Fuqua Insights Podcast: Can Shareholder Pressure Undermine Breakthrough Science?

Rashmi Shinde 00:00:03.720  

Welcome to Duke Fuqua Insights, a podcast where we explore faculty research and the actionable takeaways for business leaders at every level.

Rashmi Shinde 00:00:17.920  

In today's business landscape, activist investors play an important role in shaping corporate strategy. They push for leaner operations, sharper accountability, and faster returns, all in the name of shareholder value. But what happens when that pressure collides with a company's commitment to long term scientific research?

I'm Rashmi Shinde, a current MBA student at Fuqua and today, I'm excited to welcome Professor Elia Farracuti. Professor Ferracuti is an accounting scholar whose work explores how financial markets and governance structures influence corporate decision-making and innovation. His new research examines what happens to scientific research inside the companies after they are targeted by activist hedge funds.

The findings are striking. After activist campaigns, firms shift research and development towards safer, more incremental projects, especially in industries like pharmaceuticals. Professor Ferracuti, thanks for being here.

Elia Ferracuti  00:01:32.310  

Thank you for having me, Rashmi. I'm really excited to talk about this research, which, by the way, is joint work with another faculty at Fuqua, Rahul Vashishtha, and a former PhD student of ours, now at the University of Utah, Kevin Standridge.

00:01:47.670 Rashmi Shinde

That is amazing. To start, I'd love to hear what first inspired this research. What made you want to look at how investor activism affects corporate science?

Elia Ferracuti  00:02:00.330 

Sure. During the past 15 years or so, there is mounting evidence that the US innovation engine, in terms of both corporations and universities, has lost some steam, which puts the US at risk of falling behind. As an example, just a week ago, news came out that Harvard has lost the title of world's most productive university.

While Chinese universities have been steadily climbing in rankings that emphasize both the volume and quality of research. So this trend is worrisome because innovation, and even more so, basic research, are key drivers of growth and living standards. So we were curious to understand the possible reasons for these trends, which we see as a necessary first step that we need to take if we want to reverse it.

Now, this curiosity, combined with our understanding of the functioning of financial markets, led us to study whether the retreat from research by US corporations could be, at least in part, explained by capital market pressure in the form of hedge fund activism, a form that has gained lots of prominence during the last few years.

Rashmi Shinde  00:03:16.480 

That is such a fascinating insight. Thank you for that. Now, for those less familiar with finance, can you walk us through what hedge fund activism actually means and how it differs from other forms of shareholder involvement?

Elia Ferracuti  00:03:32.320  

Absolutely. This is, in fact, a quite important piece of our story now. Hedge fund activism refers to the phenomenon where hedge fund investors acquire a strict minority block of shares in a target firm, and then they attempt to pressure management to change governance or policies with the goal of improving shareholder returns.

Now, you may be thinking shareholders have attempted to pressure management to increase shareholder value for as long as stock markets have existed. And you would be right. So what's so unique about hedge funds? What makes them different? Well, the answer is their ability to influence management practices.

So compared to other institutional investors such as mutual funds and pension funds, hedge funds operate with much fewer regulatory constraints. For example, they are not subject to the Investment Company Act of 1940. Furthermore, they face fewer conflicts of interest and often they compensate their managers with very powerful financial incentives.

All of these characteristics combined amplify their ability to influence corporate policies. So when a firm is faced with a hedge fund activism event, they face considerable pressure to change their operations in a way that accommodates the hedge funds’ preferences.

Rashmi Shinde  00:05:01.330 

Thank you for sharing that. Your paper opens with the story of DuPont, once a powerhouse of discovery that helped invent materials like nylon. What does that story reveal about how investor pressure can change a company's approach to research and innovation?

Elia Ferracuti  00:05:21.970 

Yeah, so the DuPont example is extraordinary because of how much information we have about the sources of disagreements between DuPont management and Traian Partners, which is the hedge funds that targeted it. Now, what emerges from this information is that there exists a clear difference in preference for scientific research.

For example, Traian declared in their presentation to shareholders that DuPont was spending too heavily on what they called speculative corporate science projects. Now, the campaign was followed by leadership turnover, restructuring and substantial cuts to research, all of which resulted in a significant shift of operations for scientists within the company.

For example, Ron Ozer, who's a chemist who worked at DuPont for decades, declared in an interview with The Atlantic that at DuPont, research was traditionally very academic, with people studying issues that may not have had immediate implications or commercialization opportunities. However, after the Traian campaign, there was a clear change in expectation and now scientists were required to focus on problems with a clear profit objective in mind.

Now, while it is difficult to find as much information as we have on DuPont for other activism campaigns, what they do point example shows so powerfully. And what our broader analysis illustrates is that when shareholder pressure intensifies, foundational scientific research may be among the first activities to go.

Rashmi Shinde  00:07:05.830 

Thank you, professor. That is indeed a very important insight for all of us to know. That brings me to my next question. You find that after activist interventions, companies publish fewer papers, especially in top tier scientific journals. What does that tell us about the kind of innovation being lost?

Elia Ferracuti  00:07:28.750 

Oh, yeah. Very good. So in the paper, we use publications in academic journals as a proxy or as a way to measure corporate scientific research. And as you mentioned, what we find is that these publications decline after activist interventions. Now, in an ideal world, what we truly would like to measure is how many resources corporations dedicate to scientific research, which unfortunately, we cannot observe.

However, what our measure allows us to capture is the portion of scientific activity that generates codified knowledge spillovers. Why is that the case? Well, the reason is that publications are public. Everybody can see them. And as a consequence, they expand our collective scientific stock. They fuel downstream innovation, and they are widely viewed as the primary source of science’s social benefits.

So to answer your question, what our evidence tells us is that after an activism campaign, corporations produce less of the kind of innovation that others can build on, and as a consequence, do less of this socially valuable component under broader corporate scientific activity.

Rashmi Shinde  00:08:46.210 

Your paper also finds that these effects don't stop at targeted companies. Rival firms in the same industries pull back on science too. Why do you think that happens?

Elia Ferracuti  00:08:59.920 

So as you say, one of our findings is that when a firm is targeted by a hedge fund, not only that targeted firm publishes less research, but so do its peers. So this result is quite important, because what it means is that even a fairly small amount of activism events can produce widespread, industry wide retractions from corporate research.

But why would that be the case? In our opinion, this finding is a reflection of the possibility that when firms see a peer being targeted, they perceive an increased threat of hedge fund activism, and as a consequence, they respond proactively to mitigate that threat. Something along the lines of thinking ‘if my peer was targeted, I could be next, so I better step up my game.’

Rashmi Shinde  00:09:52.200 

That is fascinating indeed, so much like human psychology. Which brings me to my next question: in the pharmaceutical industry, your research shows that targeted firms develop more “Me-Too” drugs instead of exploring new ones. Can you explain what a “Me-Too” drug is and how that shift affects both business performance and social impact?

Elia Ferracuti  00:10:20.590 

Absolutely. So to your first question, we can think of new drugs as belonging to a spectrum of innovativeness. On the one end of the spectrum, we have what we call “Me-Too” drugs. Those are compounds that are structurally similar to existing molecules, for example, in terms of chemical composition, and often even share the same mechanism of action.

Now, on the other end of the spectrum, we have novel drugs. Those would be compounds that differ significantly from existing molecules in terms of chemical composition and or mechanism of action. So these two types of drugs are not the same. And they differ along two important dimensions. First, when we look at the stock of drugs available today, many of the most transformative therapies such as antibiotics, mRNA vaccines or monoclonal antibodies originated from deep scientific discovery rather than incremental modifications of existing drugs.

For example, the invention of statins was possible only after scientists identified a key enzyme in cholesterol metabolism. Now, the second dimension in which those two types of drugs differ, which is perhaps more important, is the extent to which they generate positive health outcomes for patients and the extent to which they inspire the development of subsequent drugs, both of which are much larger when it comes to novel drugs.

So what this implies is that the shift from novel to me-too drugs following an activism event that we document means that as a society, we may be losing out on better health outcomes, both directly through fewer novel drugs, but also indirectly through fewer follow-on drug innovations.

Rashmi Shinde  00:12:15.080 

Understood. That is such an interesting and valuable point. Some might say activist investors are simply cutting waste, eliminating projects with low returns. How do your findings challenge that idea?

 Elia Ferracuti  00:12:31.480

That is a very fair concern. There's a ton of convincing work, some of which from colleagues here at Fuqua, that are showing that investor pressure can and does indeed improve efficiency. So a natural question is whether the same dynamic could extend to our paper, where hedge funds simply identify and remove wasteful corporate research.

Now, admittedly, it's very difficult to completely rule out that possibility. However, in the paper, we offer two pieces of evidence that point in a different direction, and in our opinion, they do so quite convincingly. So we do find that hedge fund activism is associated with a particularly large decline of publications in top-tier scientific journals.

So to the extent that publications in higher tier academic journals are of higher quality, these findings suggest that activism eliminates not exclusively low quality or unproductive research, but also original and fundamental science. Furthermore, our evidence in the pharmaceutical setting that we just discussed, where we find that pharmaceutical companies switch from novel to “me-too” drugs, which have documented smaller clinical benefits and fewer knowledge spillovers, indicates a conscious shift away from identifying transformational discoveries towards simply finding new applications for existing knowledge. So when we consider those results jointly, what they imply is that hedge fund activism pushes corporations away from risky activities with long gestation periods and large spillovers, even when those activities could produce large societal benefits.

Rashmi Shinde  00:14:28.690 

Huh? I had not thought of it that way. That is interesting indeed. Looking ahead, if large public firms are retreating from deep research, who is filling that gap? Are startups and universities picking up the slack, or are we losing something that can't be easily replaced?

Elia Ferracuti  00:14:49.010 

This is something very important, and it's something that we thought about long and hard. So as you hinted, the most natural candidate to replace research corporations would be research conducted at universities. Yet public funding for science, especially for basic and exploratory research, is facing increasing political and fiscal pressure, which makes it quite unlikely that universities have the resources necessary to fill this gap.

Now, a second natural candidate, which you also mentioned, would be startups or more broadly, privately owned firms. Now, we think that this is also unlikely when you think about R&D, particularly the research component. Those activities exhibit significant economies of scale and scope, implying that the research conducted in smaller private firms is not going to be equivalent to the research conducted at large public firms.

Now, this conclusion may appear surprising, particularly in light of the research trend of massive investments in emerging technologies such as artificial intelligence and quantum computing from private firms. OpenAI is the obvious example that comes to mind. However, it's important to realize that much of this activity reflects applied engineering rather than basic, fundamental science.

For example, large expenditures on LLMs, proprietary algorithms and quantum hardware are typically directed toward product development, optimization, and data center infrastructure rather than open science inquiry. Moreover, even in these fields, most of the research underpinning the frontier technologies is concentrated in a small number of large public conglomerates.

Think about Google, Microsoft and IBM. As a consequence, it is unclear and in our opinion, unlikely, that smaller private firms can fully replicate the research efforts of large public corporations. So if both public and corporate sources of research are weakening simultaneously, and if private firms cannot step in to fill this gap, then the long run consequences of our findings for both innovation and economic growth could be quite substantial.

Rashmi Shinde  00:17:22.089 

That is indeed a little concerning. Thank you for sharing that. Finally, what should corporate leaders and policymakers take away from your findings? Is there a way to preserve long term innovation, even in a world driven by shareholder pressures?

Elia Ferracuti  00:17:39.930  

That is a $100 billion question, isn't it? And it's a tough issue. It's a tough question to answer. What we believe our paper can show is that there exists a fundamental trade off. On the one end, shareholder activism create tremendous value by improving efficiency and disciplining managers. Yet, it may also reduce the market's ability to sustain long-term, uncertain scientific efforts that can bring about tremendous benefits for society.

So what can corporate leaders and policymakers do? A temptation may be to fiddle with the functioning of capital markets. For example, perhaps we want to make it more difficult for hedge funds to operate. We think that pursuing such policies would be a serious mistake. Markets are a tremendous source of value creation and have served us well for a very long time.

So in our opinion, any attempt to improve upon their functioning with centralized intervention would be quite likely ill suited. So perhaps the cleaner policy implication from our findings is that because firms investments in fundamental research cannot be taken for granted, particularly in the presence of investor pressure, perhaps preserving and incentivizing research at universities is as important as it has ever been—unfortunately, at a time when public support for universities appears to be declining.

Rashmi Shinde  00:19:12.780 

Well, that brings us to the end of our podcast. Thank you so much, professor, for taking the time and sharing your thoughts. The conversation was extremely enlightening. Thank you for taking the time.

Elia Ferracuti  00:19:24.820 

Thank you for having me. That was great.

 Rashmi Shinde  00:19:32.820 

Duke Fuqua Insights is produced by the Fuqua School of Business at Duke University. You can learn more at Fuqua.duke.edu/podcast