In Good Times but Not in Bad: The Role of Managerial Discretion in Moderating the Stakeholder Management and Financial Performance Relationship

• Author: Ali M. Shahzad,Mark P. Sharfman,Matthew A. Rutherford
• Date: 01 December 2016
• Published date: 01 December 2016
• DOI: http://doi.org/10.1111/basr.12100

In Good Times but Not in Bad:

The Role of Managerial

Discretion in Moderating the

Stakeholder Management and

Financial Performance

Relationship

ALI M. SHAHZAD, MATTHEW A. RUTHERFORD, AND

MARK P. SHARFMAN

ABSTRACT

We examine the role of managers in controlling the posi-

tive impact of stakeholder management (SM) on firm

financial performance (FP) in the long term. We develop

and test competing hypotheses on whether managers act

as “good citizens” or engage in “self-dealing” when allowed

greater discretion. We test our assertions using dynamic

panel data analysis of a sample of 806 U.S. public firms

operating in 34 industries over 5 years (2005–2009). Our

results indicate a nuanced influence of managerial discre-

tion contexts on the SM-FP relationship. We infer that giv-

en more latitude in decision making, as long as the “going

is good” managers act as good citizens, but otherwise they

revert to managerial self-dealing. In light of our results,

firms designing governance mechanisms to encourage

Ali M. Shahzad is Assistant Professor at the Department of Management, James Madison Uni-

versity, Harrisonburg, VA, 22801. E-mail: shahzaam@jmu.edu. Matthew A. Rutherford. E-

mail: rutherma@jmu.edu. Mark P. Sharfman. E-mail: msharfman@ou.edu.

V

C2016 W. Michael Hoffman Center for Business Ethics at Bentley University. Published by

Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington

Road, Oxford OX4 2DQ, UK.

Business and Society Review 121:4 497–528

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managers to balance the needs of both shareholders and

stakeholders must remain cognizant of contextual

contingencies.

INTRODUCTION

Prior research suggests that managing relationships with pri-

mary stakeholders such as customers, suppliers, employ-

ees, local government, and communities (Clarkson 1995) is

key to eliciting the enhanced co-operation of these groups toward

the fulfillment of organizational goals (Harrison et al. 2010).

Indeed, extensive prior research confirms that effective stakeholder

management (SM) is not only the right thing to do (Wood 1991),

but from an instrumental perspective, also may be linked with

superior financial performance (FP) (Berman et al. 1999; Hillman

and Keim 2001).

An important assumption inherent within these arguments is

that when managers are given the opportunity for their decisions

to prevail, their actions allow the benefits from SM to enhance

shareholder value. Challenging this assumption, a contrasting SM

perspective is offered by the agency theory, or shareholder, per-

spective of public corporations. According to this view, managers

are assumed to be rational self-interested individuals whose per-

sonal goals may be at odds with those of both shareholders and

stakeholders (Donaldson and Lorsch 1983). Given the opportunity

to exercise their will, managers are considered likely to engage in

self-dealing. For example, managers may reap personal gains by

using the benefits of SM to placate some stakeholder groups and

entrench themselves while continuing to destroy potential share-

holder value (Cespa and Cestone 2007). From an agency perspec-

tive, the positive outcomes from SM investments may end up being

usurped by managers for their own benefit or for the benefit of a

select group of stakeholders negating their potentially positive

influence on FP. In this vein, pursuing a strategy of continued

investments in SM is viewed as an agency problem between the

firm’s managers and both shareholding and non-shareholding

stakeholders (Barnea and Rubin 2010; Hill and Jones 1992; Jen-

sen and Meckling 1976).

498 BUSINESS AND SOCIETY REVIEW

In this study we evaluate the SM and FP relationship within con-

texts that vary in terms of the discretion they provide to managers.

Research on top managers’ strategic decision-making supports the

assertion that the extent to which managers are able to exercise dis-

cretion or “latitude of managerial action” (Hambrick and Finkelstein

1987, p. 371) over strategy formulation and resource allocation activi-

ties varies with different contexts. In certain contexts (Hambrick and

Abrahamson 1995) managerial decisions have a greater impact on the

relationship between firm strategies and outcomes (Hambrick and

Finkelstein 1987). Hence, managerial discretion is “central to discus-

sions of strategy formulation and implementation” (Carpenter and

Golden 1997, p. 187) and facilitates a more complete understanding

of the links between strategic managerial decisions and FP (Adner and

Helfat 2003). As channeling the positive externalities arising out of

superior SM is an important strategic managerial decision (Ackerman

1975), it seems appropriate to include consideration of managerial

discretion contexts when investigating the link between SM and FP.

Examining the SM-FP relationship using managerial discretion as

a moderating condition is an appropriate research setting for at

least two reasons. First, SM is synonymous with a firm’s strategic

choices

1

of deploying firm resources to address the social and envi-

ronmental issues concerning primary stakeholders (Agle et al. 1999;

Money et al. 2012). Such choices help generate socially complex and

causally ambiguous intangible resources and capabilities (Surroca

et al. 2010) which may lead to competitive advantages and the crea-

tion of firm value (Hillman and Keim 2001; Wood 1991). We assert

that the appropriability or “ability of the firm to extract economic

benefits” (Husted and Allen 2007, p. 599) from the use of such valu-

able, rare, and inimitable (VRI) resources or capabilities depends

heavily on their effective management. In modern firms, managers

control most of the resources required to address stakeholder-

related issues (Frooman 1999). Under pressure from shareholders

and other stakeholder groups to “do good,” managers are expected

to make strategic choices and address stakeholder demands in pur-

suit of activities that may help the firm jointly enhance stakeholder

welfare and generate competitive advantages (McWilliams and Siegel

2011; Mitchell et al. 1997). The managerial discretion view suggests

that there is variation in managerial influence over the link between

organizational strategy and outcomes. Given that situations which

offer managers latitude in decision-making impact their resource-

499SHAHZAD, RUTHERFORD, AND SHARFMAN