Over the past decade, the meaning of shareholder democracy has shifted dramatically. Investors are no longer a uniform bloc, focused solely on financial returns, but increasingly diverse. Some press companies to pursue environmental and social goals, while others adhere to Milton Friedman’s dictum that the only social responsibility of business is to maximize profits. At the same time, shareholders have become more vocal, frequently advancing proposals and exercising their voting rights. This growing heterogeneity and engagement create strategic challenges for firms. How should managers position their companies when investors disagree over the balance between profit and purpose? And what happens when shareholders act not only as providers of capital but also as active participants in corporate governance?

In a recent paper, we examine these questions through a modified Hotelling–Downs model of competition. The model allows us to capture how two firms, each seeking outside equity financing, differentiate themselves along a “social impact” spectrum. Investors are assumed to value both financial returns and social outcomes, but they disagree on how much weight to put on the latter.

Firms Position Themselves for Investor Bases

In the first stage of our analysis, investors are passive; they buy shares but do not attempt to influence corporate policy afterward. Firms know that investors differ in their social preferences and choose social positions to appeal to different types of investors.

A key insight is that firms tend to over-differentiate. One firm positions itself as the least socially oriented, the other as the most pro-social. This differentiation softens competition in the capital market, allowing each to set a higher offering price when raising equity from investors.

We also allow for external stakeholder awareness, the idea that investors care not only about their own firm’s social impact but also, to a lesser extent, about the externalities generated by other firms. It plays an important role. Paradoxically, when investors care more broadly about society’s total externalities (thus higher external stakeholder awareness), firms differentiate less, pushing the more pro-social firms toward the middle. The result can be a decline in the economy’s average level of social activity.

Shareholder Democracy Changes the Equilibrium

We then introduce active shareholder engagement: Investors can vote to shift their firm’s social position after the financing stage. By the Median Voter Theorem, the winning position reflects the median shareholder’s preference, not the extremes. This means both types of firms move toward the center; the less pro-social firm chooses higher social impact, while the more pro-social firm scales back.

This has several consequences. First, share prices fall because firms are less differentiated, intensifying competition. Second, the composition of the shareholder base shifts. Because investors anticipate voting, they consider not only the firm’s initial position but also how it will be adjusted later.

The results a feedback loop. Firms announce initial social positions to compete for financing, but investors know these positions can later be altered with a cost by shareholder voting. Anticipating this, investors choose which firm to invest in based on both the announced position and the likely post-vote outcome. The shareholder base then determines the voting result, which in turn determines the firm’s final actions. Thus, with heterogeneous investor preferences, firms differentiate on proposed social policies to attract their shareholder base. The shareholder base then drives voting, and the voting outcome determines firm policy, thus creating a feedback loop through which capital markets shape governance.

Implications for Regulation and Welfare

Our analysis contributes to debates in corporate governance and regulation by showing that shareholder democracy is more complex than it first appears. Prior models often treat shareholder composition as fixed or shaped only by secondary trading, but we demonstrate that firms themselves, through strategic differentiation, play a central role in shaping who their shareholders are. Because the shareholder base is endogenous, voting outcomes are also endogenous: Who ultimately votes depends on how firms differentiated themselves at the outset.

Another striking finding is about cost of capital. Intuitively, one might expect the less pro-social firm, which is able to set a higher offering price when raising equity, to enjoy a lower cost of capital. Our model shows the opposite: The more pro-social firm has a lower cost of capital. This aligns with empirical evidence suggesting that socially responsible firms often finance themselves more cheaply, because pro-social investors are willing to shoulder part of the cost of social initiatives.

From a welfare perspective, shareholder democracy improves total welfare. By curbing excessive differentiation, it reduces the inefficiency created when firms cater only to the extremes. However, the effects on average social impact are more nuanced. Shareholder democracy raises (lowers) average social impact when external stakeholder awareness is high (low). When external stakeholder awareness is low, investors focus only on their own firm’s impact, and firms initially announce extreme positions. After voting, the pro-social firm moderates more, lowering average social impact. When awareness is high, investors care about both firms’ impacts, and more socially conscious investors invest in the less pro-social firm, shifting its median voter to be more pro-social. Overall, the shift in shareholder base dominates, raising the economy’s average social impact after shareholder voting.

Conclusion

The rise of shareholder democracy thus reflects a profound shift in capital markets. Firms no longer face a homogeneous investor body but a fractured audience with competing visions of what corporations should do. Our model shows that this heterogeneity, combined with shareholder democracy, sets off a feedback loop linking firm strategy, shareholder base, and governance outcomes. Shareholder democracy is not simply aggregating shareholder’s preference, but a two-way interaction between firm strategies and shareholder base. Firms strategically differentiate to attract investors, investors self-select into firms, and shareholder composition determines the ultimate governance outcomes. Appreciating this loop is important for understanding the relationship between shareholder democracy and corporate strategy.

This post comes to us from Hui Chen at the University of Zurich, Zeqiong Huang at Yale School of Management, and Mingxuan Ma at the University of Zurich. It is based on their recent article, “Shareholder Democracy and Strategic Differentiation in Capital Markets,” available here.