09 Jul 2014Working Paper Summaries

Activist Directors: Determinants and Consequences

by Ian D. Gow, Sa-Pyung Sean Shin and Suraj Srinivasan

Hedge fund activism has become a significant phenomenon in recent years. Compared to traditional shareholder activists, for instance, hedge fund activists have been making a broader range of demands and adopting a wider range of tactics to have those demands met. Given the importance that the demand for board positions has in the activist game plan, the authors of this paper examine hedge fund activism through cases where candidates sponsored by the activists become directors of the target companies. Findings show that activist directors appear to be associated with significant strategic and operational changes in target firms. The study also shows evidence of increased divestiture, decreased acquisition activity, higher probability of being acquired, lower cash balances, higher payout, greater leverage, higher CEO turnover, lower CEO compensation, and reduced investment. The estimated effects are generally greater when activists obtain board representation, consistent with board representation being an important mechanism for bringing about the kinds of changes that activists often demand. Key concepts include:

Activists are more likely to gain board seats at smaller firms and those with weaker stock price performance.
Gaining board positions is an important mechanism that allows hedge fund activists to have an impact in ways that line up with the demands that they make of companies.

Author Abstract

This paper examines the determinants and consequences of hedge fund activism with a focus on activist directors, i.e., those directors appointed in response to demands by activists. Using a sample of 1,969 activism events over the period 2004-2012, we identify 824 activist directors. We find that activists are more likely to gain board seats at smaller firms and those with weaker stock price performance. Activists remain as shareholders longer when they have board seats, with holding periods consistent with conventional notions of "long-term" institutional investors. As in prior research, we find positive announcement-period returns of around 4% to 5% when a firm is targeted by activists and a 2% increase in return on assets over the subsequent one to five years. We find that activist directors are associated with significant strategic and operational actions by firms. We find evidence of increased divestiture, decreased acquisition activity, higher probability of being acquired, lower cash balances, higher payout, greater leverage, higher CEO turnover, lower CEO compensation, and reduced investment. With the exception of the probability of being acquired, these estimated effects are generally greater when activists obtain board representation, consistent with board representation being an important mechanism for bringing about the kinds of changes that activists often demand.