, within neoclassical economics the separation of ownership and control has always been an essential element of efficient corporate governance and corporate finance. This paper explores the history of the concept of separation of ownership and control within neoclassical economics, starting with Yale economist Irving Fisher's separation theorem developed early in the twentieth century, which held that a corporation's profit function could not be derived from shareholders' utility functions; Ronald Coase's The Nature of the Firm (1937), which applied purely marginalist analysis to the determinants of the horizontal and vertical structure of the corporation; and then to the great corporate finance theorems of the 1950s and 1960s. These concluded that ownership and debt are nothing more than alternative, fungible sources of capital, and that a profitable stock ownership strategy involves no knowledge whatsoever about the firms in which purchasers are investing. Within this model "separation of ownership and control" actually understates the degree of separation. A better phrase would be "separation of ownership and awareness."