Change in stakeholder utility function during crisis

Abstract

The purpose of this paper is to examine firm theory through the lenses of stakeholder utility function. Stakeholders are reluctant to leave a company when it faces financial distress. However, they maximize their utility function by seeking other alternatives. The observed behavior may be a result of biased assessment of firm’s prospects and available market options. The study provides empirical evidence that stakeholders are risk averse. We defined the utility function of stakeholders as the second moment of economic value added (EVA). The results show that stakeholders' perception of risk is conservative: the distribution of the function is exponential. The higher the return, the higher the expected utility function with declining marginal utility of return. The application of this function to various sets of options revealed that risk attitude of stakeholders depends on the firm’s profitability. With a high degree of uncertainty stakeholder perceptions of risk change. We found that probability of stakeholders leaving a company when it is distressed is considerably low, 15.65%. Although they are reluctant to exit, they become more intemperate and, as a consequence, more short-term which undermines the long-run prospects of the business. The findings of this paper are relevant to the evaluation of company’s sustainability and estimation of contract duration.