6.2 The Interaction Between Exit and Voice

Clearly, the easy availability of exit may discourage voice: If one can easily exit, why bother to use voice? The notion that the easy availability of exit may encourage voice therefore seems counterintuitive at first. However, as Hirschman explains, "The chances for voice to function effectively as a recuperation mechanism are appreciably strengthened if voice is backed up by the threat of exit, whether it is made openly or whether the possibility of exit is merely well understood to be an element in the situation by all concerned." As a result, while "the willingness to develop and use the voice mechanism is reduced by exit, [the] ability to use it with effect is increased by it." The probability that the use of voice will be effective obviously plays an important role in deciding whether to exit or use voice. If exit is easily available, this makes the threat of exit more credible; this in turn results in a higher probability that the use of voice will be effective. Viewed this way, easy availability of exit makes voice more attractive.

As an example of this peculiar interaction between exit and voice, consider the dilemma faced by a corporate shareholder who is dissatisfied with the way her portfolio firm compensates its executives. Such a shareholder can either exit or use voice. The formal way to use voice is by voting: the recent Dodd-Frank Act grants shareholders say-on-pay, albeit the outcome of the vote is not legally binding. The informal way to use voice is by communicating concerns directly to management, a real option to institutional shareholders; studies have found that as many as 55 percent of institutional investors are willing to engage directly in discussions with the firm's executives.1 In both cases, management will have discretion in deciding whether or not to take measures alleviating the shareholder's concerns. The probability that management will do so, that is the probability that the use of voice will be effective, depends in part on how credible the threat of exit is. Management will generally want to prevent dissatisfied shareholders from exiting, given the downward pressure on the share price this may cause. A decrease in the share price, after all, negatively affects the variable compensation many executives receive.2 Moreover, a decrease in the share price increases the probability of a hostile takeover.3

At first glance, the threat of exit appears credible given how easily investors can sell their corporate shares in liquid markets. However, a significant downside to exiting (or "switching" from one portfolio firm to another) is that the cash amount that a shareholder receives for selling her shares in the market may not suffice, and is indeed unlikely to suffice, to purchase a substitute share that is expected to yield higher returns. This mitigates the threat of exit and therefore makes it easier for management to ignore the shareholder's concerns. The fact that sale prices in corporations reflect expected returns thus lowers the probability that the use of voice will be effective and, all else being equal, makes voice less attractive.