Hedge Funds Activism and Firm Performance

Hedge funds Activists want to obtain great returns through their agitation. In order to get the company to make meaningful changes that will uplift their stock price. Instead of aiming to take over a company in which they assume an equity position.

Hedge Fund Study

One study by Brav, et al. noticed that the performance of the companies improved after being targeted by hedge funds. Particularly an average abnormal return of 7%. They found this out by analyzing the market’s reactions to activists. Hedge funds’ announcement assuming positions in companies over the period 2001 up to 2006. They also found out greater CEO turnover and increased use of pay for performance. They generalized how useful to powerful CEOs who may fail to bring about stock price growth hedge funds are.

In another study by Bebchuk, et al., operating performance was found to improve after activist interventions. Based on a sample of 2040 activist interventions over the period 1994–2007. Focusing on performance measures like return on asset and Tobin’s Q. They also concluded that these performance improvements were not offset by falloffs somewhat later. Which could have implied that they were just temporary and perhaps a function of accounting manipulation. This study found the same results as Solarz’ with a smaller sample. He found that if the hedge funds indicated in their filings that they made specific actions like board seats or a proxy fight, they are activists.

This kind of hedge fund also shows the short-term. And excess returns that are greater at about 10% than passive investments, as shown in the data provided by the researcher. More specifically, the study measured the performance of companies with active and passive investors. He found out that after a two-year period there were improvements in the company’s return on assets for the active group and declines in the passive group. He also found that shareholders gained through increases in leverage and a greater dividend payout ratio.

Activist Hedge Funds

As previously mentioned, activist edge funds oppose takeover bids since they included an insufficient takeover premium. Private equity buyers’ goal is to get the target as cheap as possible and to sell it later at a higher price. Target shareholders do not usually bargain for a higher premium and rely on boards to act in their best interests. But when the target shareholders’ ranks include an activist hedge fund with great stock or have at least one seat on the board. Everything is different and does not go well for the private equity buyer.

For instance, Huang found out that a one standard deviation increase in the fraction of equity of the target. That is held by hedge funds prior to a buyout announcement that was associated with a 3.6% increase in the buyout premium through an analysis of 237 buyout proposals for US public targets. He also concluded that mutual funds, pension funds, and other shared held by other types of institutional investors did not affect buyout premiums. Moreover, the premium uplifting effect was greater for management buyouts than outside initiated buyouts. And also stronger for club deals where more than one buyout firm combines to make a joint bid than solo buyout offers.

It should be noted that managers of hedge funds will take much greater relative positions than other institutions. Because of this, diversified portfolios are not required by law. Hedge funds, unlike mutual funds, can hold large percentages of stakes in individual companies. And may allow investors to commit for a period of 2 years or longer to “lock-up” their investments. In comparison, the law requires mutual funds to hold a diversified portfolio. And selling securities within a day to satisfy redemptions from investors.

Institutions vs Retail Investors

Institutions have been owning great percentages of equities than retail investors do for many years now. The former vote their shares while the latter do not bother to vote at all. Considering there are also rules adopted that limit a broker’s ability to vote uninstructed retail shares in street names. Thus, institutions become the concentration of voting power.

Aside from opposing takeover bids, activist hedge funds also do not hold very large equity positions in the target. Nevertheless, large-cap companies’ holdings represent a large financial investment for them, despite relying on institutional investors’ financial support. These institutional investors haven’t really been activists in their investment approach. And they also own the bulk of the shares in a typical public company.

Statistical Analysis

According to Broadridge Financial Solutions, Inc in Retail ownership of public company shares There is a declining percentage of total shares outstanding owned by retail investors. A few very large institutional investors have a disproportionate interest in large-cap companies. Meanwhile, according to data provided by CamberView Partners in Sullivan and Cromwell LLP Memo. Shareholders and their voting power have been more controlled by a few major financial institutions. The statistics show the percentage of shares, a rising percentage, in the S&P 500 companies held by just four firms: Blackrock, Fidelity, State Street, and Vanguard. It went from above 15% but below 20% in 2012, and above 20% in 2016.

This means that these institutions’ support for activists is really vital to the success of the activists’ campaigns. When it became clear to institutional investors that when an activist targets a company, share values can rise and performance often improves. Institutional investors gained a financial incentive to support their activist initiatives. Even if institutions have raised concerns about the short-term orientation of various activists, they are also the ones who are under short-term performance pressures and have the tendency to positively respond to proposals. That will allow them to make short-term returns and bonuses for fund managers.

Index Fund

The institutional support of activists can be even greater for index funds managers since these investors are not discretionary. They do not vote with their feet and they may be locked in an equity position in a company that generates low returns. These kinds of managers are more likely to support activists who plan to improve performance and generate higher returns. Many mutual fund investors have changed to lower-cost index funds from active funds with the increased awareness that these managers frequently fail to make enough returns to compensate their fees. Therefore increasing the importance of index fund and their voting power.