Recent advances in research on hedge fund activism: Value creation and identification

Hedge fund activism has emerged as a major force of corporate governance since the 2000s. By the mid-2000s, there were between 150–200 activist hedge funds in action each year, advocating for changes in 200–300 publicly listed companies in the U.S. In this paper, we review the evolution and major characteristics of hedge fund activism, as well as the short- and long-term impact of such activities on the performance and governance of the targeted companies. Though most of the analyses are based on a comprehensive sample of over 2,000 activism events in the U.S. from 1994 to 2011, hand-collected by the authors from regulatory filings and news searches, this paper covers all major studies on the topic, including those on non-U.S. markets

Event Studies in Securities Litigation: Low Power, Confounding Effects, and Bias

An event study is a statistical method for determining whether some event—such as the announcement of earnings or the announcement of a proposed merger—is associated with a statistically significant change in the price of a company’s stock. The main inputs to an event study are historical stock returns for the companies under study, benchmark returns like the return to the broader stock market, and standard statistical tests like t-tests that are used to test for statistical significance. In securities litigation and regulation, event studies are used primarily to detect the impact of disclosures of alleged fraud on the price of a single traded security. But are event studies in securities litigation reliable? What is interesting about the use of event studies in securities litigation is that the methodology litigants use in court differs from the methodology that economists apply in their research. With few exceptions, securities litigation event studies are single-firm event studies, while almost all academic research event studies are multi-firm event studies. Multi-firm event studies are generally accepted in financial economics research, and peer-reviewed journals contain them by the hundreds. By contrast, single-firm event studies—the mainstay of modern securities fraud litigation—are almost nonexistent in peer-reviewed journals. Importing a methodology that economists developed for use with multiple firms into a single-firm context creates three substantial difficulties. First, single-firm event studies suffer from a severe signal-to-noise problem in that they lack statistical power to detect price impacts unless the price impacts are quite large. Inattention to statistical power lowers the deterrent effect of the securities laws by giving a “free pass” to some economically meaningful price impacts and may encourage more small- and mid-scale fraud than is socially optimal given the costs of litigation. Second, single-firm event studies do not average away confounding effects. While this problem is well known, some courts have unrealistic expectations of litigants’ ability to quantitatively decompose observed price impacts into those caused by alleged fraud and those unrelated to alleged fraud. Third, low statistical power and confounding effects combine to generate sizeable upward bias in detected price impacts and therefore in damages. To improve the accuracy of adjudication in securities litigation, we suggest that litigants report the statistical power of their event studies, that courts allow litigants flexibility to deal with the problem of confounding effects, and that courts and litigants consider the possibility of upward bias in the detection of price impacts and the estimation of damages

Wolf pack activism

It is alleged that activist hedge funds congregate around a common target, with one acting as the "lead" activist and others as peripheral activists, or "wolf pack" members. We model this phenomenon as a coordination game, and show that the concentration of capital and skill matters: Holding constant total activist ownership, the presence of a lead activist increases the probability of successful activism due to improved coordination among activists. We model the dynamics of share acquisition by wolf pack members and the lead activist: Block acquisition by the lead activist spurs significant entry by wolf pack members, while the lead activist acquires only if the expected wolf pack is large enough. Finally, we provide predictions concerning which wolf pack activists will buy ahead of the lead activist, and which will wait to acquire until after the lead activist's stake is announced

Using Expectations to Test Asset Pricing Models

Peer Reviewedhttp://deepblue.lib.umich.edu/bitstream/2027.42/72165/1/j.1755-053X.2005.tb00109.x.pd

Failed Anti-Activist Legislation: The Curious Case of the Brokaw Act

The Brokaw Act was proposed legislation aimed at “financial abuses being carried out by activist hedge funds who promote short-term gains at the expense of long-term growth . . . .” Sponsoring Senators named it after a small town in Wisconsin that, according to the Act’s sponsors, was decimated by the actions of a hedge fund activist in shutting down the local paper mill with a loss of hundreds of jobs. The Brokaw Act represented the first attempt at federal legislation aimed at restricting hedge fund activism. Since then, new and similar bipartisan proposals have appeared as have threats of state regulation. In this Comment, we show that the occurrences in Brokaw, Wisconsin are far different from the representations the sponsoring Senators made. Hedge fund activists played essentially no role in the closure of the Brokaw mill. To the contrary, the paper company’s incumbent management closed the mill—just the latest in a series of management’s mill closures—amid an industry-wide decline that made the mill uneconomic to keep open. We then consider two claims of hedge fund activism’s opponents that appear to motivate the Brokaw Act. The first claim—that hedge fund activists typically use the ten-day disclosure period of Rule 13d-1 to accumulate positions significantly in excess of 5%—has been the subject of empirical study and is incorrect. The second claim—that hedge fund activists often form a “wolf pack” in the pre-disclosure period to act collectively against a target—is also without support from empirical evidence. Neither claim warrants legislative action. Finally, we consider two additional parts of the Brokaw Act. The first would expand the concept of beneficial ownership to include certain derivatives linked to the value of equity securities, while the second would require increased disclosure of short positions in the stock of public companies. Neither activity plays an important role in hedge fund activism, and both require additional study before the passage of any legislation

The Real Effects of Hedge Fund Activism: Productivity, Risk, and Product Market Competition

This paper studies the long-term effect of hedge fund activism on the productivity of target firms using plant-level information from the U.S. Census Bureau. A typical target firm improves its production efficiency within two years after activism, and this improvement is concentrated in industries with a high degree of product market competition. By following plants that were sold post-intervention we also find that efficient capital redeployment is an important channel via which activists create value. Furthermore, our analyses demonstrate that measuring performance using the Compustat data is likely to lead to a downward bias because target firms experiencing greater improvement post-intervention are also more likely to disappear from the Compustat database. Finally, consistent with recent work in asset-pricing linking firm investment decisions and expected returns, we show how changes to target firms’ productivity are associated with a decline in systemic risk, particularly in competitive industries.

Wolf pack activism

Blockholder monitoring is central to corporate governance, but blockholders large enough to exercise significant unilateral influence are rare. Mechanisms that enable moderately sized blockholders to exert collective influence are therefore important. Existing theory suggests that engagement by moderately sized blockholders is unlikely, especially when the blocks are held by delegated asset managers who have limited skin in the game. We present a model in which multiple delegated blockholders engage target management in parallel, that is, “wolf pack activism.” Delegation reduces skin in the game, which decreases incentives for engagement. However, it also induces competition over investor capital (i.e., competition for flow). We show that this increases engagement incentives and helps ameliorate the problem of insufficient engagement, although it can also foster excess engagement. Under competition for flow, the total amount of capital seeking skilled activist managers is relevant to engagement incentives, which helps to predict when and where wolf packs arise. Flow incentives are particularly valuable in incentivizing engagement by packs with smaller members.This paper was accepted by Gustavo Manso, finance