Corporate Reputational Dynamics, Private Regulation, and Activist Pressure

Abstract

We model the interaction between a profit-maximizing firm and an activist using an infinite-horizon dynamic stochastic game. The firm enhances its reputation through “self-regulation”: voluntary provision of an abatement activity that reduces a negative externality. We show that in equilibrium the externality-reducing activity is subject to decreasing marginal returns, which can cause the firm to “coast on its reputation,” that is, decrease the level of externality-reducing activity as its reputation grows. The activist, which benefits from increases in the externality-reducing activity, can take two types of action that can harm the firm’s reputation: criticism, which can impair the firm’s reputation on the margin, and confrontation, which can trigger a crisis that may severely damage the firm’s reputation. The activist changes the reputational dynamics of the game by tending to keep the firm in reputational states in which it is highly motivated to invest in externality-reducing activity. Criticism and confrontational activity are shown to be imperfect substitutes. The more patient the activist or the more passionate it is about externality reduction, the more likely it is to rely on confrontation. The more patient the firm and the more important corporate citizenship is to firm’s brand equity, the more likely that it will be targeted by an activist that relies on confrontation.

Citation

Abito, J.M., Besanko, D. and Diermeier, D. (2016), "Corporate Reputational Dynamics, Private Regulation, and Activist Pressure", Strategy Beyond Markets (Advances in Strategic Management, Vol. 34), Emerald Group Publishing Limited, Leeds, pp. 235-299. https://doi.org/10.1108/S0742-332220160000034008