Defining Managerial Entrenchment

One of the biggest threats to long-term success is managerial entrenchment, which occurs when corporate leaders put their own self-interests ahead of the company's goals. This is of concern to people working in finance and corporate governance such as compliance officers and investors because managerial entrenchment can affect shareholder value, employee morale, and even lead to legal action in some instances.

Definition

Managerial entrenchment can be defined as an action, such as investing corporate funds, that is made by a manager in order to boost his or her perceived value as an employee, rather than to benefit the company financially or otherwise. Or, in the phrasing of Michael Weisbach, a noted finance professor and author:

"Managerial entrenchment occurs when managers gain so much power that they are able to use the firm to further their own interests rather than the interests of shareholders."

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Corporations depend on investors to raise capital, and these relationships can take years to build and maintain. Companies rely on managers and other employees to cultivate investors, and it's expected that employees will leverage these connections to benefit corporate interests. Some workers also use the perceived value of these transactional relations to ensconce themselves within the organization, making them difficult to dislodge.

Experts in the field of finance call this a dynamic capital structure. For example, a mutual-fund manager with a track record of producing consistent returns and retaining large corporate investors may use those relationships (and the implied threat of losing them) as a means of earning more compensation from management.

Noted finance professors Andrei Shleifer of Harvard University and Robert Vishny of University of Chicago describe the problem this way: 

"By making manager-specific investments, managers can reduce the probability of being replaced, extract higher wages and larger prerequisites from shareholders, and obtain more latitude in determining corporate strategy."

Risks

Over time, this can affect capital structure decisions, which in turn affects the way in which shareholders' and the managers' opinions affect the way a company is run. Managerial entrenchment can reach all the way to the C-suite. Plenty of companies with sliding stock prices and shrinking market shares have been unable to dislodge powerful CEOs whose best days are well behind them. Investors may abandon the company, making it vulnerable to a hostile takeover.

Workplace morale can also suffer, prompting talent to leave or for toxic relationships to fester. A manager who makes purchasing or investment decisions based on personal bias, rather in a company's interests, can also cause statistical discrimination. In extreme circumstances, experts say, management may even turn a blind eye to unethical or illegal business behavior, such as insider trading or collusion, in order to retain an employee who is entrenched.

Sources

• Martin, Gregory, and Lail, Bradley. "The Downside to Limiting Manager Entrenchment." Columbia.edu, 3 April 2017.
• Schleifer, Andrei, and Vishny, Robert W. "Managerial Entrenchment: The Case of Manager-Specific Investments." Journal of Financial Economics. 1989.
• Weisbach, Michael. "Outside Directors and CEO Turnover." Journal of Financial Economics. 1988.
• Wharton School of University of Pennsylvania staff. "The Cost of Entrenchment: Why CEOs Are Rarely Fired." UPenn.edu, 19 January 2011.