Hedge Fund Investor Activism and Takeovers

by Robin Greenwood & Michael Schor

Overview — Are hedge funds better than large institutional investors at identifying undervalued companies, locating potential acquirers for them, and removing opposition to a takeover? Are they best equipped to monitor management? While blockholding by large institutional investors—pension funds and mutual fund investment companies—is widespread, there is virtually no evidence that these institutional shareholders are effective monitors of management or that their presence in the capital structure increases firm value. When institutional blockholders make formal demands on management, there is no evidence of their success. This working paper outlines the advantages and limits of hedge funds to manage these tasks. Greenwood and Schor's characterization differs markedly from previous work on investor activism, which tends to attribute high announcement returns to improvements in operational performance. Key concepts include:

While recent popular accounts suggest that we are in an era of the "imperial shareholder," the results in this working paper indicate that activism tends to be most successful when there is a high probability of a takeover.
Where improvements may take several quarters or even years to realize, the investment horizon of hedge funds makes them unsuitable overseers of management.
Firms that would benefit from modest changes in operating policy or governance, or for which a reduction in CEO pay is to be desired, are not likely to hit the radar screen of hedge funds.
While hedge funds do occasionally succeed in changing the board, initiating or increasing dividends, repurchasing shares, or cutting executive pay, it is not clear that these changes increase shareholder value relative to getting the target acquired.

Author Abstract

We examine long-horizon stock returns around hedge fund activism in a comprehensive sample of 13D filings by portfolio investors between 1993 and 2006. Abnormal returns surrounding investor activism are high for the subset of targets that are acquired ex-post, but not detectably different from zero for targets that remain independent a year after the initial activist request. Announcement returns show a similar pattern. Firms that are targeted by activists are more likely to get acquired than those in a control sample. We argue that the combination of hedge funds' short investment horizons and their large positions in target firms makes M&A the only attractive exit option. The results also suggest that hedge funds may be better suited to identifying undervalued targets and prompting a takeover, than at engaging in long-term corporate governance or operating issues. Download from the Social Science Research Network.