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Recent Paper Shows Hedge Fund Activism Generally Helps Companies
August 19, 2013
From Apple to JC Penney, activist hedge funds have been in the news recently. Activists purchase minority blocks in target companies and are able to intervene in various firm policies. Critics say that intervention hurts companies in the long run and that activist hedge funds are only out for short-term profits.
A recent paper from Duke University's Fuqua School of Business' Alon Brav, Harvard Law School's Lucian Bebchuk, and Columbia Business School's Wei Jiang proves the critics wrong. The study "The Long-Term Effects of Hedge Fund Activism" shows companies' performance improves, on average, subsequent to activists' involvement (read the full paper about activist hedge funds here).
Finance professor Alon Brav explains the findings in a Fuqua Q and A.
1. What would you consider the most significant finding of this study?
We use a dataset consisting of approximately 2,000 interventions in the U.S. by activist hedge funds over the period 1994-2007. We identify for each event the month in which the activist initiative was first publicly disclosed (usually through the filing of a Schedule 13D to the SEC). Using the data on operating performance and stock returns of public companies during the period 1991-2012, we track the operating performance and stock returns for companies during a long period - five years - following the month of the intervention. We also examine the three-year period that precedes activist interventions and that follows activists' departure.We find that the operating performance improves following activist interventions and there is no evidence that the improved performance comes at the expense of performance later on. In addition, we find significant positive (roughly 6%) stock price reaction around the period in which activist interventions are disclosed to the public. This short-term market reaction to the entry of activists does not reflect an inefficient market reaction since we do not find any subsequent negative price drift in the ensuing few years post-activism.
2. One of the most widely circulated criticisms of activist hedge funds is that they only look at the short term to make a profit. Your study shows that is not true. Tell us why.
We examine the two subsets of activist interventions that are most criticized - first, interventions that lower or constrain long-term investments by increasing leverage, beefing up shareholder payouts, or reducing investments and, second, adversarial interventions employing hostile tactics. In both cases, interventions are followed by improvements in operating performance during the five-year period following the intervention. Finally, we also ask whether activist interventions render targeted companies more vulnerable to economic shocks by examining whether companies targeted by activist interventions during the years preceding the financial crisis were hit more in the subsequent crisis. We find no evidence that pre-crisis interventions by activists were associated with greater declines in operating performance or higher incidence of financial distress during the crisis.
3. Another criticism of activists is that they "pump and dump" or pour money in and then get out before living with the long term results. What did you find regarding this?
We also analyze whether activists cash out their stake in the target company before negative stock returns occur. To do so, we examine whether targets of activist hedge funds experience negative abnormal returns in the three years after an activist discloses that its holdings fell below the 5% threshold that subjects investors to significant disclosure requirements. Again, we find no evidence of underperformance.
4. If activists are largely good for companies, in your opinion, should there be more of these types of hedge funds?
Like other trading strategies and, more generally, other competitive environments, the profitability of activist investing will likely decline as more funds engage in activism and larger amount of capital flows into these hedge funds. Consequently, while more activism should still be beneficial, it is likely that we will see profitability decline and the nature of fund interactions with management turn more hostile.