New strategic management study shows activist directorships yield increased reports of stakeholder harm

The appointment of activist-nominated directors is an emerging phenomenon, but they’ve come with increased reports of stakeholder harm. A new study published in Strategic Management Journal found that activist directors bring immediate benefits to shareholders, but they appear to impose a managerial myopia that results in executives becoming less inclined to make long-term investments. The research team also found that the adverse effects on stakeholder harm are strongest when a director is a delegate — i.e., they work directly for an activist investor — compared with a trustee, who is appointed by, but does not work for, an activist investor.

The research team — Brian L. Connelly of Auburn University, Mark R. DesJardine of Dartmouth College, Wei Shi of University of Miami, and Zhihui Sun of Capital University of Economics and Business in Beijing — pulled data on thousands of companies that had directors appointed to their board by an activist investor between 2008 and 2019. They compared these boards to those without activist-nominated members to determine the likely consequences of the board appointments across a broad range of scenarios.

The team’s definition of stakeholder harm includes a wide range of non-financial corporate outcomes related to the interests of non-shareholders who are connected to the company: customers, suppliers, employees, alliance partners, and the community where it operates. Because the researchers couldn’t precisely know when the organization began the process of harming stakeholders, they focused on observable outcomes by way of three different types of reports. These included rater reports, which come from evaluator agencies such as KLD who consider the extent to which companies engage in behavior that is concerning for community, diversity, employees, products, the environment, or human rights. They also reviewed media reports, which are somewhat more grievous because they are focused on violations that rise to the level where they attract journalist attention. Lastly, they looked at regulator reports, which are more rigid in that they operate in an institutional context, originating from federal agencies such as OSHA and the EPA as well as state and local agencies.

“Stakeholder harm often manifests when executives shift their organizational priorities away from the interests of stakeholders,” Connelly says. “When the focus of executives becomes sufficiently detached from stakeholders, an environment in which stakeholders might be harmed will take hold, and external audiences will take note.”

They found that activist directors do bring immediate benefits to shareholders, but they also appear to reduce executives’ inclinations to make long-term investments. The team also discovered the adverse effects on stakeholder harm to be most profound when a director is a delegate — meaning they work directly for an activist investor — compared to when the director is a trustee — meaning they are appointed by, but do not work for, an activist investor.

“Activist directors bring a ton of value to the boards on which they serve: They bring fresh perspectives, demand attention to pressing matters, and offer new kinds of expertise to the group dynamic,” Connelly says. “Our study just lends an additional cautionary measure to throw into that mix: Activist directors and the boards on which they serve should keep the end in mind. Nobody, including the activist directors themselves, wants to see more stakeholder harm.”

According to Connelly, this negative outcome is likely a consequence of extreme pressure on short-term results. The researchers suggest that, if this effect can be tempered with an appreciation for the potential consequences of re-allocating strategic resources, boards could get the best of both worlds: immediate benefits to financial outcomes without sacrificing strategic, sustainably related outcomes. They also recommend that companies vie for a trustee, as opposed to a delegate, whenever possible.

To read the full context of the study and its methods, access the full paper available in the Strategic Management Journal.

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