1. 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

2. Brav, Jiang, Partnoy, and Thomas
Shareholder activism
Acquire shares and take actions that increase value.
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).
2006
Brav, Jiang, Partnoy, and Thomas

3. 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
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.
2006
Brav, Jiang, Partnoy, and Thomas

4. Brav, Jiang, Partnoy, and Thomas
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?
2006
Brav, Jiang, Partnoy, and Thomas

5. Brav, Jiang, Partnoy, and Thomas
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: ; new sample:
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.
2006
Brav, Jiang, Partnoy, and Thomas

6. 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.
2006
Brav, Jiang, Partnoy, and Thomas

7. Stated objective of hedge funds
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.
2006
Brav, Jiang, Partnoy, and Thomas

8. Brav, Jiang, Partnoy, and Thomas
Activists’ Tactics
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%
2006
Brav, Jiang, Partnoy, and Thomas

9. Brav, Jiang, Partnoy, and Thomas
Commitment of capital
The maximum capital is retrieved from one of the 13D/A files that reports the highest holdings by the filing party in the target.
2006
Brav, Jiang, Partnoy, and Thomas

10. 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%
2006
Brav, Jiang, Partnoy, and Thomas

11. 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.
2006
Brav, Jiang, Partnoy, and Thomas

12. 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
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.”
2006
Brav, Jiang, Partnoy, and Thomas

13. Market reaction: 5-7% abnormal return
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.”
2006
Brav, Jiang, Partnoy, and Thomas

14. Longer-term returns (in months)
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.
2006
Brav, Jiang, Partnoy, and Thomas

15. Which activism matters?
Regressing (-20, 20) abnormal returns on stated objective:
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.
2006
Brav, Jiang, Partnoy, and Thomas

16. Ongoing work: Effect on operational performance
Capital structure decisions before and after (relative to matched firms)
2006
Brav, Jiang, Partnoy, and Thomas

17. Brav, Jiang, Partnoy, and Thomas
Ongoing work
Finishing a complete sample of 130 activist funds, all their 13D filings, and out-of-13D activism in , 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.
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.
2006
Brav, Jiang, Partnoy, and Thomas