Is Managerial Entrenchment Always Bad and Corporate Social Responsibility Always Good?

Ruth V. Aguilera is Professor at the D’Amore-McKim School of Business at Northeastern University. This post is based on an paper, forthcoming in Strategic Management Journal, by Professor Aguilera; Jordi Surroca, Associate Professor of Management at Universidad Carlos III de Madrid; Kurt A. Desender, Associate Professor of Management at Universidad Carlos III de Madrid; and Josep A. Tribó, Professor of Corporate Finance at Universidad Carlos III de Madrid. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Corporate governance research is highly concerned with how to ensure that senior management acts in the benefit of the firm’s shareholders. Through the adoption of corporate governance provisions or through the engagement in CSR, scholars predict there will be less room for managerial opportunism and stronger incentives for generating shareholder value. The empirical evidence has, however, yield mixed findings regarding the influence of takeover provisions, CSR, and other governance arrangements on firm value. Some research attributes these inconclusive findings to the independent evaluation of the impact of each provision, neglecting the configurational relationship of these arrangements as well as where they are embedded (Aguilera, Desender, Bednar, & Lee, 2015; Aguilera, Filatotchev, Gospel, & Jackson, 2008; Misangyi & Acharya, 2014). Building on the governance bundle literature, we argue that bundles of governance practices interact with the institutional system to create or destroy firm value. In particular, we propose that each set of countries in an institutional system, has its own bundle of interrelated corporate arrangements that reinforce one another by generating shareholder value if they are adopted with the same rationale (i.e., they are coherent).

In our paper entitled, Is managerial entrenchment always bad and corporate social responsibility always good? a cross-national examination of their combined influence on shareholder value, forthcoming in Strategic Management Journal, we explore the effectiveness of governance bundles by focusing on the interplay between managerial entrenchment provisions and CSR activities. We argue that their combined effect on firm value is explained by their complementarity (or lack thereof), which in turn depends on the governance rationale behind their adoption—rationales that may vary from country to country. When managerial entrenchment provisions and CSR are adopted with the same rationale (i.e., they are coherent between them), they will work together as complements by mutually reinforcing each other to enhance firm value. Yet, as each national institutional system may possess a distinctive dominant governance logic (Aguilera, Judge, & Terjesen, 2018; Crossland & Hambrick, 2011), we expect this coherence between managerial entrenchment provisions and CSR to be fundamentally different across countries, therefore affecting firms’ ability to create value differently.

To explore the influence of the institutional context on the effectiveness of corporate arrangements, we adopt Hall and Soskice’s (2001) framework, which distinguishes Liberal Market Economies (LMEs) from Coordinated Market Economies (CMEs). LMEs are characterized by a stock market-based financial system, fluid labor markets, education and training systems offering general skills, a limited use of networks and alliances among firms, and a concentration of firms’ decision-making power in top management. On the other hand, CMEs are characterized by a bank- or state-based financial system providing patient capital, strong internal labor markets based on employment protection, training systems that promote firm-specific skills, an extensive use of networks and alliances among firms that favors the internalization of three stakeholder groups’ interests—top management, shareholders, and workers—in firm’s decision making (Kang & Moon, 2012). Based on these institutional differences, we examine how managerial entrenchment provisions and CSR coalesce to shape firm value in firms located in these two distinctive types of capitalisms.

We propose that, in LMEs, the adoption of managerial entrenchment provisions relaxes short-term market pressures and, hence, empowers managers to embrace a long-term perspective in decision making, such as the engagement in mutually beneficial long-term relations with firm stakeholders through CSR. This coherence between managerial entrenchment provisions and CSR is likely to generate positive firm value. In contrast, in CMEs, non-market (negotiated) institutional arrangements exert strong influence on firms’ governance and CSR. In this context, we argue that discretionary increases in managerial entrenchment provisions and CSR do not appear to target the creation of shareholder value. Rather, CSR activities exceeding the stakeholders’ negotiated expectations accompanied with the adoption of managerial entrenchment provisions can be justified by the reputational rents and private benefits that CSR may grant to top managers and large shareholders (blockholders), typically at the expense of minority shareholders. We therefore expect the combination of managerial entrenchment provisions and CSR to be positively linked to firm value in LME institutional systems, but negatively in CME institutional systems.

We find support for our argument using a dataset that combines information on social, environmental, and governance dimensions with other firm- and macro-level variables of a sample of 3,187 publicly listed corporations from 37 countries. Our analysis demonstrates that the institutional system has a strong influence on the combined effect of managerial entrenchment provisions and CSR. When the institutional system supports solutions to coordination problems among economic agents through market-based arrangements, managerial entrenchment provisions allow the implementation of strategies directed to promote long-term investments and relationships. In this case, managerial entrenchment provisions when paired with CSR allow generating intangibles that contribute to create shareholder value. Contrarily, in systems with coordination mechanisms based on non-market arrangements, the joint adoption of managerial entrenchment provisions and CSR destroys value by increasing the power of managers and blockholders to extract rents at the expense of firms’ minority shareholders.

Our analyses and findings have significant implications for a myriad of institutional actors, including investors and regulators. In absence of the protection provided by managerial entrenchment provisions, the market-based discipline of LMEs reduces the incentives for managers to invest in valuable long-term relationships with stakeholders. In this situation, managers will have more incentives to spend generous amounts of company resources in symbolic CSR activities to avoid being disciplined by firm investors (Prior et al., 2008). Our findings for LMEs suggest that managers immune to the short-term pressure of external markets through the protection granted by managerial entrenchment provisions, can credibly fulfill contracts with stakeholders, who in exchange will be more willing to acquire costly firm-specific skills that are necessary to create shareholder value. Hence, a clear recommendation for LMEs is not to hinder the adoption of managerial entrenchment provisions if they are accompanied by the implementation of explicit and substantive CSR activities. Moreover, in order to deter the risk that such CSR would be part of a managerial entrenchment strategy, managers’ compensation should be designed to remunerate the generation of shareholder value together with the advances in CSR (Flammer & Bansal, 2017; Flammer et al., 2019).

Our findings for CMEs also reveal some managerial insights to reduce the negative consequences for firm value from combining managerial entrenchment provisions and externally oriented CSR. It is worth noting that the negative financial outcome is particularly damaging in situations where minority shareholders’ rights are weak. One possible solution to this problem would be limiting the possibility of raising managerial entrenchment provisions in firms with highly concentrated ownership structures or to require the approval of such modifications by a larger percentage of owners. A second step in this direction would be to enforce financial reporting practices that require providing more detail about the CSR expenses in the company’s public accounts. Another measure to prevent stakeholders’ actions that, in the end, harm minority shareholders’ interests would be to give stakeholders economic and political rights over the corporation to align their interests to those of shareholders.

The complete paper is available for download here.

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