The Game Of 'Activist' Hedge Funds: Cui Bono?

The Game Of ‘Activist’ Hedge Funds: Cui Bono?

Institute for Governance of Private and Public Organizations (IGOPP)

August 31, 2015

Abstract:

This paper aims to describe the contemporary tactics and objectives of activist hedge funds as well as the actions taken by targeted companies as a result of their intervention. While doing so, we explored the consequences of activism over time when compared to a random sample of firms with similar characteristics at the time of intervention (effects on operational performance and share price returns), and we analyzed the singularities associated with salient sub-groups of targeted firms. The sample used for our analysis consists of all 259 firms targeted by activist hedge funds in 2010 and 2011. We found evidence that any improvements in operating performance (ROA, ROE, Tobin’s Q) result mainly from selling assets, cutting capital expenditures, buying back shares, reduce workforce, and other basic financial manoeuvres. Although there is no evidence of deterioration over a three-year period, the stock’s performance of targeted companies over a three-year span barely matches the performance of a random sample of companies. We found that the best way for activists to make money for their funds is to get the company sold off or substantial assets spun-off. If not sold, the hedge fund episode often results for the targeted firms in change of senior management and board members, stagnation of assets and R&D. This research does not provide any evidence of the superior strategic sagacity of hedge fund managers but does point to their keen understanding of what moves stock prices in the short term.

The Game Of ‘Activist’ Hedge Funds: Cui Bono? – Introduction

Shareholder activism comes in many shapes and hues (Nili, 2014). There’s the socially minded, issue-driven, form of activism (Rehbein et al., 2013:137), the “soft” activism of institutional investors and the “hard”, financially driven, activism practiced principally by hedge funds. Social activism usually takes the form of pressures on corporations to change their social agenda and cope with environmental, moral, religious or other non-business issues. The soft activism of institutional investors usually involves shareholder proposals aimed at “improving corporate governance” (Thomas and Cotter, 2007). The Shareholder Rights Project set up by the Harvard Law School Program on Institutional Investors is representative of this type of activism.

Finally, the financially driven activism of hedge funds consists of targeting companies where it is expected that implementing measures from a menu of manoeuvres will likely boost their stock prices. The activist first determines whether a company would likely “benefit” from its intervention; if deemed so, the hedge fund takes an equity position and then begins to agitate for changes (Kahan & Rock, 2007). This form of activism is the focus of this paper.

Over the last few years, hedge fund activism has received a great deal of coverage in financial media (and in the mainstream press), has triggered heated debates and been the focus of much academic research. Saviour of capitalism for some, for others, activist hedge funds are but mongers of short-term tactics which eventually damage business corporations. (See “The case for and against activist hedge funds”, Allaire (2015). The funds invested with these activists by institutional investors have been increasing at a 25.4% compounded annual rate between 2010 and 2015 (Turner, WSJ, 2015).

Flush with the cash showered on these funds by institutional investors and increasingly supported in their campaigns by mutual funds, pension funds and other institutional investors, some hedge funds are now targeting larger firms with the intention of forcing a split of their operations or an outright sale of the whole company. (Examples of these include Pershing Square at Allergan, Mondelez, etc.; Trian at Pepsico, Mondelez, Dupont, etc.; Value Act at American Express).

Much academic research has been carried out on the topic but the results are less than compelling. As usual, academia is enlightening but not decisive.

Here are some of the limitations of recent research:

1. Events included as actual hedge fund interventions are vaguely or poorly identified, leading to very different numbers of occurrences for the same years in different studies. Table 1 illustrates this point rather strikingly, indicating large variations in definitions of activist events used by different researchers. For the same period of time or very close periods, researchers come up with different numbers of activist interventions.

2. The date at which the intervention really occurs is rarely explicit; the intervention’s impact may be measured from the date of 13D filing or other public announcement, or the date at which the activist’s demands are satisfied and whether the activist is eventually successful or not with his demands; these different dates and events make a significant difference in assessing the impact of the intervention (Goodwin, 2015). Karpoff (2001) illustrated the discrepancies among 20 empirical studies on the effects of shareholder activism. He pointed out differences in time periods, sample sizes, types of events examined, and definitions of success in shareholder activism (he found 6 different definitions of success).

3. Several studies, as shown in our Table 1, have gathered data on hedge fund activism going back to the 1990s; the nature and form of this activism have changed greatly over the years; by including older instances, these studies risk mixing apples and oranges in their analysis. Indeed, the findings from earlier work on activism seem to be contradicted by more recent research. For instance, according to Denes et al. (2015), “activism in more recent years is more frequently associated with increased share values and operating performance” while Ikenberry and Lakonishok, in 1993, found that “[W]hen dissidents are successful in acquiring board seats […] a downward drift in cumulative abnormal returns extending over a 2-year period following the announcement of the contest is observed.”