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.

Keywords: shareholder engagement, communication, advice, managerial learning, cheap talk, heterogeneous beliefs, ownership structure, passive funds, advisory voting, index funds

JEL Classification: D71, D74, D82, D83, G34