merged

than contributing to team production. Shirking activities might include arriving late for work, taking
long breaks, leaving work early, making personal phone calls, surfing the internet, etc. Most of the
harm of this shirking may fall on the other members of the team.
Firms often employ managers to oversee teams of employees. One of a manager’s duties is to
limit shirking behavior and to promote productive behavior. But what is to keep a manager from
shirking his or her own duties? One way to encourage a manager to be diligent to limit the
shirking behavior of employees is to make the manager a residual claimant (e.g. with a profitsharing
plan or a bonus based on firm profitability or team productivity). Residual claimants of a
firm receive a share of the firm’s profits. Some firms take the additional step of making all
employees residual claimants.
The Principal-Agent Problem
The problem of shirking by employees is a specific example of a common problem called the
principal-agent problem. An agent is a person who agrees to act for the benefit of another, the
principal. In an employment situation, the employee is an agent of the firm. The employee agrees
to work for the benefit of the firm.
But humans are by nature self-interested. Any agent who finds a conflict between his or her selfinterest
and the principal’s interest will tend to pursue self-interest. This is the principal-agent
problem. Thus, managers try to compel employees to pursue the firm’s interest. And business
firms sometimes make employees residual claimants so that the employees will have a selfinterest
in pursuing the firm’s goal of profit-maximization.
Business Firms
Firms are either business firms or nonprofit firms. Business firms are owned by individuals;
proprietors, partners, or stockholders. These owners are the residual claimants of the business
firm. Business firms come in different legal types, and vary widely in size. The most common
legal type of business firm is the proprietorship, but in terms of total sales, corporations are the
most important type of business firm.
Example 7A: According to the “Statistical Abstract of the United States: 2012”, proprietorships
make up 72% of business firms, and have 4% of total sales, partnerships make up 10% of
business firms, and have 15% of total sales, and corporations make up 18% of business firms
and have 81% of total sales.
Most corporations are small businesses. But the small percentage of corporations that are large
provide the majority of total corporate sales.
Example 7B: According to the “Statistical Abstract of the United States: 2012”, over 80% of
corporations have annual sales of under $1 million. The fewer than 20% of corporations with
annual sales of over $1 million have over 96% of total corporate sales.
The Chief Goal of Business Firms
All types of business firms are assumed to pursue profit-maximization as their chief goal. It is in
the best interest of the residual claimants of a business firm for the firm to achieve maximum
profits. But is it in the best interest of society that business firms seek to maximize profits?
Generally, yes. In a competitive market, the goal of profit-maximization will compel a business
firm to do two things that serve the best interest of society:
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1. The firm will use its resources to produce in response to consumer demand.
Competition forces a profit-seeking firm to be responsive to consumer demand. In a
competitive market, a firm that is not responsive to consumer demand will lose customers to
its competitors. Producing in response to consumer demand contributes to society’s goal (in
19 - 3 The Firm