Wolves At The Door: A Closer Look At Hedge Fund Activism
Columbia Business School – Accounting, Business Law & Taxation; Columbia University
Michael Mauboussin: Here’s what active managers can do
January 8, 2016
Some commentators attribute the success of hedge fund activism to the support offered by other investors, many of whom are thought to accumulate stakes in the target firms before the activists’ campaigns are public disclosed. This phenomenon is commonly referred to as “wolf pack” activism. This paper explores three research questions: Is there any evidence of wolf pack formation? Is the wolf pack formed intentionally (by the lead activist) or is the result of independent activity by other investors? Does the presence of a wolf pack improve the outcome of the activist’s campaign? First, consistent with wolf pack formation, I find investors other than the lead activist accumulate significant share-holdings before public disclosure. Second, these share accumulations are more likely to be mustered by the lead activist rather than occurring spontaneously. Notably, for example, the other investors are more likely to be those who had a prior trading relationship with the lead activist. Third, the presence of a wolf pack is associated with a greater likelihood that the activist will achieve its stated objectives (e.g., will obtain board seats) and higher future stock returns over the duration of the campaign. This positive association is more consistent with the idea that members are providing support for the lead activist during the campaign and less consistent with the idea that members are “free riding” and joining campaigns that are more likely to be successful.
Wolves At The Door: A Closer Look At Hedge Fund Activism – Introduction
A large body of literature in finance and accounting examines the economics of various corporate governance mechanisms (Bushman, Chen, Engel and Smith 2004; Armstrong, Guay and Weber 2010).1 This paper focuses on hedge fund activism, which over the past decade has emerged as a new type of external governance mechanism, attracting the attention of policymakers and researchers (Brav, Jiang, and Kim 2009; Briggs 2007; Gillan and Starks 2007). Prior studies document that stock prices at firms targeted by activist investors (the ?target firms?) significantly increase when a hedge fund activist‘s plan is publicly disclosed, consistent with shareholders expecting an increase in firm value. Brav et al. (2009) and Klein and Zur (2011), for example, find that target firms earn, on average, abnormal returns of 2%–4% when a hedge fund files the initial schedule 13D, a filing that activist investors must file upon acquiring 5% or more of the target firm‘s stock. These studies also find that activists enact significant changes in target firms, including changes in operating, investing, financing, and payout policies, as well as internal governance practices. Brav et al. (2009) and Klein and Zur (2009) report that hedge fund activists achieve their stated objectives (fully or partially) in about 60%–70% of cases.
Because hedge fund activists typically hold a relatively small stake in the target firms (about 6%; see Brav et al. 2009), this evidence raises the question of why they have they been so successful in pressuring target firms to acquiesce to their requests. Some commentators have suggested that, before the 13D filing by an activist, other investors accumulate smaller stakes (i.e., below the 5% threshold) in the firm and signal their willingness to support the activist‘s campaign, a tactic referred to as ?wolf pack? activism (Briggs 2007; Coffee and Palia 2015). The presence of these other investors effectively increases the percentage of voting shares directed by the activist fund and thus makes the threat of further action, such as a proxy fight, more credible, causing the firm to accede to the activist‘s demands.
However, there is little empirical evidence on the existence of wolf packs. In this paper, I fill this gap by addressing three questions. First, how frequently do wolf packs form in activist campaigns? Second, is pack formation consistent with intentional coordination or does it result from multiple investors independently targeting a similar set of firms around the same time? Third, how does the presence of a wolf pack affect the outcome of a campaign, in terms of the activist‘s ability to achieve its stated objectives? I investigate these questions using 1,922 activist hedge funds‘ campaigns—all campaigns in the SharkRepellent database from 1990 through 2014 in which an activist filed Schedule 13D.
To identify the occurrence of wolf-pack activism —my first research question— I examine trading patterns on the day when the 13-D filer crosses the 5% threshold (the ?trigger date?). This date is not publicly observable until the 13D filing. Similar to prior studies, I document a high level of share turnover on this date, about 325% of the normal trading volume (defined as the average trading volume over the (?120,?60) window before the trigger date). While this could be consistent with wolf-pack formation (e.g., Coffee and Palia 2015), Bebchuk et al. (2013) note that it may simply indicate that the lead activist accumulates most of its holdings on the trigger date. To examine the source of abnormal trading volume, I exploit the fact that activists must report any purchase or sales of the target firm‘s equity for at least the 60 days before the filing date, and therefore including the trigger date, on Schedule 13D. Using this (hand-collected) information, I split the share turnover on the trigger date into two separate components: trades by the 13D filer and trades by other investors. I find that, even after removing trades by the 13D filers, the remaining average share turnover is about 250% of normal trading volume. Hence, the bulk of trading volume on the trigger date reflects trades by other investors, possibly an indication of the presence of a wolf pack.
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