Stakeholder Activism, Managerial Entrenchment, and the Congruence of Interests between Shareholders and Stakeholders

she can invest x_c at cost Kx_c , and learn with probability x_c how to implement stakeholder-
friendly projects yielding a private benefit B to stakeholders (e.g., projects requiring coop-
eration from the local community, pollution-free projects, etc.); in this case the private cost
of implementing such projects is reduced to zero. Investing in the relationship with stake-
holders and local communities requires time; hence, this investment is not feasible to outside
managers. We assume that K = c, which implies that the investment is never profitable
unless it is part of an entrenchment strategy. We also assume:

Assumption 1

ατR < c.

This assumption implies that when an investment xc is undertaken, with probability xc
the incumbent manager’s preferences are congruent with stakeholders’: the manager picks
the stakeholders’ favorite project even at the expense of monetary profits. With probability
(1-x_c), the manager gains no expertise and her preferences are congruent with shareholders’;
hence, she only picks the stakeholders’ favorite project with probability λ. This directly
implies the following lemma:

Lemma 1 The degree of congruence between the incumbent manager’s and the stakehold-
ers’ objectives is measured by λ+(1-λ)xc; it increases from λ to 1 as the “stakeholder-specific
investment” xc is raised from 0 to 1.

x_c thus measures the amount of managerial concessions to stakeholders. At t = 1,
stakeholders are willing to support the incumbent CEO provided xc satisfies the following
constraint:

θ_I(1 - x_r)(1 - λ)Bx_c ≥ (θ_R - θ_I) [λ + (1 - λ)x_r] B

that is, the concessions to be expected under the incumbent management outweigh the cost
for stakeholders of bearing a less efficient manager. This constraint implies that managerial
concessions must lie above a threshold x_c(x_r). Notice that x_c(x_r) is increasing in x_r: if
stakeholders’ interests are protected by regulation or by an explicit contractual agreement
between the stakeholders and the firm, then stakeholders are more hardly convinced to back
an inefficient CEO.

A self-entrenchment strategy whereby the CEO invests x_c ≥ x_c(x_r) in stakeholder rela-
tionships is profitable if and only if:

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