DP17363 Advising the management: A theory of shareholder engagement
We study the effectiveness of shareholder engagement, i.e., shareholders communicating their views to management. When shareholders and management have different beliefs, each shareholder engages more effectively when more 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, who 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.