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

Proposition 1 Suppose managerial entrenchment is to be countered. Then, if the incum-
bent’s control benefits are large (Γ > ∆θ(p + τ(1 - λ))), shareholder value is concave in π.
It is maximized when the managerial replacement threat is 0 < π * << 1, and a minimal
level of formal protection b_r (π*) ∈ (0,1) is provided to stakeholders. π* is decreasing in Γ
and a.

Proof. See the appendix. ■

Notice that, in contrast with section 2.1, when managers can entrench themselves through
a stakeholder-friendly behavior shareholder value is a concave function of π. Thus, share-
holders’ interests are best served when competition in the managerial labor market is not
too high (i.e. π is strictly lower than 1). This is so as by lemma 3 countering managerial en-
trenchment when π is high may prove very costly (i.e. require setting very strong stakeholder
protection rules).

The following two examples show that depending on parameter values shareholders have
two ways of countering managerial entrenchment. In the first example, where a and Γ are not
too large, a high level of legal stakeholder protection (i.e., x_r “large”) can be associated to
a tough replacement threat (π “large”), so that stakeholders are led to trust the alternative
manager. The cost imposed on profits by stakeholder protection is outweighed by the higher
expected managerial quality induced by managerial turnover. Notice that in example 1,
the corporate pie (inclusive of stakeholder welfare) is increased at the expense of incumbent
managers, though some shareholder value must be sacrificed to guarantee a minimal amount
of welfare to stakeholders.

The above solution may become very costly, however, when stakeholders campaigns are
very effective (a close to 1), and managers value much their private benefits of control (Γ
“large”), as in example 2. Indeed, stakeholders are easily lured by incumbent’s large conces-
sions. In such case, shareholder value is maximized by insulating CEOs from a replacement
threat (i.e., setting π low) and giving poor formal protection to stakeholders. Incumbent
managers, who do not need stakeholders’ support to buttress their positions, make few
concessions to stakeholders; their preferences on projects are then more aligned with share-
holder value. ¹⁶ In example 2, shareholder value is preserved by leaving rents to incumbent
managers. Hence, the corporate pie (inclusive of stakeholder welfare) is reduced as average
managerial quality is lower, but shareholder value is increased at the expense of stakeholder

¹⁶The idea that boards may prevent inefficient entrenchment strategies simply by “granting the CEO some
insulation from competition for his job” has been often advanced in the corporate governance literature. See
for instance Shleifer and Vishny (1989).

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