What Is Managerial Entrenchment?

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Entrenchment is a possible description of the actions of managers of firms who make investments that are more valuable under themselves than under alternative managers. Those investments might not maximize shareholder value, rather the personal value of the manager.

Or, in the phrasing of Weisbach (1988): "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."

Managerial entrenchment affects the basic structure of capital in a company, which, depending on who invests the most, could drastically alter the daily operations of a given business. For this reason, entrenchment should be avoided, especially on the managerial level.

Capital and Investors

A lot of how corporations raise capital comes from the investors that contribute monetary investments in the company, oftentimes at the request of a firm's manager. If a manager has more clout at a company because of his or her personal contacts, then, that manager could entrench themselves in the firm by only seeking investments from known sources that favor that manager.

Put simply, a manager who commits entrenchment raised business capital through investors that are personal contact with that manager, who would, in turn, threaten to pull out their investment if that manager were fired.

This creates what's known as a dynamic capital structure, which hinges upon the manager's longevity at a company, and the manager in this scenario would, therefore, begin seeking investments from entities that do not necessarily benefit the ethos of the company he or she represents, creating room for statistical discrimination.

Large Shareholders and The Effects of Entrenchment

Companies should avoid managers who are entrenching themselves in the company, even if they seem like good employees with the company's best interest at heart, because large shareholders control the way in which a company is run, and in the long-term, these investments could drastically alter its course.

The abstract to Shleifer and Vishny, 1989, is nicely explicit in explaining the detriment of entrenchment to a company's longevity: "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."

Managerial entrenchment affects capital structure decisions, which in turn affects the way in which shareholders' and the managers' opinions affect the way a company is run. For this reason, companies should seek to disentangle the incentive and entrenchment effects of large shareholders.

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Moffatt, Mike. "What Is Managerial Entrenchment?" ThoughtCo, Sep. 18, 2017, thoughtco.com/definition-of-entrenchment-1148004. Moffatt, Mike. (2017, September 18). What Is Managerial Entrenchment? Retrieved from https://www.thoughtco.com/definition-of-entrenchment-1148004 Moffatt, Mike. "What Is Managerial Entrenchment?" ThoughtCo. https://www.thoughtco.com/definition-of-entrenchment-1148004 (accessed January 19, 2018).