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

2 The model

Consider a firm run by a manager (I) enjoying a large private benefit of control γ from
running the firm. A fraction of shares α is held by the manager, while (1 - α) shares
are dispersed among small shareholders (SH). Dispersed shareholders have no control over
the firm’s course of action. The firm generates both a monetary profit, which accrues to
its owners, and a non-monetary externality on its other stakeholders (ST). We may think
of natural stakeholders like potential pollutees and environmentalists, customers or local
communities. Stakeholders derive no utility from money. All agents in the model are risk-
neutral.

Projects

The firm’s manager can either run the status quo project, or try to improve on it by
discovering a new project. The status quo project (project zero) is highly disliked by both
shareholders and stakeholders, in that it yields no profits and no private benefits to stake-
holders. There are also N a priori identical projects, k ∈ {1, 2,  , N}, which yield a verifiable
monetary profit R with probability p + τk (and zero with probability (1 - p - τk)), and a
non-verifiable private benefit to stakeholders B_k. It is known that (N - 2) projects are worse
than project 0 for both SH and ST, and that at least one of them has disastrous consequences
for both. The only two “relevant projects” generate the following expected monetary payoffs
to shareholders and externalities on stakeholders:

The shareholder’s preferred project succeeds with probability p + τ ; the stakeholders’
preferred project exerts a positive externality B on stakeholders. B can be thought of as
the foregone pollution with respect to the status quo project, the value of preserved em-
ployment for a local community, or the value of additional product safety for consumers.
With probability λ the shareholders’ and the stakeholders’ preferred projects coincide; with
probability (1 - λ), the shareholder’s preferred project yields no private benefit to stakehold-
ers, while the stakeholder’s preferred project only succeeds with probability p. We assume
that λ belongs to (0, 1). λ measures the congruence of interests between shareholders and
stakeholders; alternatively, (1 - λ) captures the trade off between profit maximization and

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