# Presentation: 106506

## Hedge Fund Activism, Corporate Governance, and Firm Performance

**Alon Brav**, Duke University
**Wei Jiang**, Columbia University
**Frank Partnoy**, University of San Diego
**Randall Thomas**, Vanderbilt University

## Shareholder activism

- Tools: shareholder proposal, media campaign, proxy contest, takeover.
- Very different from traditional strategy:
- Identify mispricing, trade accordingly, and passively wait for convergence.
- Can be denoted as *activist arbitrage *vs. *pure trading arbitrage*.
- Trade off between two strategies has been analyzed  theoretically:
- Bolton & von Thadden (1998), Kahn & Winton (1998), Maug (1998).

**Shareholder activism**

- Brav, Jiang, Partnoy, and Thomas

- 2006

## What we know about activism

- Informed shareholder monitoring can reduce agency problems
- But collective action problem
- Non-HF activism positive but insignificant
- Other agency problems
- Regulatory/liquidity constraints
- Why are HFs different?
- Manager incentives
- Fewer conflicts of interest
- Flexibility, unregulated

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
Cost of monitoring at the micro-level of any single firm is too high compared to the private benefit, and free riding by other shareholders is wide spread
Other institutions face regulatory constraints, including prohibitions on accumulating large block positions in any single firm, or the necessity to maintain liquidity of the portfolios that prevents them from intervening actions that might subject them to insider trading regulation.  

The unique structure and status of hedge funds suggest they have the potential to fill some of the gaps left by pension funds and mutual funds.

## Goal of the study

- Bradly, Brav, Goldstein,and Jiang (2005):  the 1st large-sample study on HF activism, but the targets are confined to closed-end funds.
- Clear identification
- But CEFs are a small set of publicly traded companies
- This one:  first large-sample study on HF activism in regular corporations:
- Type of target?
- Typical strategies?
- Success?
- Short-term?
- In general, does HF activism enhance or destroy shareholder value?

- Brav, Jiang, Partnoy, and Thomas

- 2006

## Data

- No centralized data base for activist hedge funds.
- Initial sample started with news search on “hedge fund” and “activism.”  All 13D files by these funds are retrieved.
- More funds recovered from processing the initial funds, and supplemented by people in the business.  Retrieve all 13D files by the new funds.
- Add activist events for the group of funds outside 13D from Spectrum 13F filings and news search.
- Current sample:  2004-2005; new sample:  2001-2005.

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
At various stages during this process, we have shown our list of hedge funds to participants in the hedge fund industry and obtained comments and suggestions for additions and deletions.

## Overview (current sample)

- 110 activist hedge funds.
- 374 hedge fund-target company pairs.
- 339 unique target companies in 54 SIC two-digit industries.
- 41.7% (156 cases) of the sample saw aggressive activism launched (beyond “communicating with the managers” on “maximizing shareholder value”).
- 27% of all the 13D filings involve group of hedge funds.

- Brav, Jiang, Partnoy, and Thomas

- 2006

## Stated objective of hedge funds

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
If the hedge fund and the company reached some settlement through negotiation that partially meets the hedge fund’s original goal, it is considered partially successful.  
In about 62 cases the hedge fund wants the company to sell itself, 20 of them end up being sold, an additional 8 cases the company remains as a stand-alone but agrees to undergo a major reform.

## Activists’ Tactics

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
Among the confrontational cases, firms choose to fight about 50% of the times, accommodate about 30% of the times, and the rest 20% is negotiation or ingoring.

156 cases are aggressive, 42%

## Commitment of capital

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
The maximum capital is retrieved from one of the 13D/A files that reports the highest holdings by the filing party in the target.

## Length of investment (by June 2006)

-  In about 85% of the cases, HFs appear to still hold more than 5%.
-  Spectrum 13Fs reveal equity portfolio annual turnover rates of these funds at the 25th, 50th, and 75th percentile:  29.5%; 55.3%; 82.7%

- Brav, Jiang, Partnoy, and Thomas

- 2006

## Characteristics of target companies

- Two methods:
- Compare the target company to the mean statistics of industry-size-B/M matched firms.
- Rank each target company within the match group, and calculate the mean ranking/percentile.

- Brav, Jiang, Partnoy, and Thomas

- 2006

## Characteristics of target companies

|  | Dif w/ Match | t-stat | Avg
 Percentile |
| --- | --- | --- | --- |
| Mkt Cap | -628 | -5.28 | 0.51 |
| Book to Mkt | 0.148 | 4.90 | 0.59 |
| Growth | -0.018 | -1.20 | 0.49 |
| ROA | 0.048 | 5.83 | 0.60 |
| Cash Flows | 0.035 | 3.89 | 0.55 |
| LEV (Debt/Cap) | 0.039 | 2.47 | 0.53 |
| CASH | -0.037 | -3.65 | 0.48 |
| DIV YLD | -0.004 | -4.46 | 0.46 |
| R&D | -0.029 | -3.99 | 0.39 |
| HERFINDAHL | -0.033 | -2.26 | 0.47 |
| GINDEX | 0.707 | 3.38 | 0.57 |
| %INSTITUTION | 0.122 | 8.04 | 0.64 |
|  |  |  |  |

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
Target firms do not seem to suffer from serious operational difficulties.  They are actually profitable and enjoy handsome cash flows.  The potential problem that these companies firm is likely related to the agency problem of free cash flows, such as relatively low payout, and diversifying investments that may not be in the best interest of shareholders.  
The Gindex tracks 24 takeover defenses (including state laws) hat forms could adopt.
Average size, but avoid top quintile-sized firms.
Value investing:  High BM.
Fine operations:  growth, ROA and CF.  
About average leverage and diversification.
Low tech:  R&D
“Bad” governance:  GINDEX
High institutional ownership.  
Target general issues rather than firm-specific operational problems.
Maintain the option of getting value-investing returns.
Avoid retail investor “apathy.”

## Market reaction: 5-7% abnormal return

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
T-10 is roughly the date of the last trade that crossed the 5% ownership threshold.
Robert Chapman, who runs the activist fund Chapman Capital, refers to hedge fund investors who tag along for the ride as “Remora”—the suckerfish that attach themselves to sharks and suck off parasites and bacteria as food.
Stocks that are overly crowded with hedge funds are known as “hedge fund roach motels.”

## Longer-term returns (in months)

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
No reversal of the market response rules out the possibility that the positive abnormal return in the event window is driven by the price impact of buying by the hedge funds.

## Which activism matters?

|  | coef | t-statistic |
| --- | --- | --- |
| ln(MV) | -0.003 | -0.230 |
| General | 0.055 | 3.764 |
| CapStructure | 0.000 | 0.001 |
| BusStrategy | 0.059 | 2.567 |
| Sale | 0.104 | 4.865 |
| Gov | -0.005 | -0.296 |
| Financing | 0.168 | 2.592 |

-  Strongest response to sale (of the company) and financing related activism.
-  Purely capital structure and governance targeting do not generate abnormal returns.
-  Hostile activism generates stronger market reaction than friendly ones.

- Regressing (-20, 20) abnormal returns on stated objective:

- Brav, Jiang, Partnoy, and Thomas

- 2006

## Ongoing work:  Effect on operational performance

- Capital structure decisions before and after (relative to matched firms)

- Brav, Jiang, Partnoy, and Thomas

- 2006

## Ongoing work

- Finishing a complete sample of 130 activist funds, all their 13D filings, and out-of-13D activism in 2001-2005, altogether about 800 events.
- Analyze the long term effect on target firms.
- Analyze returns to hedge funds and the life cycle of the activist investment strategy.
- Model the decision to launch activism.

- Brav, Jiang, Partnoy, and Thomas

- 2006

**Notes:**
If activism can be viewed as another form of arbitrage, then it is likely that the abnormal returns associated with it will decline, or even disappear, as more funds chase after fewer attractive targets, and as the market incorporate the potential of investor intervention and improvement into security prices.