Obstructing Shareholder Coordination In Hedge Fund Activism
Northeastern University – D’Amore-McKim School of Business
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Northeastern University, D’Amore-McKim School of Business, Finance Area
February 8, 2016
Recent theoretical work argues that shareholder coordination can contribute to success in hedge fund activism. We examine the actions that target firms take to limit coordination among shareholders, thus obstructing the ability to coordinate. Targets most often obstruct coordination when the potential for incumbent shareholder coordination is highest and when the target firm stock experiences abnormal turnover just before the activism announcement. Firms that obstruct coordination suffer worse long-term stock and operating performance and a lower probability of mergers, payouts, asset sales, and management changes following activism. Our results are robust to propensity score matching and an instrumental variables analysis.
Obstructing Shareholder Coordination In Hedge Fund Activism – Introduction
“Prevention of, or response to, an activist attack is an art, not a science.” – Martin Lipton, creator of the poison pill.
A large and growing literature examines the role that hedge fund activists play in corporate governance. Focusing on hedge fund activism campaigns, Brav, Jiang, Partnoy, and Thomas (2008) and Klein and Zur (2009) document a positive stock price reaction that does not reverse over the next year. These authors and others also find evidence for positive changes in longer-term operating policies and operating and stock performance (see, for example, Clifford (2008), Becht, Franks, Mayer, and Rossi (2009), Boyson and Mooradian (2011), Boyson, Ma, and Mooradian (2016), Bebchuck, Brav, and Jiang (2015), and Brav, Jiang, and Kim (2015), among others). Greenwood and Schor (2009) argue that hedge fund activists put firms into play, and Boyson, Gantchev, and Shivdasani (2016) find that merger-related activism results in positive outcomes for both targets and bidders, even if the firms are not eventually acquired.
This brief review of the academic literature indicates that most prior work focuses on the activism itself, but is generally silent about the target firm’s response to activism.2 By contrast, accounts from the popular press indicate that potential and current targets of hedge fund activism pend significant time and resources crafting their responses to the threat of activism. In particular, Martin Lipton, the creator of the poison pill, has outlined a comprehensive approach to resist activists, arguing that, “Hedge fund activism requires attention and warrants similar preparation as to that we recommend for responding to a hostile takeover bid.”3 To date, however, no study directly examines the strategies that target firms employ to resist activists, nor the impact of resistance on target firm performance and activist success. Our paper aims to fill this gap.
An analysis of resistance that obstructs the ability of shareholders to coordinate is particularly important in light of recent work highlighting the potential role of coordination in activism. In a theoretical model Brav, Dasgupta, and Mathews (2015) investigate the process by which institutional investors coordinate with each other when intervening in a target firm. Coffee and Palia (2015) describe the formation of “wolf packs” which they describe as “a loose network of activists investors that act in a parallel fashion.”4 These authors argue that coordination is a potentially important, and as yet unstudied, aspect of hedge fund activism.5 Hence, our study of coordination-impeding target firm resistance both complements and expands this recent work.
This paper has two novel findings. First, target firms are more likely to resist activism in ways that directly hinder shareholder coordination when the potential influence of shareholder coordination, as measured by our proxies, is highest. We use two proxies to measure the potential for shareholder coordination. The first is the target firm’s total Shapley value, as in Chakraborty and Gantchev (2013). The Shapley value captures the relative importance of each voting shareholder in terms of his ability to have a pivotal vote in changing firm policy. The second proxy is abnormal stock turnover just before the announcement of activism as suggested by Brav, Dasgupta, and Mathews (2015) and measured as in Brav, Jiang, and Kim (2009) using the 10 days prior to the announcement of activism. These authors argue that abnormal stock turnover around the onset of activism may be due to stock purchases by other institutional investors who are willing to implicitly coordinate with the activist. Using a Probit model, we find that high levels of Shapley value and abnormal stock turnover in the period preceding activism are associated with significant increases in the probability that a target firm will resist activism in a way that directly impedes shareholder coordination. A one standard deviation increase in the total Shapley value is associated with a 31% increase in the probability that a target firm will resist by hindering shareholder coordination, and a one standard deviation increase in abnormal stock turnover is associated with a 22% increase. These results are robust to both propensity score matching and an instrumental variables analysis. By contrast, there is no relation between Shapley value or abnormal stock turnover and target firm resistance that does not directly impede shareholder coordination.
The paper’s second key finding is that resistance that impedes shareholder coordination is associated with worse long-term stock performance, worse long-term operating performance, a lower likelihood of a merger, and a reduced probability that the hedge fund achieves its stated activism goals such as payouts, asset sales, and management changes. The announcement of the resistance itself also generates a negative three-day CAR. Multivariate analyses show that coordination-impeding resistance is associated with a 1900 basis point drop in the target firm’s long-term abnormal stock performance beginning 20 days before and ending 1 year after the onset of activism. The change in operating cash flows is 500 basis points lower, the probability that the firm will merge when the hedge fund is campaigning for a merger is 32% lower, and the probability that edge funds will achieve their other activism goals (including payouts, management changes, and asset sales) is 24% lower.
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