Advising the Management: A Theory of Shareholder Engagement

Abstract

We study the effectiveness of shareholder engagement, that is, shareholders communicating their views to management. When shareholders and management have different beliefs, each shareholder engages more effectively when other shareholders engage as well. A limited shareholder base can thus prevent effective engagement. However, a limited shareholder base naturally arises under heterogeneous beliefs because investors who most disagree with management do not become shareholders. Passive funds, which own the firm regardless of their beliefs, can counteract these effects and improve engagement. When shareholders’ and management’s preferences are strongly misaligned, shareholders’ engagement decisions become substitutes and the role of ownership structure declines.

Public Information as a Source of Disagreement Among Shareholders

“…Similarly, if selling is driven by different opinions rather than private information, then the exit of a blockholder should not be interpreted as a negative signal on firm value, and thus the "Wall Street Walk" (Admati and Pfleiderer 2009) would inefficiently discipline a hard-working manager who enhances firm value but is unfavored in the blockholder's idiosyncratic opinions. Finally, the desirability and organization of the communication between shareholders and managers also depends on whether shareholders have common or heterogeneous opinion (see Levit 2019, 2020 for a model with common opinion, and Kakhbod et al 2022 for a difference-of-opinion model).…”

Trading and Shareholder Democracy

“…10 Garlappi, Giammarino, andLazrak (2017, 2022) analyze group decision-making about investment projects and show how trade among group members may overcome inefficiencies from differences in beliefs. Kakhbod et al (2023) study how shareholders with heterogeneous beliefs trade prior to communicating their views to management. These papers focus, respectively, on the dynamics of group decision-making and externalities in communication, and thus, do not feature the mechanisms and results that arise in our model.…”

What Role Do Boards Play in Companies with Visionary CEOs?

“…Our paper also relates to the fast-growing literature on behavioral biases and heterogeneous beliefs. 3 This literature studies how overconfidence and other biases affect managers' inclination to overinvest in projects (Heaton [2002], Malmendier and Tate [2005]), the optimal design of debt covenants (Infuehr and Laux [2022]), the relation between litigation risk and misreporting incentives (Laux and Stocken [2012]), managers' risktaking incentives (Gervais, Heaton, and Odean [2011]), CEO promotion decisions (Goel and Thakor [2008]), communication between shareholders and managers (Kakhbod et al [2023]), and the costs and benefits of public versus private ownership (Boot, Gopalan, and Thakor [2006]). More closely related to our study, Che and Kartik [2009] show that differences of opinion can increase incentives for information acquisition because an advisor who disagrees with a decision maker is eager to produce additional information to persuade the latter to make "better" decisions.…”