The Case For And Against Activist Hedge Funds

The Case For And Against Activist Hedge Funds by igopp

Activist hedge funds can count on a number of supporters in academia and in the media rising up in defense of their actions. No doubt activist hedge funds have found their most persistent academic supporters in Professor Lucian Bebchuk of the Harvard Law School and his co-authors. In several papers, but most particularly in the Bebchuk, Brav and Jiang (2013) paper, the authors make several claims, which are summarized in Bebchuk’s op-ed piece in the Wall Street Journal:

“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:

Basically, Bebchuk et al’s argue that their vast base of empirical data does not support the claims made by opponents of activist hedge funds.

Other academic researchers have also produced studies somewhat supportive of hedge fund activism. (See for instance Gow et al (2014)4, Zhu (2013)5, Krishnan, Partnoy and Thomas (2015), and for an exhaustive survey Denes, Karpoff and McWilliams (2015).

Then, The Economist in its February 7th 2015 issue imagines a dystopian world where corporate managers and boards of directors are generally incompetent, most investors are lazy and activist
hedge funds have become “a force for good”, “capitalism’s unlikely heroes” and “the saviors of public companies”. However, these claims are but weakly supported in their piece.

Shortly afterwards the AIMA, the “Alternative Asset Management Association”, essentially the hedge funds’ advocacy group, issued a long detailed paper, purporting to show how activist hedge funds (or “alternative asset managers” as they prefer to be called) are “unlocking value”.

But here is the best case that can be made for these hedge funds:

Indeed, over the last fifteen years, institutional investors pursued policies of “soft activism” urging boards to eliminate the staggered election of board members, to separate the chair and CEO positions, etc. Eventually, faced with what they perceived as the inability or unwillingness of boards to rein in executive compensation, they supported “say-on-pay” initiatives (which then became law in the U.S.). They bought the services of proxy advisors, which thrived on ever expanding rules for “good” governance.

As a result, board members, generally honest, responsible, dedicated people, operate in a framework of governance prescriptions which actually consolidate the board’s dependence on management’s vastly superior information, expertise, and experience. Activist hedge funds have tapped into this governance “imperfection”11. They believe that management, unless prodded, will not propose the sort of radical, shareholder centric, measures hedge funds advocate. They also believe that boards of directors are generally ill-equipped, and unlikely, to pressure management to implement these kinds of measures. As institutional investors came to believe this argument, boards gradually lost their trust and confidence.

Increasingly, institutional investors have come to side with, and support with their money, the hard activism of hedge funds in their battles with corporate boards and management. A recent study by FTI Consulting shows that 76% of institutional investors had favorable views of shareholder activism, and 84% of them believed that activism did add value to a target company.

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