Activist Hedge Funds And Firm Disclosure

Jing Chen

State University of New York at Buffalo

Michael J. Jung

New York University – Leonard N. Stern School of Business

September 28, 2015

Review of Financial Economics, Forthcoming


This study examines whether firms’ disclosure decisions are affected by the presence of activist hedge funds. Using a large sample of firms that experienced increases in ownership by activist hedge funds, we find that firms are more likely to cease providing financial guidance or reduce the information in the guidance in the quarter subsequent to new investment by activist hedge funds. These results hold even for firms that experienced good quarters and consistently provided guidance in previous quarters. Since guidance has been shown to be beneficial to capital market participants in many ways, reduced guidance has meaningful market implications. Our findings highlight a negative and possible unintended consequence of activist hedge funds’ investment in firms, which provides some counterbalance to the numerous positive consequences documented in the prior literature on hedge fund activism.

Activist Hedge Funds And Firm Disclosure – Introduction

This study examines a possible unintended consequence of activist hedge funds’ investment in firms—a reduction in firms’ voluntary disclosure. The prior literature on activist hedge funds has documented numerous positive consequences after their investment in firms, including reduced agency costs (Brav, Jiang, Partnoy, & Thomas, 2008; Clifford, 2008; Klein and Zur, 2009), improved corporate innovation, productivity, and tax planning (Brav, Jiang, Ma, & Tian, 2015; Brav, Jiang, & Kim, 2015; Cheng, Huang, Li, & Stanfield, 2012), reduced earnings management (Hall & Trombley, 2012), and greater accounting conservatism (Cheng, Huang, & Li, 2015). However, little research has focused on governance reforms involving disclosure practices, as evidence has been based on a small number of cases in which activist hedge fund blockholders (who own >5% equity) expressly state in Schedule 13D filings that they seek more information disclosure from target firms (e.g., Brav et al., 2008).1 There has also been limited evidence of negative capital market consequences of activist hedge funds’ investment in firms. We posit that, on a broader scale, a possible negative consequence is firms’ reduced likelihood to issue public management forecasts, also known as management guidance, after investment by activist hedge funds.

Some institutional evidence suggests that firms reevaluate their policies regarding guidance as activist hedge funds begin to take initial positions in the firms. Firms cognizant of being targeted by an activist hedge fund or a “wolf pack” of funds (Briggs 2007) are advised by numerous law firms and investment banks to regularly monitor changes in activist hedge fund holdings and to prepare for potential confrontational campaigns by continuously reviewing external communications policies (Christopher & Sheng, 2007; Zenner, Gosebruch, & Berkovitz, 2010; Lipton, 2013; Gelles, 2013; Sullivan & Cromwell, 2013). Since activist hedge funds tend to target firms with predictable revenues and positive cash flows (Brav et al., 2008; Klein & Zur, 2009), firms that provide long-term guidance have been susceptible to becoming a target (NIRI, 2006). This scenario suggests that firms that have detected even small increases in ownership by one or more activist hedge funds may reduce the guidance information that they provide to avoid attracting further attention from the funds.

We also posit that firms’ ability to forecast future financial results, which directly affects their propensity to issue guidance, is reduced by the governance reforms documented in prior studies. Once activist funds begin proactive campaigns against firms, the actions they initiate include requesting meetings with management, seeking board representation, filing formal shareholder proposals, recommending disposal of unproductive assets, demanding changes in capital structure, and lobbying for the sale of the entire firm (Brav et al., 2008; Clifford, 2008; Klein & Zur, 2009; Greenwood & Schor, 2009). Under these conditions in which a firm’s operating, investing, and financing environment is in flux, it would not be surprising for new or existing management to lose some ability to accurately forecast future sales, expenses, earnings, and cash flows. Therefore, even though activist hedge funds may not explicitly demand governance reforms related to firms’ disclosure practices in general, and guidance policies in particular, an unintended consequence can be the cessation or reduction in guidance information provided to capital market participants.

Activist Hedge Funds

Activist Hedge Funds

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