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

πa{γ - c - αR∆θ [(p + τ) - (1 - λ)τx_r]} ≥

[1 — π(1 — a)] [αRθI(1 — x_r)(1 — λ)τ] x_c(x_r) (2)

that is, the higher expected rents enjoyed by the incumbent CEO owing to self-entrenchment
outweigh the cost of the pro-stakeholder concessions. A first inspection of condition (2) allows
us to state the following lemma:

Lemma 2 The CEO’s incentives to self-entrench by establishing stakeholder relationships
are stronger the tougher is the replacement threat (the higher is π) and the more effective
is stakeholder activism (i.e., a is large).

When good corporate governance deprives managers of standard tools to protect their
jobs (such as anti-takeover defenses and CEO-dominated boards) CEOs turn to subtler
ways to stay in power. As the effectiveness of social activists’ campaigns increases, building
a relationship with stakeholder representatives may become a powerful self-entrenchment
tool.

Let us define:

_γ ≡ (Y ^{- c})

αR ^,

which measures the relative importance of private benefits of control versus monetary
returns in the CEO’s objective function. This variable is of crucial importance to our results;
indeed, only when control benefits are large enough compared to the managerial equity stake,
is the CEO willing to resist a replacement, even undergoing the cost of pro-stakeholder
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concessions. ¹⁴

The following lemma establishes how, for any intensity of the managerial replacement
threat, an appropriate level of stakeholder protection can counter the CEO’s entrenchment
strategy:

¹⁴One may argue that increasing the CEO’s equity stake α would eliminate the incumbent’s incentive to
resist a replacement. Hence, our results would depend on α being an exogenous variable in the model. Our
answer is that even if α was endogenous, it could still be too costly to discourage managerial entrenchment
by raising the CEO equity share. Notice that if large equity stakes were an effective, cheap instrument to
deter managerial entrenchment, we would not observe top executives pressuring against corporate governance
reforms that make control contestable, and engaging in creative self-entrenchment strategies, as we in fact
do. See also Shleifer and Vishny (1988) for a discussion of reasons why many top executives own relatively
little equity in the firms they run.

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