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



managerial effort is instrumental to reducing workers’ wages, hence takeover gains occur
via a reduction in stakeholder welfare. In Pagano and Volpin (2001) this has two natural
implications. First, workers are always opposed to rules favoring control contestability. Sec-
ond, incumbent managers can only gain (and shareholders lose) by an institutionalization of
employment protection, to the extent that long term labor contracts can be used as poison
pills to deter takeovers. We derive opposite predictions in a model where raiders increase
the corporate pie rather than simply redistribute it from stakeholders to shareholders.
6 In-
deed, it is this feature of our model that leaves room for a “congruence of interests” between
shareholders and stakeholders over the security of managerial jobs and the formal protection
of stakeholders.

The paper is related to the recent literature on the political economy of corporate gov-
ernance (see Pagano and Volpin, 2002b and Perotti and von Thadden, 2002 for the relevant
references), to the extent that its results can be applied to a political economy framework to
study how corporate governance and stakeholder protection laws are simultaneously deter-
mined. Our results also relate to the well-known Porter hypothesis (see Porter and van der
Linde, 1995) that environmental regulation enhances innovation. This conjecture has been
recently formalized in a mechanism design model by Ambec and Barla (2001), who argue
that environmental regulation reduces agency costs. Notice that while their work relies on
the crucial assumption that more polluting technologies are also costlier, we argue that en-
vironmental regulation may benefit shareholders even in cases where polluting technologies
are more profitable.

The paper proceeds as follows. In section 2 we set up the basic model. We rule out
potential collusion between incumbent managers and stakeholders, and study how share-
holder value and stakeholder welfare are affected by stakeholder protection and corporate
governance. In section 3, we assume that incumbent managers can commit to a stakeholder-
friendly behavior, in order to obtain stakeholders’ support against a replacement attempt.
We study under which conditions an implicit agreement between managers and stakehold-
ers arises. In section 4, we analyze shareholders’, stakeholders’ and incumbent managers’
preferences over corporate governance and explicit stakeholder protection. In section 5 we
briefly discuss two applications of our result.

6Whether takeovers can only create value by reducing stakeholder welfare is largely an empirical question:
while evidence on the effects on the wage bill is mixed (see Becker, 1995 and Bhagat, Shleifer and Vishny,
1990, but also Jarrell, Brickley and Jeffry, 1988 and Rosett, 1990) casual observations suggest that hostile
takeovers may well benefit natural stakeholders like consumers and potential pollutees. See also footnote 12.



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