The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Labor Outcomes

Alon Brav

Duke University, Durham, NC 27708, USA

National Bureau of Economic Research, Cambridge, MA 02138, USA

Wei Jiang

Columbia University, New York, NY 10027, USA

Hyunseob Kim

Cornell University, Ithaca, NY 14853, USA

Abstract

This paper studies the long-term effect of hedge fund activism on the productivity of target firms using plant-level information from the U.S. Census Bureau. A typical target firm improves its production efficiency in the three years after an activist intervention, and the improvements are most pronounced in those interventions specifically targeting the firm’s business strategy. We also find that plants sold postintervention exhibit a significant improvement in productivity under new ownership, consistent with the view that efficient capital redeployment is an important channel via which activists create value. We further find that employees of target firms experience a reduction in work hours and  stagnation in wages despite an increase in labor productivity. Additional tests refute alternative explanations that attribute the improvement to mean reversion, management’s voluntary reforms, industry consolidation shocks, or hedge funds’ stock picking abilities. The overall evidence is consistent with hedge fund intervention having a real and long-term effect on the fundamental values of target firms.

The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Labor Outcomes

A growing literature on hedge fund activism shows that the stock prices of target firms experience significantly positive returns when the market first learns of the presence of the activist. The range of abnormal returns during the short-term announcement window is highly consistent across different studies and markets.1 A subset of this literature also documents a significant improvement in operating performance in the period following hedge fund interventions. Using our sample of close to 2,000 activism events in the U.S. from 1994 to 2007, we validate and summarize this pattern using return on assets (ROA) as the performance measure. Figure 1 plots the target firms’ average ROA in excess of that of a control group—where the control group consists of firms in the same three-digit SIC industry and year, and is adjusted for firm size and age—from three years before to three years after the public announcement of activism. There is a clear “V” shaped pattern centered on the year of intervention, and the level in the third year post intervention is significantly higher than that during the year of intervention or the year prior to intervention.

While the evidence regarding both stock returns and firm operating performance speaks favorably on the impact of hedge funds activism, several important related questions have yet to be addressed. First, research to date has not explicitly identified how hedge fund activists create value. As a result, little is known about the precise mechanism via which activists are able to improve efficiency and increase shareholder value. In fact, opponents of hedge fund activism often consider hedge fund activists to be “short-term focused” and “financial engineering oriented,” and deny that such activists have any meaningful real and long-term impact.2 Moreover, performance measures at the firm level, such as ROA, do not reveal the underlying channels of improvement. That is, these measures cannot isolate gains from production efficiency of existing assets from those due to capital reallocation, such as the divestiture of underperforming assets, because firm-level analysis cannot trace out the performance of the underlying assets subsequent to the change in ownership.

Second, since previous research is based on databases that cover only public companies at the firm level (such as Compustat), it has been a challenge to address the potential survivorship bias in the post-intervention period. Within two years of activists’ intervention, close to 26% of companies targeted by activists disappear from the Compustat database because they were either acquired or delisted, a rate almost twice the normal attrition rate of the Compustat universe. As a result, researchers have not been able to directly assess post-intervention performance based on an uncensored sample. Third, while existing research has focused on the effects of hedge fund activism on shareholder wealth and the overall operating performance of the target firms, little is known about its impact on the firms’ other stakeholders, particularly the employees.

The limitations of previous research are due both to the novelty of the topic, and hence the lack of a large sample of post-intervention data, and the reliance on firm-level information of public companies. This paper addresses these important impediments by exploring the U.S. Census Bureau’s longitudinal databases of manufacturing establishments (i.e., plants), including the Census of Manufacturers (CMF) and the Annual Survey of Manufacturers (ASM). We match these plant observations to hedge fund activism events from 1994 to 2007 and then examine the dynamics of productive efficiency at firms targeted by activists, measured by total factor productivity (TFP). We assess the relative importance of the gains in efficiency among assets in place and those due to reallocation of the target firms’ plants. In addition, we are able to investigate the impact of hedge fund activism on labor by examining changes to labor productivity, work hours, and wages obtained from the Census Bureau datasets.

Hedge Fund Activism

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