In our previous article, Information Asymmetry in Venture Investing, we discussed how investors can reduce the information gaps between themselves and portfolio companies. In this piece, we turn to another agency problem that quietly erodes shareholder value: management entrenchment.
Coined by economists Michael Jensen (Harvard Business School) and William Meckling (University of Rochester), management entrenchment is a critical concept in corporate governance and agency theory.
What is Management Entrenchment?
Management entrenchment occurs when executives take actions to protect their positions and personal interests—often at the expense of shareholders. Instead of acting as stewards of the company, entrenched managers use their authority to resist oversight, suppress dissent, and avoid accountability.
Common signs of entrenchment include:
- Empire building: Pursuing unnecessary acquisitions to grow headcount or budget, not value.
- Personal perks: Investing in lavish offices or executive benefits.
- Strategic obstruction: Blocking restructuring, M&A deals, or leadership changes that threaten their control.
These behaviors represent classic agency costs, where the incentives of managers (agents) diverge from those of shareholders (principals).
How Entrenchment Develops
Entrenchment is a byproduct of the separation of ownership and control. Shareholders own the company, but day-to-day decisions are delegated to managers. The board of directors is responsible for holding management accountable, yet boards can themselves be “captured” by executives—through influence, long-standing relationships, or information control.
While headline-making entrenchment usually involves CEOs or founders, a more subtle but equally damaging version can occur in middle management. This type often flies under the radar—until it’s too late.
A Case Study: The Fire You Didn’t See
To illustrate, let’s consider a fictionalized but realistic scenario:
A manager, recently hired after being dismissed from a previous role, joins a new company determined to secure his position. Over time, he replaces competent team members with familiar allies from past jobs—creating a closed circle of loyalty. He purchases a modest amount of equity to project alignment with shareholders, but not enough to feel real downside risk.
Soon, he restructures reporting lines so that other departments funnel through his own, consolidating his influence. Attrition begins—top performers leave, morale drops, and productivity erodes. Favoritism replaces meritocracy. A dysfunctional culture takes hold.
By the time senior leadership realizes the damage, it’s too late. The fire is already spreading. And the shareholders foot the bill.
How to Prevent Management Entrenchment
Management entrenchment is not rare—and it is preventable. Below are three concrete strategies companies and investors can use to guard against it.
1. Hire Deliberately—At Every Level
Entrenchment often begins with a bad hire. That’s why world-class organizations place enormous emphasis on recruitment.
Ken Griffin, founder of Citadel, has personally interviewed over 10,000 people. Ray Dalio of Bridgewater Associates developed a rigorous hiring framework to reduce risk, writing:
“Months or even years and countless dollars can be wasted in training and retraining. Some of those costs are intangible—loss of morale, cultural drift, and diminished standards.”
Early-stage companies, in particular, cannot afford to delegate hiring to others too quickly. The wrong hire in a critical role can quietly corrode a company from within.
2. Build a Decentralized Culture
Decentralization dilutes the ability of any one person to dominate or distort a company’s operations. Tom Murphy and Dan Burke, who led Capital Cities to outperform the S&P 500 by nearly 10 percentage points annually from 1966 to 1995, ran their organization with a deeply decentralized model.
Their credo:
“Our goal is to hire the best people and give them the authority they need. All decisions are made at the local level.”
In The Outsiders, author William Thorndike notes that this culture reduced “rancor”—a subtle but important signal of a healthy, non-political workplace.
Decentralized structures require managers to earn authority through execution, not internal maneuvering. It also makes it harder for entrenched behavior to scale across departments.
3. Require Co-Investment, Not Just Incentives
Many executive incentive plans rely on stock options, RSUs, or performance bonuses. But these instruments often offer asymmetric risk: managers enjoy upside when things go well, but face little personal downside when they don’t.
Options are essentially free call options—with positive carry.
To better align interests, shareholders should require direct co-investment from management. This creates real ownership—real “skin in the game.”
Family-run businesses, which make up 30–40% of large global companies according to Credit Suisse, often outperform peers for this reason. When the operator is also an owner, their incentives are naturally aligned with long-term value creation.
Final Thoughts
Management entrenchment is a slow-burning threat. It doesn’t usually show up in earnings reports, but it corrodes a company from within—leading to talent loss, cultural decay, and eventually underperformance.
By hiring carefully, decentralizing decision-making, and requiring genuine co-investment from management, companies can protect against this hidden cost and preserve alignment with shareholders.
