Empirical Finance Newsletter, September 2009 (plus Stock Screen Results)
Our partners Wesley R. Gray of the University of Chicago and Andrew E. Kern of the University of Missouri present:
September 2009 — Empirical Finance Newsletter on Hedge Fund Activism, Corporate Governance, and Firm Performance, a paper by Alon Brav, Wei Jiang, Randall Thomas and Frank Partnoy
Abstract: Using a large hand-collected dataset of hedge fund activism in the U.S. over the period 2001 through 2005, we find that activist hedge funds act both as value investors and shareholder advocates. They target undervalued firms, and propose an array of strategic, operational, and financial remedies. Most tactics are non-confrontational, and attain success or partial success in two-thirds of the cases. However, hedge funds seldom seek control of target companies. The market reacts favorably to hedge fund activism, as the abnormal return upon announcement of potential activism is in the range of 5-7 percent, with no apparent reversal in the subsequent year. We show that this positive market reaction does not reflect anticipated wealth transfers from creditors to shareholders, but instead reflects anticipated improvement in performance. Indeed, target firms see moderate improvement in operational performance and considerably higher CEO turnover after activism. Our analysis provides important new evidence on the mechanisms and effects of informed shareholder monitoring.
Conclusions: The contribution of this paper is to show that activist hedge funds are good for corporations, shareholders and the economy generally: They are not short term traders, they encourage the efficient allocation of capital, they generate higher returns for shareholders and do not harm creditors in the process. In light of this evidence, it is difficult to understand the enmity shown by politicians and the media towards the activist hedge fund industry. Of course, it is less difficult to understand why an entrenched CEO who has successfully extracted wealth from the corporation at the expense of other stakeholders might show such enmity. And therein lies a possible explanation as to why activist hedge funds often get such a bad rap.