Shareholder Activism and CEO Quality
Abstract
We examine the relationship between shareholder activism and managerial quality at
firms targeted by activists. We decompose variations in different measures of firm performance
into firm and manager components and use principal component analysis of the manager fixed
effects to construct a measure of managerial ability. We find that this measure of CEO quality isa significant predictor of shareholder activism. In addition, conditional on a firm being targeted,
we find that the likelihood of the activist’s demand being control-related is higher for firms withlower quality CEOs. Finally, hedge fund activists appear no different from other activists in their
sensitivity to CEO quality when making control-related demands, but hedge funds are moresensitive to their percentage shareholding in the target firm when making control-related
demands.

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Shareholder Activism and CEO Quality
1. Introduction
This paper examines the relationship between shareholder activism and the quality of theincumbent CEO at targeted firms. Shareholder activism can take many forms, but essentiallyinvolves a non-controlling and dissatisfied equity investor in a company who uses her ownershiprights to pressure the company to improve performance. As pointed out by Gillan and Starks(2007), shareholder activism can be viewed as a spectrum of responses by investors. At one
extreme, dissatisfied investors can simply sell their shares (i.e., “vote with their feet”). At theother extreme, they can accumulate controlling stakes with the intention of making fundamental
changes, as in corporate takeovers and buyouts. In this study, we focus on governance-based
activism, whereby dissatisfied equity-holders with minority stakes “voice” their dissatisfaction
and attempt to implement changes in the target company while maintaining or even increasing
their investment in the company (Gillan and Starks (1998)).
Shareholder activism has grown in prominence in recent years, which has coincided with theincreasingly important share of public equities being held by institutional investors (Sias andStarks (1998); Gillan and Starks (1998)). In particular, hedge funds have become prominent
shareholder activists and are now a dominant force in such interventions (Gillan andStarks (2007)).
At its root, the phenomenon of shareholder activism has been viewed as a response to afundamental agency problem inherent in the typical public corporation with absentee owners andrun by hired managers whose interests are different from those of the owners (Jensen andMeckling (1976)). Kahn and Winton (1998) develop a model of intervention decision by aninvestor in a poorly performing firm taking into account the resulting effect on the value of2

currently held shares as well as potential profits from trading in the firm’s shares. There is also alarge body of empirical research examining the effectiveness of shareholder activism on firm
performance (see, for example, Karpoff (2001), Romano (2001), Gillan and Starks (2007) for
surveys of the literature). These empirical studies cover a broad variety of types of shareholder
activism (e.g., shareholder proposals, “just vote no” campaigns, Schedule 13D filings), identitiesof the shareholder activists (e.g., pension funds, hedge funds, labor unions, institutionalsponsors), and measures of firm performance (e.g., short-term stock market reactions toannouncements of activism, long-term stock market and operating performance changes, voting
outcomes for shareholder proposals, changes in strategy or investment policies). Not
surprisingly, given the broad range of issues covered, these studies reach different conclusions
about the effectiveness of shareholder activism. Gillan and Starks (2000), for example, conclude
that governance-related shareholder proposals have been largely ineffective in improving firms’
operations. However, focusing on hedge fund activists, other studies find that hedge funds may
be more successful than other shareholders in increasing shareholder value. For instance,
publicly listed target firms have positive abnormal returns of 7% when hedge fund shareholders
announce activist intentions through Schedule 13D filings with the SEC (Brav et al. (2008)).
Moreover, these abnormal returns are higher when the filings are made by hedge fund activists
that when they are made by other private investors (Klein and Zur (2009)).
There has been much less research about determinants of shareholder activism beyond thepoor prior performance record of targeted firms. An early study (Nesbitt (1994)) finds thatcompanies targeted by one activist pension fund, CalPERS, underperformed the S&P 500 by
66% in the five years before being targeted and outperformed by 41% in the five years
afterwards. John and Klein (1995) examine factors associated with the likelihood of a company

3

being targeted by shareholder proposals on corporate governance and social issues, and find thattargeted companies are larger, more likely to have reported losses in the preceding year, haveworse accounting profitability measures, more outside directors, lower share ownership bydirectors, and are more likely to ask their shareholders to ratify the choice of external auditors.
These studies were conducted at a time before hedge funds emerged as activists, and therefore do
not examine differential activist tactics to potentially explain the superior performance of hedge
fund activists.
In this paper, we examine the types of demands made by activist shareholders in
Schedule 13D filings with the Securities and Exchange Commission (SEC). Schedules 13D are
required to be filed, within ten days, by any person or group of persons who acquire beneficial
ownership of more than 5% of a voting class of a company’s equity securities. The filingdiscloses, along with other information, the purpose of the transaction and the aggregate amountand percentage of the target firm’s securities owned by the filer. We hypothesize, based onstandard agency theory, that activists will make more control-related demands (such as a statedintention to replace management, to acquire control, or to change or nominate the board of
directors) when the incumbent management team of the target firm is of lower quality. Noncontrol related demands include a stated intention to hold discussions with management, capital
structure issues, calls for or against a proposed merger or acquisition, but with no direct andexplicit intention to replace the incumbent management or to obtain control.
We examine a comprehensive sample of Schedule 13D filings over the period 2000 to 2009.
Managerial quality is not directly observable but can be estimated through manager fixed effects,
as in Bertrand and Schoar (2003), who analyze a sample of managers who have changed firms,
an approach which yields relatively small sample sizes. We use an alternative approach to4

estimate manager fixed effects based on Abowd, Kramarz, and Margolis (1999; AKM
henceforth), which allows for fixed effects to be estimated for a larger number of managers. An
implementation of the AKM approach in the finance literature is provided by Graham et al.
(2009) who provide evidence to validate the interpretation of manager fixed effects as innate
managerial ability or social capital. Using Execucomp data, we estimate manager fixed effects inregressions of several measures of firm performance, and we then perform a factor analysis togenerate a single summary measure of managerial quality for each executive. We find that firms
led by lower quality CEOs are more likely to be targeted by shareholder activists and that alower quality CEO is associated with a higher likelihood of an activist’s demand being controlrelated and with the number of times that the targeted firm is subject to a control-related demandduring the CEO’s tenure. We also examine hedge funds’ sensitivity to CEO quality and otherfactors in their activism decisions compared to other categories of activists, and while the results
are not very strong, possibly due to the small sample size, we find that the activist’s percentage
ownership plays a greater role for hedge funds in making control-related demands than for otheractivists.
This paper’s findings complement existing studies of shareholder activism. Whereas otherstudies have examined the determinants of what companies get targeted, we further examine
determinants of the types of demands made by activists and show that managerial quality in thetarget company is an important factor. In addition, we contribute to the growing literature on
hedge fund activism, which has shown positive stock market reactions upon announcement ofactivism by hedge funds (Brav et al. (2008); Klein and Zur (2009)), but remains unclear about
the source of hedge funds’ returns. Greenwood and Schor (2009) find evidence suggesting thatthe superior performance may be linked to hedge funds’ ability to force the target firm into a5takeover, and our analyses provide additional insights about hedge funds’ decision-making when
they intervene in target firms.
The rest of the paper is organized as follows. Section 2 provides a review of the related
literatures on shareholder activism and on managerial quality. In section 3, we formulate ourhypotheses based on standard agency theory models. Section 4 describes the data andconstruction of the sample. Section 5 presents the analyses, and section 6 concludes.

2. Prior Literature
2.1 Shareholder Activism
Shareholder activism has a long history in the U. S. (see Gillan and Starks (2007) for areview). In its modern form, the current wave of shareholder activism can be traced back to theintroduction by the SEC in 1942 of a rule that allowed shareholders to submit proposals forinclusion in the matters to be voted on at annual general meetings. In the first several decades
after the introduction of the rule, most activist shareholders were individual investors.
Institutional activists became more prominent starting from the 1980s, initially comprised ofpension funds, followed by corporate raiders, labor unions and, more recently, hedge funds andprivate equity funds.
Shareholder activism spans a variety of activities, and empirical studies of shareholder
activism have generally focused on one particular activity, for example, the submission of ashareholder proposal, the votes cast at annual general meetings, whether there were proxycontests or not, or the accumulation of shares and voting rights to pressure the target firm’s
management. The timing of activism on the part of the investor also varies, as do investor
horizons. A relatively recent category of investors, hedge funds, are often considered to have6

short-term investment horizons but, as documented by Brav et al. (2008), hedge funds also
engage in relationship investing, i.e., have an ongoing long-term relationship with the target firm.
The empirical literature on shareholder activism has examined its effectiveness, with mixed
results. Several studies conclude that shareholder proposals are largely ineffective. They have noeffect on executive compensation (Johnson et al. (1997)) and there is no improvement in longterm stock market or operating performance (Gillan (1995), Karpoff et al. (1996), Wahal (1996),
Del Guercio and Hawkins (1999)). Other studies suggest that coordinated activism may be more
successful (Opler and Sokobin (1995)), that shareholder reaction and voting outcomes depend on
the issues raised and the identity of the sponsor (Gillan and Starks (2000)), for example, private
investment groups and individuals are most effective in garnering voting support (Thomas andCotter (2006)). Focusing on hedge fund activists, studies by Brav et al. (2008) and Klein and Zur(2009) find significant abnormal returns in the targets upon announcement of the activism.
There is a much smaller body of work examining determinants of shareholder activism.
Studies focusing on firms targeted by pension funds and by institutional activists find that thetargets tend to have lower insider ownership and larger shareholdings by other institutions(Carleton et al. (1998)). With regards to profitability, poor operating performance in the periodleading to the activists’ intervention appears to characterize targets (Karpoff et al. (1996), John
and Klein (1995)), however, firms targeted by activist hedge funds are more profitable thansimilar non-targets (Brav et al., 2008).

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2.2 Estimating Managerial Quality
Managerial quality or ability is inherently an unobservable characteristic, making empiricalinvestigation of managerial quality a challenging task. Existing research has tackled thischallenge in several ways. Francis et al. (2008), for example, use press coverage of CEOs toproxy for CEO reputation, which they view as “the totality of enduring images that major
stakeholders form based on perceived CEO performance, his or her ability, and values” (p. 114).
Fischer et al. (2009) make use of stock market reactions to CEO turnover announcements.
Bertrand and Schoar (2003) rely on a sample of CEOs and CFOs who move across firms, andascribe fixed effects in regressions of corporate investment policies to differences in managerial“style”. More recently, Graham et al. (2009) propose an estimation approach for firm andmanager fixed effects in a panel dataset of executive compensation using the method of Abowd,
Kramarz, and Margolis (1999; “AKM”). Whereas the Bertrand and Schoar approach restricts the
sample to managers who have moved between firms, the AKM method estimates fixed effects
for moving as well as non-moving managers (as long as they are employed by a firm with at least
one mover), and therefore results in the estimation of fixed effects for a greater number ofmanagers.
The method that we use in this paper implements the AKM approach. Our basic statisticalmodel decomposes time-varying measures of firm performance, yit (for firm i at time t), into firm
fixed effects θi, CEO fixed effects ψj (for CEO j employed by firm i at time t), other timevarying characteristics represented by the matrix xit (with no intercept included in xit), and aresidual εit:8

The AKM method identifies manager (and firm) fixed effects through connectedness: A
group of persons and firms are connected when the group contains all persons who ever worked
at any of the firms and also contains all firms at which any person in the group were employed.
The entire available sample is partitioned into a finite number G of mutually exclusive groups,
whereby each group contains firms and CEOs that are connected, but no two groups areconnected. In order to construct the groups, the following grouping is applied, as set out in
Abowd, Creecy and Kramarz (2002):“For g = 1, …, repeat until no firms remain:
The first firm not assigned to a group is in group g.
Repeat until no more firms or persons are added to group g:
Add all persons employed by a firm in group g to group g.
Add all firms that have employed a person in group g to group g.
End repeat.
End for.”Abowd et al. (2002) show that, for each group g, the group mean of y and Ng – 1 + Jg -1
person and firm effects are identified, where Ng is the number of persons in group g and Jg is thenumber of firms in group g.

3. Development of hypotheses
In classical principal-agent settings, information asymmetry exists between the principal andagent, and the private information can be about what the agent does and the decisions he takes(“hidden action”), or it can be about who the agent is and what his characteristics are (“hidden
information”) (Salanié (2005)). We use this dichotomous distinction between two classes ofprivate information to develop our hypotheses.
If a shareholder is dissatisfied with some aspect of an investee firm’s performance, she canchoose from among a variety of actions. One response would be to sell shares in the firm and9instead invest in other firms. Another response would be to accumulate more shares in the firmin order to eventually acquire and exercise control with the objective of extracting value from thefirm’s assets and generate positive investment returns through the “market for corporate control”(Jensen and Ruback (1983)). However, there are circumstances in which these responses may not
be available, for example, if the investor is an indexed mutual fund. Even so, if the activist
shareholder decides to intervene in an investee firm, there is a second decision to be maderegarding the type of demand made as part of the intervention. We hypothesize that both theinvestor’s decision to intervene and the type of demands she makes will reflect her perception of
the quality of the incumbent management. If the investor perceives that the executives currently
in place have high ability, and that the poor performance is a result of unsatisfactory actions, her
demands will focus on rectifying the actions that gave rise to the poor performance. On the other
hand, if the investor is of the opinion that the existing management is of low quality, one of her
demands will involve replacing the low quality executives. We refer to such demands as controlrelated demands. A recent study by Fischer et al. (2009) presents evidence consistent with our
hypotheses: the authors find that uncontested director elections reflect positive perceptions byinvestors of the board’s performance. Stated formally in alternative form, our first two
hypotheses are that:
H1a:Firms with lower quality CEOs are more likely to be targeted by activist
shareholders than firms with higher quality CEOs.

H2a:

Conditional on shareholder activism, firms with lower quality CEOs are more
likely to face control-related demands compared to firms with higher quality
CEOs.

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In recent years, hedge funds have emerged as a dominant class of activist shareholders. As
unregulated pools of capital, hedge funds are subject to much less regulation and constraints thanother activists such as pension funds and mutual funds, and they also have at their disposal moreresources than individual shareholders. Hedge funds appear to be able to intervene successfully(Brav et al. (2008), Klein and Zur (2009)) whereas other shareholder activists appear largely
ineffective (Gillan and Starks (2000, 2007)). Greenwood and Schor (2009) suggest that one
reason may be hedge funds’ greater success in forcing target firms into a takeover. Given that
hedge funds as a class appear to be different from other categories of shareholder activists, weinvestigate whether they are more or less sensitive to targets’ managers’ quality and other factors
during their interventions. Since we do not have a strong theoretical basis for making directional
predictions, we state our third hypothesis in null form:
H30:

Conditional on shareholder activism, the extent to which CEO quality affects thetype of demand made is no different for hedge fund activists than for othershareholder activists.

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4. Data
4.1

Sample Construction
We combine two main databases in order to construct our sample. The two main variables ofinterest for our study are CEO quality and shareholder activism being pursued (including
whether or not a firm is being targeted by activists and the type of demands that have beenmade).
We use Compustat’s Execucomp database to compute measures of managerial quality. The
Execucomp database covers the period 1992 to 2009 and contains information collected from theannual proxy statements (Form DEF14A) of companies in the S&P 1500. We collect data on all
executives appearing in the database. For our main analyses, we focus on the CEOs, but we also
repeat our analyses using both CEO and non-CEO executives, and our conclusions continue tohold.
Our shareholder activism data is obtained from Audit Analytics. Audit Analytics’
Shareholder Activism dataset contains all Schedule 13D and Schedule 13D/A filings made with
the SEC over the period 2000 to 2009. Any person or group of persons who acquire beneficial
ownership of more than 5% of the voting shares of a company are required to file a Schedule
13D with the SEC within ten days after the purchase2. Schedule 13D/A are amendments to theoriginal Schedule 13D filing and are required whenever there is a material change in the facts
disclosed, including additional accumulation or disposal of shares. In addition to the identity of
the activist filer and of the target firm, the filings also disclose the aggregate amount andpercentage of shares owned by the filer. Audit Analytics also classify the matter disclosed in the“Purpose of Transaction” section (Item 4) of the filings into seven main categories: 1)

In some circumstances, such as accumulation of shares by passive investors which takes them above the 5%
threshold, filers can file a more abbreviated Schedule 13G. Our sample does not include Schedule 13G filings.
2

12Agreements, 2) Concerns, 3) Control, 4) Discussions, 5) Dispute, 6) Support, and 7) Other. We
create a dummy variable for control-related demands equal to one if the activist’s campaign
includes at least one control-related matter in the third category. In our study, we focus on thefirst filing to indicate the start of activism. We use the subsequent Schedule 13D/A’s filed
throughout the activist’s campaign to calculate the maximum percentage holdings in the target
firms and to determine whether there was a control-related demand made at any point during the
campaign.
Over the period 2000 to 2009, there are 3,919 unique CEOs employed by 2,398 unique firms
in the Execucomp dataset. After merging with the Audit Analytics database, we identify 793
firms that were the subjects of Schedule 13D and 13D/A filings over the same time period. Notethat the same firm can be targeted by more than one activist. In total, we identify 2,153 firmactivist pairs representing interventions by 905 activists in those 793 unique firms. In the next
section, we present some descriptive statistics for our final sample.

4.2

Descriptive Statistics
Table 1 provides summary descriptive statistics. Panel A shows firm-level characteristics

across the sample period 2000 to 2009. We show separately the descriptive statistics for firmyears targeted by shareholder activists and non-targeted firm-years. The average firm in thesample had total assets of $2,029 million, a market-to-book ratio of 2.85, return on assets (ROA)
of 4%, return on equity (ROE) of 10%, and an abnormal stock market return over the past 12
months of 9.5%.
When comparing firm-years targeted by activists to non-targets, we find that targeted firmyears are much less profitable (an average ROA ratio of 2% compared to 5% for non-targeted13firm-years) and also have lower returns on their stock over the previous year (3% compared to11%). These patterns are consistent with prior research (John and Klein (1995), Gillan and Starks(1998)). The average firm in our sample reported sales growth of 12%, had employed theincumbent CEO for the past seven years, and had almost 3% of their shares held by insiders.
Panel B shows the industry distribution of firms in our sample. Activists appear to refrainfrom targeting utilities companies, but otherwise, there does not appear to be strong industry
concentrations.

4.3

Estimating CEO quality using the AKM method
We implement the method in Abowd, Kramarz and Margolis (1999; AKM) to estimate

managerial fixed effects. We consider several measures of firm performance in the regressions
used to estimate the manager fixed effects. We consider measures reflecting returns to all capitalproviders (return on assets) or to equity investors in particular (return on equity), and we also
consider cash flow as well as income measures. In addition, we calculate abnormal stock market
returns over a 12-month period ending at the end of the third month following the fiscal year end.
We separately run ordinary least squares regressions of each measure of firm performance onmanager and firm fixed effects, firm size, and year dummies. We collect the results for manager
fixed effects from each of the specifications and standardize the measures by demeaning anddividing by the sample standard deviation for each set of measures. We then perform a principal
component analysis to derive a summary measure of managerial quality. For the estimation ofmanagerial ability, we utilize all available years on Execucomp. Although the AKM method
allows us to estimate manager fixed effects for a larger number of executives compared to the“mover dummy variable method” used by Bertrand and Schoar (2003), it still requires that non-14

movers have worked in firms that have hired at least one mover. Table 2 summarizes the
managerial quality measures obtained for CEOs. Of the 5,629 CEOs tracked by Execucomp over1992 to 2009, we are able to estimate fixed effects for 5,236 CEOs. We obtain CEO quality
measures which show a fair degree of heterogeneity, consistent with results documented in
Graham et al. (2009). We are thus able to estimate a CEO quality measure for each firm-year in
the Execucomp sample. When identifying which firm-years were targeted by activists, we
restrict the sample to the period 2000 onwards since the Audit Analytics Shareholder Activism
database only covers those years.

4.4

Validating the CEO quality measures obtained using the AKM method
Next, we conduct validation tests on the CEO quality measures derived from the AKM

approach. First, we re-estimate CEO fixed effects using the same performance variables as in the
AKM estimations, but using the approach in Bertrand and Schoar (2003). This yields CEO fixed
effects for [ ] CEOs over the Execucomp sample period. We then compare the Bertrand andSchoar to the AKM measures for overlapping CEOs whose fixed effects can be estimated underboth methods. The Pearson (Spearman) correlation between the two measures is [% (%)].
We run an alternative validation exercise using the stock market reaction to announcement ofCEO departures. The sample of 165 departing CEOs and market reaction data is the same as inFischer et al. (2009)3. Ceteris paribus, upon announcement that a good quality CEO is leaving,the market is expected to react negatively, whereas the market reaction is expected to be positive
if a bad quality CEO is leaving. The Spearman rank correlation between abnormal announcement
returns and the CEO quality measures obtained from the AKM estimation is -0.18 with a p-value

3

We thank Hal White for providing these data. The measurement window for the announcement return is from 3days before to one day after the announcement date15

of 0.02, and the Pearson correlation is -.04 and not statistically significant. After examining thedata more closely, we note that there are extreme values of announcement returns to CEO
departures: the highest 5-day cumulative abnormal return value is +45% and the lowest value is 31%. After removing extreme outliers (the top and bottom 1% of observations sorted byannouncement abnormal returns), the Pearson correlation is -0.15 with a p-value of 0.06. These
patterns suggest that the AKM approach yields measures of CEO quality that are consistent withmarket perceptions of departing CEOs.

5. Analysis
5.1

Effect of CEO quality on the probability that a firm-year will be subject to shareholder
activism
First, we investigate the role of CEO quality on the likelihood that a firm-year is the target ofany type of Schedule 13D filing. We start with all available firm-years in the Execucomp sample
over the period 2000 to 2009. We then use the Audit Analytics database to identify firm-years
which were subject to an activist Schedule 13D filing. We analyze the effect of CEO quality on
the likelihood of activism using probit tests. The probit model uses lagged values of CEO
quality, i.e.,:
Pr(Activism)it = a0 + a1 * CEO Qualityi, t-1 + control variables
Table 3 shows the results of the probit tests. We obtain a significantly negative coefficient on
the CEO quality variable, indicating that the likelihood of a firm-year being targeted byshareholder activists is lower for firms with higher quality CEOs. In terms of economic
significance, the predicted probability of a firm being targeted by activists increases from 10%
for a CEO at the lower quartile of the CEO quality measure to 13% for a CEO at the upper

16

quartile. The probit analysis also confirms earlier studies that targeted firms tend to be poor
performers. For instance, they have lower ROA in the previous year and have also reported
slower growth in sales. Targeted firms also tend to have CEOs with shorter tenure, and havegreater insider ownership of shares in the firm. For robustness, we also conduct logit regressions,and the results continue to hold.
The results on firm size are opposite in direction to those in John and Klein (1995) who
document that firms subject to shareholder proposals tend to be larger. One explanation could bethat their study and ours examine different forms of shareholder activism (shareholder proposals
and Schedule 13D filings, respectively). We further explore this apparent discrepancy andinteract the size variable with a dummy variable equal to one if the activist is a hedge fund. The
results (untabulated) suggest that hedge funds tend to target larger firms whereas non-hedge fundactivists tend to target smaller firms. Recent research also suggests that hedge funds tend totarget more profitable companies (Brav et al., 2008). When interacting the ROA variable withthe hedge fund activist dummy, we find that the coefficient on the interaction term is positiveand significant, consistent with those prior studies.

5.2

Effect of CEO quality on type of activism conditional on CEO’s firm being targeted
Next, we investigate the role played by CEO quality in the activist’s choice of tactics. We

classify the activists’ tactics into two main groups: control-related demands and non-controlrelated demands. Control-related demands explicitly indicate that the activists’ objective is toreplace management, whereas non-control-related demands focus on other specific aspects of thetarget, such as capital structure or dividend policies. For these tests, the unit of analysis is a firmactivist combination pair, representing an activist campaign. Note that the same firm may be

17subject to more than one activist campaign, and each campaign may or may not involve acontrol-related demand. We analyze the effect of CEO quality on the likelihood of the activist’s
demand being control-related using probit tests. The probit model is run according to thefollowing specification:
Pr(Control-related demand | Activism)it = a0 + a1 * CEO Qualityi, t-1 + control variables
Table 4 shows that firms targeted by shareholder activists are more likely to face controlrelated demands if their CEOs are of lower quality. The negative coefficient of -0.057 in the
probit model corresponds to an increase in the predicted probability of a demand being controlrelated from 6% for a CEO at the lower quartile of CEO quality to 8% for a CEO at the upper
quartile. On the other hand, the percentage of shares in the targeted firm owned by the activist is
only weakly associated with the type of demand made, but in the expected direction. Althoughother shareholders are not obligated to participate in the activist’s campaign and bear the
resulting costs, they stand to gain from any improvement in operational performance andultimately in the value of the target firm. Given that shareholder activists face this free rider
problem, it is not surprising that the greater their shareholding in the target firm, the more theystand to gain from a successful intervention, and the more likely they are to be more forceful intheir demands and therefore make control-related demands.
The likelihood of an activist’s demand being control-related is also higher for target firms
with lower market-to-book ratios and where the CEO has been in place for a longer time. Thus,
shareholder activism appears to address CEO entrenchment problems at targeted firms.
As for the previous tests, we repeat all the analyses using alternative logit regression
specifications and our conclusions are unchanged.

18

5.3

Comparing hedge fund activists and non-hedge fund activists
In this section, we compare hedge fund activists to other activists. Recent research suggeststhat hedge funds are more successful than other activists (e.g., Brav et al., 2008, Klein and Zur,
2009). We obtain a list of activist hedge funds studied by Brav et al. (2008)4 and we create adummy variable to indicate whether the activist in our sample was a hedge fund or not. We thenrun the probit regressions with interactions of CEO quality with this dummy variable, and ofactivist’s shareholding percentage with the hedge fund dummy:
Pr(Control-related demand | Activism)it = a0 + a1 * CEO Qualityi, t-1+ a2 * CEO Qualityi, t-1 * Dummy for hedge fund activist + control variables
Table 5 presents the results. The CEO quality variable continues to be significant andnegative, however, the interaction term of CEO quality and hedge fund dummy, while negativein magnitude, is not statistically significant. The coefficient on activist’s share ownership also
continues to hold. The interaction of activist’s share ownership and hedge fund dummy is weakly
significant and of positive sign, suggesting that hedge funds are more likely to base theirdecisions on whether to make control-related demands on the percentage of shares they hold in
the target firm. In terms of economic significance, the probability of a control-related demand
being made goes from 13.1% at the lower quartile of activist’s ownership to 14.2% at the upper
quartile of activist’s ownership if the activist is a hedge fund, compared to corresponding
predicted probabilities of 6.3% and 7.1% for non-hedge fund activists. The results suggest that
hedge funds’ approaches to shareholder activism differ from those of other investor activists.

4

We thank Alon Brav for providing the list of activist hedge funds.

196. Conclusion
In this paper, we examine the role of CEO quality on shareholder activism. We study
shareholder activism manifested through Schedule 13D filings with the SEC. We exploit
disclosure requirements in item 4 of the filing which indicates the purpose for which the filer hasentered into the transaction thus resulting in their accumulating more than 5% of the voting
rights of the target company.
We introduce to the accounting literature a new method to estimate manager fixed effects
across a large sample, based on Abowd, Kramarz, and Margolis (1999), and we use thesemanager fixed effects from firm performance regressions as proxies for managerial quality. We
hypothesize and find evidence that shareholder activists are more likely to target firms withlower quality CEOs, and that the nature of the activists’ demands also varies with the quality of
the incumbent CEO at the target firm: Shareholder activists are more likely to make controlrelated demands when they perceive the CEO to be of lower quality. We also examine hedge
fund activists separately. Despite being relatively new entrants to shareholder activism, hedge
funds have nevertheless become an important force pushing for change in targeted companies.
We do not find differences in hedge funds’ sensitivity to CEO quality when making controlrelated demands, but we document that hedge funds are more likely than other activists to makecontrol-related demands when they own greater percentages of the shares of the target firm.
This paper does not address a number of important questions that would be fruitful avenues
for future research. In particular, the role of hedge funds as shareholder activists is not wellunderstood. While several studies suggest that hedge funds are more effective than other activists
in generating gains from activism, the sources of these gains are unclear. This paper’s findings
suggest that hedge funds make choices differently from other activist investors, but further

20

research is warranted to establish whether there are causal consequences in terms of long-term
effects on the targeted companies arising from their different approaches to activism. It would
also be interesting to investigate further questions about whether investment gains made byhedge funds derive from improvement in the target firms’ fundamentals or, as has been allegedby several commentators, whether these gains are made at the expense of other stakeholders in
the target firms, such as debtholders.

21References
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Firms,” Econometrica 67(2): 251-333.
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23

Table 1: Summary Statistics
This table provides summary statistics for the sample of firm-years appearing on the Execucomp
database between 2000 and 2009. Activism is an indicator variable that equals 1 if the there wasa Schedule 13D filing for the firm-year, 0 otherwise. Size is the natural logarithm of total assets
in $ millions. Market-to-Book is market value of equity measured three months after the end of
the fiscal year divided by book value of equity at the end of the fiscal year. ROA is income
before extraordinary items divided by lagged total assets. Sales Growth is the annual percentage
of growth in sales. Abnormal Returns is the monthly return minus the corresponding market
returns cumulated from the fourth month of the fiscal year till the third month of the next fiscal
year. CEO Tenure is the number of years that the person has been CEO. Insider Ownership isthe number of shares held by the CEO divided by the total number of shares outstanding. SIC
codes are classified into the 12 Fama–French Industry Groups following the definition at
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

Panel A: Firm-Year Characteristics

Activism=0
Size
Market-to-Book
ROA
Sales Growth
Abnormal Returns
CEO Tenure
Insider Ownership
Activism=1
Size
Market-to-Book
ROA
Sales Growth
Abnormal Returns
CEO Tenure
Insider Ownership

Obs.

Mean

Median

Std.
Dev.

11782
11758
11782
11782
11595
11350
11396

7.67
3.03
0.05
0.13
0.11
7.05
0.02

7.51
2.24
0.05
0.09
0.04
5.04
0.03

1.72
3.08
0.11
0.27
0.45
6.05
0.05

3.93
-6.34
-0.48
-0.50
-0.82
0.67
0

12.17
19.44
0.34
1.62
2.14
22
0.33

1544
1541
1544
1544
1462
1480
1483

7.21
2.59
0.02
0.10
0.03
6.70
0.03

7.14
1.91
0.04
0.07
-0.06
4.58
0.04

1.63
3.39
0.12
0.26
0.49
6.07
0.06

3.93
-6.34
-0.48
-0.50
-0.82
0.67
0

12.17
19.44
0.34
1.62
2.14
22
0.33

24

Min.

Max.

Table 1: Summary Statistics (continued)
Panel B: Industry Distribution (Fama–French 12 Industry Groups)

Consumer Non-Durables
Consumer Durables
Manufacturing
EnergyChemicals and Allied Products
Business Equipment
Telecommunication
Utilities
Shops
Health
Money
Other
Total

Activism=0
Freq
Pct
694
5.89
322
2.73
1,447
12.28
474
4.02
344
2.92
2217
18.82
203
1.72
626
5.31
1450
12.31
915
7.77
1763
14.96
1327
11.26
11,782100.0025

Activism=1
Freq
Pct
116
7.51
61
3.95
188
12.18
32
2.07
59
3.82
277
17.94
61
3.95
45
2.91
213
13.80
100
6.48
167
10.82
225
14.57
1,544
100.00Table 2: CEO Quality Measures
This table provides summary statistics of CEO personal effects estimated using the AKM
method and based on different firm performance measures. FE_OROA is the CEO personal
effects using firm’s operating ROA as performance measure. Operating ROA is operating cash
flow divided by lagged total assets. FE_OROE is the CEO personal effects using firm’s
operating ROE as performance measure. Operating ROE is operating cash flow divided bylagged shareholder’s equity. FE_ROA is the CEO personal effects using firm’s ROA as
performance measure. ROA is income before extraordinary items divided by lagged total assets.
FE_ROE is the CEO personal effects using firm’s ROE as performance measure. ROE isincome before extraordinary items divided by lagged shareholder’s equity. FE_Abret is the CEO
personal effects using firm’s Abnormal Returns over the fiscal year as performance measure.
Abnormal Returns over the fiscal year is the monthly return minus the corresponding market
returns cumulated from the fourth month of the fiscal year till the third month of the next fiscal
year. CEO Quality is the first principal component of the five individual CEO personal effects:
FE_OROA, FE_OROE, FE_ROA, FE_ROE, and FE_Abret.

FE_OROA

Obs.
25695

Mean Median
0.000 -0.006

Std.
Dev.
0.089

Min
-0.467Max
0.601

FE_OROE

25695

0.000

-0.0170.264-1.692

2.516

FE_ROA

26723

0.000

0.000

0.092

-0.784

0.847

FE_ROE

26723

0.000

0.017

0.217

-1.7481.295

FE_Abret

24731

0.000

-0.0290.473-1.894

1.906

CEO Quality

23703

0.000

0.013

1.669

-13.208

9.307

26

Table 3: Likelihood of Activism
This table shows results examining the role of CEO quality on the likelihood that a firm-year is
the target of any type of Schedule13D filing. The dependent variable (Activism) is an indicatorvariable that equals 1 if the there was a Schedule 13D filing for the firm-year, 0 otherwise. CEO
Quality is the first principal component of the five individual CEO personal effects: FE_OROA,
FE_OROE, FE_ROA, FE_ROE, and FE_Abret. These CEO personal effects are measured by the
AKM method based on different firm performance measures. Size is the natural logarithm oftotal assets in $ millions. Market-to-Book is market value of equity measured three months after
the end of the fiscal year divided by book value of equity at the end of the fiscal year. ROA is
income before extraordinary items divided by lagged total assets. Sales Growth is the annual
percentage of growth in sales. Abnormal Returns is the monthly return minus the corresponding
market returns cumulated from the fourth month of the fiscal year till the third month of the next
fiscal year. CEO Tenure is the number of years that the person has been CEO. Insider
Ownership is the number of shares held by the CEO divided by the total number of shares
outstanding. SIC codes are classified into the 12 Fama–French Industry Groups following thedefinition at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. We run a
probit regression with both industry and year fixed effects and cluster the standard errors at thefirm level. Z-statistics are shown in parentheses. *, ** and *** indicate significance at two-tailed
probability levels of 10%, 5%, and 1%, respectively. The constant term is not reported.

CEO Quality

Activism-0.067***(-3.15)Size-0.110***(-6.16)

Market-to-Book-0.010(-1.11)

ROA-0.801***(-2.83)

Sales Growth-0.248***(-2.65)Abnormal Returns-0.012(-0.27)

CEO Tenure-0.012***(-2.81)

Insider Ownership

0.019***(3.82)

Industry Effects

Yes

Year Effects
Observations
Pseudo R2

Yes
9126
0.101

27

Table 4: Likelihood of Control-Related Demand Being Made by the Activist
This table shows results examining the effect of CEO quality on type of activism conditional on
CEO’s firm being targeted. The dependent variable (Control) is an indicator variable that equals
1 if the activist’s demand is control-related, 0 otherwise. CEO Quality is the first principal
component of the five individual CEO personal effects: FE_OROA, FE_OROE, FE_ROA,
FE_ROE, and FE_Abret. These CEO personal effects are measured by the AKM method basedon different firm performance measures. Activist Ownership is the number of shares held by theactivist divided by the total number of shares outstanding. Size is the natural logarithm of total
assets in $ millions. Market-to-Book is market value of equity measured three months after theend of the fiscal year divided by book value of equity at the end of the fiscal year. CEO Tenureis the number of years that the person has been CEO. Insider Ownership is the number of shares
held by the CEO divided by the total number of shares outstanding. SIC codes are classified into
the12
Fama–French
Industry
Groupsfollowingthedefinitionat
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. We run a probit
regression with both industry and year fixed effects and cluster the standard errors at the activist
level. Z-statistics are in parentheses. *, ** and *** indicate significance at two-tailed probability
levels of 10%, 5%, and 1%, respectively. The constant term is not reported.

CEO Quality

Control-0.057**(-2.48)

Activist Ownership

0.006*(1.86)

Size-0.036(-1.17)

Market-to-Book-0.020**(-2.09)CEO Tenure

0.020***(2.83)

Insider Ownership-0.012(-1.47)

Industry Effects

Yes

Year Effects
Observations
Pseudo R2

Yes
2153
0.057

28

Table 5: Hedge Fund Activists and Control-Related Demands
This table shows results examining the interaction effect of CEO quality and hedge fund activist
on type of activism conditional on CEO’s firm being targeted. The dependent variable (Control)
is an indicator variable that equals 1 if the activist’s demand is control-related, 0 otherwise. CEO
Quality is the first principal component of the five individual CEO personal effects: FE_OROA,
FE_OROE, FE_ROA, FE_ROE, and FE_Abret. These CEO personal effects are measured by the
AKM method based on different firm performance measures. Activist Ownership is the numberof shares held by the activist divided by the total number of shares outstanding. Size is thenatural logarithm of total assets in $ millions. Market-to-Book is market value of equity
measured three months after the end of the fiscal year divided by book value of equity at the endof the fiscal year. CEO Tenure is the number of years that the person has been CEO. Insider
Ownership is the number of shares held by the CEO divided by the total number of shares
outstanding. Hedge Fund is an indicator variable that equals 1 if the activist is a hedge fund, 0
otherwise. SIC codes are classified into the 12 Fama–French Industry Groups following thedefinition at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. We run a
probit regression with both industry and year fixed effects and cluster the standard errors at theactivist level. Z-statistics are in parentheses. *, ** and *** indicate significance at two-tailed
probability levels of 10%, 5%, and 1%, respectively. The constant term is not reported.

29

Table 5: Hedge Fund Activists and Control-Related Demands (continued)

CEO Quality

Control-0.052**(-2.29)CEO Quality*Hedge Fund

-0.014(-0.20)

Activist Ownership

0.006**(2.11)

Activist Ownership*Hedge Fund

0.057*(1.82)

Hedge Fund

0.026

(0.09)

Size-0.035(-1.12)Market-to-Book-0.021**(-2.17)

CEO Tenure

0.019***(2.66)

Insider Ownership-0.010(-1.32)

Industry Effects

Yes

Year Effects
Observations
Pseudo R2

Yes
2153
0.069

30