Editor’s Note: Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Alon Brav is Professor of Finance at Duke University. Wei Jiang is Professor of Finance at Columbia Business School. This post is based on their study, The Long-Term Effects of Hedge Fund Activism, available here. An op-ed about the article published in the Wall Street Journal summarizing the results of the study is available here.
We recently completed an empirical study, The Long-Term Effects of Hedge Fund Activism, that tests the empirical validity of a claim that has been playing a central role in debates on corporate governance – the claim that interventions by activist shareholders, and in particular activist hedge funds, have an adverse effect on the long-term interests of companies and their shareholders. While this “myopic activists” claim has been regularly invoked and has had considerable influence, its supporters have thus far failed to back it up with evidence. Our study presents a comprehensive empirical investigation of this claim. Our findings have important policy implications for ongoing policy debates on corporate governance and the rights and role of shareholders.
Below is a more detailed account of the analysis in our study:
Activist hedge funds have been playing an increasingly central role in the corporate governance landscape, and their activism has been strongly resisted by many issuers and their advisors. Opponents of such activism have been advancing the “myopic activists” claim — that activist hedge funds push for actions that are profitable in the short term but are detrimental to the long term interests of companies and their long-term shareholders.
The problem, it is claimed, results from the failure of short-term market prices to reflect the long term costs of actions sought by short-term activists. As a result, activists seeking a short term spike in a company’s stock price have an incentive to seek actions that would increase short-term prices at the expense of long-term performance, such as cutting excessively investments in long-term projects or the reserve funds available for such investments.
The myopic activists claim has far been put forward by a wide range of prominent writers. Such concerns have been expressed by significant legal academics, noted economists and business school professors, prominent business columnists, important business organizations, and top corporate lawyers.
Furthermore, those claims have been successful in influencing important public officials and policy makers. For example, Chancellor Leo Strine and Justice Jack Jacobs, two prominent Delaware judges, have expressed strong concerns about short-sighted activism. And concerns about intervention by activists with short horizons persuaded the SEC to limit use of the proxy rule adopted in 2010 to shareholders that have held their shares for more than three years.
The policy stakes are high. Invoking the long-term costs of activism has become a standard move in arguments for limiting the role, rights, and involvement of shareholder activists. In particular, such arguments have been used to support, for example, takeover defenses, impediments to shareholders’ ability to replace directors, limitations on the rights of shareholders with short holding periods.
The myopic activists claim is a factual proposition that can and should be empirically tested. However, those advancing the myopic activists claim have thus far failed to back their claims with any large sample empirical evidence. Some supporters of the claim seem to assume the validity of their claims, failing to acknowledge the empirically contestable nature of their claim and the need for evidence, while other supporters of the claim have offered their experience as evidence.
At the same time, financial economists have produced significant empirical work on hedge fund activism. There is evidence that Schedule 13D filings – public disclosures of the purchase of a significant stake by an activist – are accompanied by significant positive stock price reactions as well as subsequent improvements in operating performance. However, supporters of the myopic activist claims dismiss this evidence, taking the view that losses to shareholders and companies from activist interventions take place later on.
On their view, improved performance following activist interventions comes at the expense of sacrificing performance later on, and short-term positive stock reactions merely reflect inefficient market prices that are moved by the short-term changes and fail to reflect their long-term costs. Thus, one prominent supporter of the myopic activism claim claimed earlier this year that the important question is“[f]or companies that are the subject of hedge fund activism and remain independent, what is the impact on their operational performance and stock price performance relative to the benchmark, not just in the short period after announcement of the activist interest, but after a 24-month period.”
Data about companies’ operating performance and stock returns years following activist intervention is publicly available and easily accessible. Nonetheless, supporters of the myopic activists view have failed to back their view with empirical evidence or even to test empirically the validity of their view. In our study, we seek to fill this void by providing the first comprehensive empirical investigation of the myopic activists claim.
Our study uses a dataset consisting of the full universe of approximately 2,000 interventions by activist hedge funds during the period 1994–2007. We identify for each activist effort the month (the intervention month) in which the activist initiative was first publicly disclosed (usually through the filing of a Schedule 13D). Using the data on operating performance and stock returns of public companies during the period 1991-2012, we track the operating performance and stock returns for companies during a long period – five years – following the intervention month. We also examine the three-year period that precedes activist interventions and that follows activists’ departure.
Starting with operating performance, we find that operating performance improves following activist interventions and there is no evidence that the improved performance comes at the expense of performance later on. During the third, fourth, and fifth year following the start of an activist intervention, operating performance tends to be better, not worse, than during the pre-intervention period. Thus, during the long, five-year time window that we examine, the declines in operating performance asserted by supporters of the myopic activism claim are not found in the data. We also find that activists tend to target companies that are underperforming relative to industry peers at the time of the intervention, not well-performing ones.
We then turn to stock returns following the initial stock price spike that is well-known to accompany activist interventions. We first find that, consistent with the results obtained with respect to pre-intervention operating performance, targets of activists have negative abnormal returns during the three years preceding the intervention. We then proceed to examine whether, as supporters of the myopic activism claim believe, the initial stock price reflects inefficient market pricing that fails to reflect the long-term costs of the activist intervention and is thus followed by stock return underperformance in the long term.
In investigating the presence of negative abnormal returns during this period, we employ three standard methods used by financial economists for detecting stock return underperformance. In particular, the study examines: first, whether the returns to targeted companies were systematically lower than what would be expected given standard asset pricing models; second, whether the returns to targeted companies were lower than those of “matched” firms that are similar in terms of size and book to market; and, third, whether a portfolio based on taking positions in activism targets and holding them for five years underperforms relative to its risk characteristics. Using each of these methods, we find no evidence of the asserted reversal of fortune during the five-year period following the intervention. The long-term underperformance asserted by supporters of the myopic activism claim, and the resulting losses to long-term shareholders resulting from activist interventions, are not found in the data.
We also analyze whether activists cash out their stakes before negative stock returns occur and impose losses on remaining long-term shareholders. Because activist hedge funds have been documented to deliver adequate returns to their own investors, such a pattern is a necessary condition for long-term shareholders being made worse off by activist interventions. We therefore examine whether targets of activist hedge funds experience negative abnormal returns in the three years after an activist discloses that its holdings fell below the 5% threshold that subjects investors to significant disclosure requirements. Again using the three standard methods for detecting the existence of abnormal stock returns, we find no evidence that long-term shareholders experience negative stock returns during the three years following the partial or full cashing out of an activist’s stake.
We next turn to examine the two subsets of activist interventions that are most resisted and criticized – first, interventions that lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing investments and, second, adversarial interventions employing hostile tactics. In both cases, interventions are followed by improvements in operating performance during the five-year period following the intervention, and no evidence is found for the adverse long-term effects asserted by opponents.
Finally, we examine whether activist interventions render targeted companies more vulnerable to economic shocks. In particular, we examine whether companies targeted by activist interventions during the years preceding the financial crisis were hit more in the subsequent crisis. We find no evidence that pre-crisis interventions by activists were associated with greater declines in operating performance or higher incidence of financial distress during the crisis.
Our findings that the data does not support the claims and empirical predictions of those holding the myopic activism view have significant implications for ongoing policy debates. Going forward, policymakers and institutional investors should not accept the validity of assertions that interventions by hedge funds are followed by long-term adverse consequences for companies and their long-term shareholders. The use of such claims as a basis for limiting shareholder rights and involvement should be rejected.
Our study is available here.