“Activist” hedge funds:
creators of lasting wealth?
What do the empirical studies really say?
For some time now activist hedge funds have cultivated a revamped reputation as creators of lasting economic value for shareholders. Hedge funds have now found in some academic circles supporters and champions of their enduring contribution to shareholder wealth. Some recent empirical research has indeed triggered an important debate in the American corporate/financial world, about the role of board of directors, the rights of shareholders, and the very concept of the business corporation.
The terms of the debate run as follows: Are boards of directors responsible for the long-term interest of the company? Or, are there lasting benefits from “activist funds” pushing and prodding reticent boards of directors to take actions these activists consider likely to create significant wealth for shareholders? What are the consequences of this “activism” for other stakeholders and for the very nature of board governance?
Simply stated, would a form of “direct democracy” whereby shareholders have a say in all important decisions of the company lead to better long-term corporate performance? That is the implicit claim of “activist hedge funds”.
But, a wide range of observers with considerable financial experience and expertise take a dim view of “activist hedge funds”, lambasting them for their greed-fuelled short-term stratagems and their prejudicial influence on the long-term health of companies.
Among those sharing this view, one finds top corporate lawyers, public officials, at least one SEC chairman, judges of the Delaware Chancery Court, senior corporate executives, legal academics, influential economists and business school professors, prominent business columnists, business organizations, and so on.
For instance, famed lawyer Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz, describes what he sees as the consequence of this new variant of “shareholder activism”:
“U.S. companies, including well-run, high-performing companies, increasingly face:
– pressure to deliver short-term results at the expense of long-term value, whether through excessive risk-taking, avoiding investments that require long-term horizons or taking on substantial leverage to fund special payouts to shareholders;
– challenges in trying to balance competing interests due to excessively empowered special interest and activist shareholders; and
– significant strain from the misallocation of corporate resources and energy into mandated activist or governance initiatives that provide no meaningful benefit to investors or other critical stakeholders.
These challenges are exacerbated by the ease with which activist hedge funds can, without consequence, advance their own goals and agendas by exploiting the current regulatory and institutional environment and credibly threatening to disrupt corporate functioning if their demands are not met.” (Lipton, 2013a)
However, a group of academic researchers, most prominently, Professor Lucian Bebchuk of the Harvard Law School, argue that these wise people, with loads of practical experience, have no “scientific” basis for their collective judgment that activist interventions are detrimental to the long-term interests of shareholders and companies….Having assembled reams of data and statistics, Bebchuk and his colleagues claim they have “scientifically” demonstrated that hedge funds are not “myopic activists”, but on the contrary bring to corporations they target performance improvements which last long after they have exited the target company.
He and his fellow researchers have recently published the results of a large empirical study on the topic. Bebchuk even wrote an op-ed in the Wall Street Journal (August 8th 2013) to herald their findings1. Here’s how he summarizes their study’s findings: “The Myth of Hedge Funds as ‘Myopic Activists’”
Our comprehensive analysis examines a universe of about 2,000 hedge fund interventions during the period of 1994-2007 and tracks companies for five years following an activist’s arrival. We find that:
– During the five-year period following activist interventions, operating performance relative to peers improves consistently through the end of the period;
– The initial stock price spike following the arrival of activists is not reversed in the long term, as opponents assert, and does not fail to reflect the long-term consequences of activism;
– The long-term effects of hedge fund activism are positive even when one focuses on the types of activism that are most resisted and criticized
– first, those that lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing capital expenditures; and second, adversarial interventions employing hostile tactics