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New Evidence that Hedge Fund Activism Adds Value
Benjamin S. Solarz Economics
April 6, 2009 Advisor: Dean Takahashi
Abstract Using a large hand-collected data set spanning from 2000 through 2008, I find substantial evidence that activist hedge funds do more than pick stocks; they improve them. Controlling for differences in target firms, activist investments outperform the same hedge funds’ passive investments. Over two months, they earn 3.8% greater returns; over two years, they earn 18.4% greater returns; and measured by financial statements, they improve margins and ROA, increase payout and leverage, reduce balance sheet assets, and sell their targets more frequently and for higher prices. Hedge funds follow five cohesive activist strategies: they (1) improve business strategies, (2) advise on mergers and acquisitions, (3) demand that target firms sell themselves, (4) optimize capital structures, and (5) fix corporate governance. These results imply that skilled hedge funds can add significant value as corporate partners.
Introduction If you ask CEOs about their greatest fears, they might start talking about activist hedge funds. “If someone with a 203 area code calls you, call them back very carefully,” said public relations maven Joele Frank at a 2008 panel on activist hedge funds.1,2 Apparently, Greenwich, CT can be very dangerous. As the hedge funds located there and across the country redesign corporate governance, they have kicked up a storm of controversy. In the past few years, Nelson Peltz purchased Wendy’s, Carl Icahn pushed Yahoo into Microsoft’s arms, and William Ackman encouraged Target to divest its real estate. To top it all off, activists have even targeted other hedge funds, as when Carl Icahn sued over Steel Partners’ plans to go public.3 While there is no shortage of bold claims, hard evidence is tougher to come by. Do activist hedge funds truly threaten corporate health? To the contrary, using hand-collected data on 718 activist investments, I find that activist hedge funds add substantial value to their socalled victims—measured either by stock market returns or accounting performance. I improve on the existing literature, which fails to distinguish activist investing from astute stock picking, to show that hedge funds actually catalyze their targets’ outperformance. In particular, I test whether activism adds value beyond stock picking by comparing activist investments to the same hedge funds’ passive investments. In addition, I describe the most common activist strategies. Judging by short-term returns, investors applaud an activist hedge fund’s decision to target a company. Moreover, investors prefer these activist investments to passive investments. Over 61 days, controlling for the differences in target firms, activist investments outperform passive investments by 3.8%, and investments seeking board seats outperform other activist
While the term “activist” may draw to mind images of Gandhi, I use it to refer to a better dressed, better paid, and much more self-interested cohort: aggressive investors who attempt to influence their targets. Throughout this thesis, I will use the terms “activist” and “active” interchangeably. 2 “Discussing the Perils of Activist Investors,” The ew York Times [New York], 3 April 2008. 3 “Icahn and BofA Take Steel Partners to Court,” The ew York Times [New York], 7 February 2007.
not only do activist targets sell themselves more frequently. but they also sell for higher prices. In addition. In improving target firms. Long-term returns also indicate that hedge fund activism enriches shareholders. -2- . stock prices jump significantly. Controlling for the differences in target firm characteristics. investors reward all activist strategies. I also find that these returns have declined over time. Activist targets also reduce their assets by 4. (2) advise on mergers and acquisitions. Except for activism seeking to fix corporate governance. Each strategy targets different firms and improves them in distinct ways. investors react positively to activism even when it contains no stock picking signal. and sell themselves more frequently and for higher prices. and investments seeking board seats outperform other activist investments by 18. Further. Finally.9% more. Also consistent with short-term results. Again.5% more.2%. increase their payout ratios by 2.7% more. divest unprofitable assets. except for corporate governance.investments by 3. increase their margins by 2. activist targets increase their return on assets (“ROA”) by 3. returns have declined over time. When activists change their intentions from passive to active. Activism earns these excess returns by improving its targets—they increase profitability.4%. and (5) fix corporate governance. activists follow five cohesive strategies: they (1) improve business strategies.6%. (4) optimize capital structures. optimize their capital structures.0% more than passive targets. and increase their leverage by 0. While I find evidence that activism yields significant excess returns. activist targets outperform passive targets by 18. (3) demand that target firms sell themselves. controlling for the differences in target firms. all strategies generate substantial long-term returns. except for corporate governance activism. every strategy earns significant excess returns.6% more than passive targets—most likely by shedding unprofitable divisions. Over two years.
“The directors of such [joint-stock] companies. Section I reviews the literature. This paper is organized as follows. see Berle and Means (1932) and Jensen and Meckling (1976). Section I: Background For hundreds of years. Section VI describes the fundamental improvements in activist targets. But CEOs paid based For a more modern treatment. In August 2007.”4 In modern terms: CEOs often roll up their sleeves not for auditing spreadsheets but for dealing cards. it details the firms that activists target and the strategies that they use. being the managers rather of other people’s money than of their own. Turning to the analysis. far from economic hitmen.The new evidence presented in this paper suggests that. it cannot well be expected. 2007 Wall Street Journal Article. generally because their incentives differ. Adam Smith warned.” also reported that in June alone. titled “Wall Street Bosses Spending Too Much Time on the Golf Course. Bear Stearns CEO Jimmy Cayne spent 10 days playing bridge out of state. 5 4 -3- . The same November 17. while errant hedge funds brought his firm to its knees.5 Agency costs arise whenever management (the agent) takes actions which harm shareholders (the principal). both management teams and shareholders alike should welcome their insights. Section IV shows that activists earn excess short-term returns. Cayne squeezed in 13 rounds of golf. Section VII concludes. Section V presents similar evidence for long-term returns. instead of avoiding hedge funds’ calls. that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. In 1776. Section III describes hedge fund activism. Section II explains my methodology. activist hedge funds add significant value to their targets—judged by either stock prices or financial statements. shareholders want management to invest as much as possible in projects whose internal rates of return exceed the firm’s weighted average cost of capital (“WACC”) (Koller et al. however. In general. 2005). Thus. CEOs have eroded the wealth of nations.
management might harbor other intentions. Vento failed. 8 See Rock (1992). they just might not know any better. Due to the free rider problem. managers only earn those options by meeting performance targets. Jensen (1986) argues that managers may grow the company beyond its optimal size. Bainbridge (2006). Filed 2 November 2008. Parrino et al.6 Further. 7 Predential Bancorp. 6 For the problems with performance targets. activists’ personal benefits do not justify the necessary costs. see also Hall and Murphy (2003).on earnings growth might increase earnings by investing in projects with internal rates of return (“IRRs”) greater than zero but below the firm’s WACC. And even if managers wanted to maximize shareholder value. 2007 annual meeting. large shareholders might combat misguided management teams. At Prudential Bancorp’s February 9. For the problems with options themselves. Black (1992) and Pound (1992) argue that shareholder activism could improve corporate performance. see Yermack (1995) and Bebchuk and Fried (2003). (2003) suggest that stockholders may simply prefer to walk away. which offer their own perverse incentives. pride. While doing so harms shareholders. it also increases management’s compensation. So while shareholders might want the firm to disgorge unproductive assets.7 For these reasons. the six-fold increase in large US firms’ market capitalization led directly to a six-fold increase in CEO pay. indiscriminately purchasing assets. shareholder activist Joseph Stilwell publicly wagered $25. Black (1998). But on the whole. The first problem is that too few activists play the game.8 Bebchuk (2008) discusses the costs that activists must endure. While some herald stock options as an incentive alignment panacea. SEC Schedule 13D. CEOs paid based on ROA might forgo projects with attractive IRRs if those projects would drag down a firm’s overall returns. With their voting rights. the literature strongly disagrees. Similarly. -4- . and job security. for example. and Kahan and Rock (2006). Gabaix and Landier (2008) find that from 1980 through 2003.000 that CEO Thomas Vento could not define return on equity on a per share basis.
Below. but they rarely. 9 -5- . and (6) they can use derivatives. hedge funds have the incentives to engage in activism—(1) they earn pay-for-performance bonuses. illiquid positions. For other critiques. Barber (2007). and Del Guercio. Institutions achieve the effects on firm performance that one might expect from this level of effort—namely. and Woidtke (2008). 2007). They enjoy many structural advantages that distinguish them from prior activists. especially for public pension funds. In particular. and “block purchasers. their wooden arrows make little dent in the corporate fortress. Wallis. (5) they can take can take longterm. Romano (2001). “A small number of American institutional investors spend a trivial amount of money on overt activism efforts.10 In a literature review. and Del Gurcio. and political constraints. pension funds. if ever. and Walkling (1996).Even when activists do take up arms. not much. Carleton. First. Gillan and Starks (2007). I argue why activist hedge funds might outperform their activist peers. 10 For corporate governance successes. For other failures. see Wahal (1996). regulatory constraints. See Black (1990) and Romano (1993). induce long-term changes in performance. I document empirical evidence that activist hedge funds do improve corporate value. Most institutional investors suffer conflicts of interest. and Walkling (1996). Gillan and Starks (2000). Black (1998) concludes. Malatesta. Second. Wallis. Karpoff. Karpoff. Karpoff (2001). and Woidtke (2008). Johnson and Shackell (1997). and (3) they can avoid ERISA regulation—and they have the weapons to engage in activism—(4) they can make concentrated bets. such as those mutual funds face.” While the early literature focuses on mutual funds. including diversification requirements and insider trading regulations. see Bebchuck (2005. and Weisbach (1998).9 The empirical record agrees. hedge funds are different.” this thesis argues that hedge funds succeed where others have failed. I elaborate on these points. activists sometimes induce improvements in corporate governance. (2) they suffer fewer conflicts of interest. drawing on prior legal scholarship. Black (1998). Malatesta. Nelson. Davis and Kim (2008). (A) Hedge Funds Are Different As many a pitchbook eagerly points out. see Lipton and Rosenblum (1991).
mutual funds must maintain constant liquidity to satisfy redemption requests (Klein and Zur 2008). et. hedge fund managers often earn up to 20% or more of their firm’s annual return (Brav et al. Similarly. mutual fund managers rarely earn performance bonuses. Hedge funds do not face the 1940 Investment Company Act’s pay restrictions.First. Fourth. hedge funds can take illiquid positions to weather a long fight. activists might threaten to purchase the entire target company. hedge funds can avoid ERISA or “prudent man” regulations. 11 -6- . In contrast. Third. and public pension fund managers might flatter a CEO to win contributions for a re-election campaign (Kahan and Rock 2006). mutual fund managers might placate a company to win its pension business (Davis and Kim 2007). In contrast. 13 See Christoffersen. which restrict the risks other institutional investors can stomach. hedge funds might acquire voting rights without taking on economic exposure.11 Second. al. 2008). hedge funds use exotic strategies. mutual funds cannot hold more than 10% of any company’s stock or concentrate more than 5% of their own portfolio in a given name (Klein and Zur 2008). Whereas hedge funds sign investors into lengthy lock-up agreements. restrained by subchapter M of the Internal Revenue Code and the 1940 Investment Company Act. And finally. Through stock lending and derivatives. hedge funds suffer fewer conflicts of interest than other institutional investors. Fifth. For example.13 Or hedge funds Golec (1992) and Deli (2002) find that only 6-7% of mutual fund companies offer their managers performance bonuses. (2007) and Hu and Black (2007). 12 See Coffee (1991).12 The threat of liability may scare these potential activists from taking the risk. Bhide (1993). which incentivize them to wage successful activist campaigns. Indeed. hedge funds earn pay-for-performance bonuses. hedge funds can make concentrated bets to fight entrenched management teams. often as a negotiating ploy. and Aragon (2007). Kahan and Rock (2006) report that 97% of mutual funds’ annual compensation ignores investment gains.
the literature continues to compare apples to pairs—hedge funds’ activist investments to a non-hedge fund benchmark. they provide no evidence that activists have done anything more than simply pick undervalued companies poised to outperform expectations. to test whether activism adds value beyond stock picking. positive excess returns. Clifford (2008) compares activist investments to passive investments. and Klein and Zur (2008) study large crosssections of hedge fund activism. Greenwood and Schor (2008).might use these derivatives expressly to gain economic exposure. 14 -7- . by increasing activism’s potential gains. More similar to this study. (2008). (B) Similar Studies Do ot Distinguish Activism From Stock Picking While activists proclaim their successes in myriad press releases. To mitigate this problem. Rather than activism. Puustinen (2007). To date. we must compare activist investments to passive investments. nonetheless. (2008). Clifford fails to control for Becht et al. And simply because an activist target improves its margins does not mean the activist did anything to catalyze the change. In contrast. these findings might simply mark great passive investing—choosing companies primed to improve beyond the market’s expectations.K. Brav et al. Brav et al. mutual funds must follow the Investment Company Act’s short-selling and leveraging restrictions (Klein and Zur 2008). First. But none of these studies distinguishes activism from passive investing in disguise. Several recent papers focus on hedge fund activism. They find strong evidence for short-term abnormal returns and mild evidence for long-term improvement. Clifford (2008). Simply because an activist earns abnormal returns. they justify its requisite costs. find that the Hermes U. Focus Fund’s activism earns large. Becht et al. Boyson and Moradian (2008). it is not so easy to assess their claims. (2006).14 Using a case study approach. for instance. Boyson and Mooradian (2008). Puustinen (2007). and Klein and Zur (2008) study hedge fund activism. Thus. But this study offers a flawed dichotomy. does not mean it actually used activism to earn those returns.
Further. For example.15 This paper eliminates these problems. instead. leaving little aggregate effect. which he calls passive. hedge funds must file Schedule 13Ds within 10 days of building their position but need not file Schedule 13Gs for an entire year. for instance. might benefit from leaking their best ideas to the public. And third. astute investors might prefer to file Schedule 13Ds to protect themselves from potential litigation. Second. These legally savvy investors might also have the best ideas. In particular. others. might simply represent the market preferring fresh ideas to pickled ones. But these filings differ across other crucial dimensions. like improving corporate governance. While certain activist strategies. Most importantly. Clifford’s study might measure some other confounding variable. which he calls active. may not. Clifford compares Schedule 13D filings. I analyze activists’ strategies in detail. In addition to ignoring stock picking. First. an investor might file a Schedule 13D to convey information to other investors. might generate large returns. like selling the target firm. The larger reaction around Schedule 13D filings.” Instead of capturing the active-passive distinction. Clifford also defines activism too broadly. In particular. they propose that activists simply put firms 15 There are several possible confounds. Greenwood and Schor (2008) present some evidence on heterogeneity. they disagree that activists improve their targets. Sweren (2008) documents abnormal returns when hedge funds leak their best ideas. Well-known passive investors. even though many explicitly renounce activist intentions. while capital structure activism might increase leverage. these strategies might affect companies in conflicting ways that cancel each other out.1% simply hold the stock for “investment purposes. Without doing so. prior studies barely discus heterogeneity within activism.differences in target firms. previous studies improperly conclude that fundamentals change very little. business strategy activism might reduce leverage. he calls all Schedule 13D filings activist investments. activism might outperform simply by targeting more attractive firms. In my sample of 942 Schedule 13Ds. therefore. -8- . so Clifford’s results might reflect investors’ preference for these concentrated bets. Without testing for such heterogeneity. Second. even passive investors holding at least 20% in a company must file a Schedule 13D. 48. to Schedule 13G filings. In contrast. for example.
I correct for this bias. excluding sales. (2) compare activist Schedule 13D investments to passive Schedule 13D investments. which bring down the averages. The authors show that. activist hedge funds earn negligible long-term excess returns. Prior scholars call “activist” any hedge fund which has ever filed an activist Schedule 13D. while the literature documents some activist outperformance. This structural pressure. But this includes inexperienced hedge funds. levered institutions like hedge funds unwound dramatically. Additionally. I study hedge funds that repeatedly pursue activism. and not failed sales. Expanding the activist sample to include these novices resembles defining an athlete as anyone who has ever -9- . Greenwood and Schor (2008) argue that hedge funds’ poor performance during the 2008 Credit Crunch proves that they rely on selling their targets. (4) measure short-term abnormal returns around events which occur after the hedge fund has disclosed its position. But by asymmetrically removing successful sales. Grenwood and Schor have imprecisely measured activists’ non-sale returns. (3) control for differences in target firms. But this overlooks the crisis’s main symptom. This section elaborates on these frontiers. In summary.in play. might explain the results. In Section V. I improve on the literature in several ways. Section II: Experimental Design (A) Contributions to the Literature To argue that activism adds value. and not activists’ reliance on selling their targets. This is the first paper to: (1) use a comprehensive sample of experienced hedge funds. and (6) fully document cross-sectional variation in activists’ strategies. biasing their results downward. and (2) it largely ignores heterogeneity. (5) analyze board seats. in contrast to the existing literature. (1) it fails to distinguish this outperformance from stock picking. First.
I distinguish activist instruments. I also expand on his study by more thoroughly examining changes in target firms’ accounting performance. offering to buy the target. I consider five instruments: seeking board seats. Fourth. I expand on this method below. or suing the target. By following each investment’s SEC trail. I improve his methodology by (A) limiting my focus to Schedule 13Ds and (B) recognizing that many Schedule 13Ds espouse passive intentions. I control for variation in target firm characteristics like undervaluation and underperformance. launching proxy fights. While Clifford (2008) also compares activist returns to passive returns. By selecting only hedge funds known for activism. prior scholars conclude that no one can consistently throw a 90 mph fastball. after rounding up two NY Yankees and five hundred physical education teachers. like selling the firm. the first time it expresses activist intentions. an activist uses instruments to implement its strategies. providing private financing. I find subsequent filings in which a hedge fund changes its intentions—for example. Because 80% of all investments using an instrument seek board seats. like seeking board seats. from activist strategies. I resolve this bias. Board seats distinguish activism from stock picking by providing tangible proof that the hedge fund seeks to influence its target.10 - . This improves on Clifford’s (2008) study by dismissing the alternative hypothesis that activists target more attractive firms. . Because the hedge fund has already disclosed a passive interest in the target firm. I compare hedge funds’ active Schedule 13D investments to the same hedge funds’ passive Schedule 13D investments. to disentangle activism from stock picking ability. I expand on this method below. I consider them most thoroughly. Third. Second.owned a baseball glove. I document short-term abnormal returns around events that take place after the initial Schedule 13D filing. this method more cleanly isolates the activist signal from the stock picking signal. Fifth.
a second layer of stock picking to peel back. only by understanding their strategies can we replicate activist hedge funds’ ability to improve firms. and corporate governance. perhaps because different strategies cancel each other out. then the market must have already expected those improvements—and the activist probably did not cause the change. Thus. If activism earned excess returns without improving target firms.16 There is. too. It is probably a necessary condition. however. sale. capital structure. prior studies have observed little change in target firms’ fundamental accounting performance. By comparing activist targets to passive targets. (2008) analyze short-term returns by strategy. I add evidence that strategies differ over the long-run. I come closer to measuring how these activist targets otherwise would perform than does any prior paper. . And second. if activist targets became better companies without earning excess returns. Hedge funds might pick more attractive firms for activist investments than for passive investments. Both activist and passive investments benefit from hedge funds’ superior stock picking abilities. activism must add value. Because activism costs more than passive investing. M&A. On the other hand. then hedge fund activism would simply be a penname for astute stock picking.Sixth. these findings cannot stand alone. I identify five cohesive activist strategies: business strategy. 16 Thus. First. I also investigate heterogeneity in fundamental improvements. hedge funds should demand greater returns. but only activist targets benefit from hedge funds’ activist abilities. to the extent activist investments outperform passive investments. To eliminate this bias. we must demonstrate that (1) shareholders enjoy greater returns than they otherwise would and (2) target firms improve their accounting performance more than they otherwise would. While Puustinen (2007) and Brav et al.11 - . But unlike the Beatles. (B) Testing For Activism To prove that hedge fund activism adds value. This is important for two reasons. activist outperformance is a sufficient condition to show that activism adds value.
Additionally. 18 13D Monitor sought to include every fund that repeatedly uses activism. the hedge fund has opened a dialogue with management. and Klein and Zur (2008) all use news searches to form an initial hedge fund list. Ken and Robyn deserve full credit. controlling for target firm variation. I consider the 48 hedge funds which the shareholder activism advisory firm 13D Monitor defines as most active. differences in undervaluation and in underperformance.I control for differences in target firms—in particular. I am completely indebted to Ken Squire and Robyn Rosenblatt for allowing me access to this database and for putting up with my annoying questions.12 - . 17 In particular. Brav et al. they compile a comprehensive list that fits a narrow criteria. we can conclude that activism adds value.13dmonitor. To the extent I had time to emerge from my dorm room at any point during the month of January. Thus. Clifford (2008). I study only hedge funds which focus on activism. At worst. (2008). Thus. which include hedge funds that have made very few activist investments. As before. 18 13D Monitor maintains a subscription-based database of Schedule 13D filings at http://www. that is. whereas a fine line separates activism from passive investing. Even if it never wins a seat. rather than assembling a random sample of a broad universe. Brav et al. the activist might threaten a proxy fight as a bargaining chip. the activist might get its way. seeking board seats helps activists influence the firm’s decisions. Unlike the mere rhetoric accompanying many filings. Thus.com/. board seats must add value. my sample generalizes not to every ex-Goldman Sachs trader who files a Schedule 13D. even hedge funds with only one prior activist investment enter the sample. Boyson and Mooradian (2008). Because it is comprehensive. . If activist investments still outperform passive investments. (2008) limit their sample to hedge funds with at least two activist investments. a much thicker line separates board seat investments from other investments. I analyze board seats to better distinguish activist investments from passive investments. I find no evidence of survivorship bias 17 Puustinen (2007). the list suffers from little if any bias in describing the historical record. if we observe that board seat investments outperform other activist investments. At best. but rather to experienced activists. (C) Collecting Data Unlike previous studies.
or corporate governance.000 individual SEC filings. I collected information on all 942 investments that these hedge funds made. To further dissect these investments. to focus on the current activist climate. This narrowed my sample to 718 investments. of which I classified 393 as active and 325 as passive. Without exception. these hedge funds may be the biggest culprits. In particular. buyout offers. Section 13(d) of the 1934 Exchange Act requires investors to file with the SEC when they amass large stakes with activist intentions. Thus. By reading over 6. First. filers must declare why they acquired the shares. Using 13D Monitor’s online database. I collected the entire activist history for each investment. which houses SEC filings dating back to 1994. Second. activists tend to focus on targets small enough that they can establish large positions.21 In Item 4. I classify an investment as activist if the investor announces any activist instrument—board seats. sale. 2000. private financings. I excluded filings before January 1. it would not necessarily be biased towards hedge funds whose activist investments outperform their passive investments. Of the 393 activist investments. proxy fights. or lawsuits—or any activist strategy—business strategy. the most frequent funds in each source overlapped with my sample. this sample paints an accurate picture. 13D Monitor’s sample provides a fitting laboratory. capital structure. From these 942 investments. several hedge funds in my sample performed quite poorly.20 And finally.13 - . I turned to the Edgar database. I narrowed the sample. I excluded all firms which declared bankruptcy before the hedge fund invested. hedge funds must file a Schedule 13D within 10 days of acquiring at least 5% in any public company.9% exhibit negative average activist abnormal returns. 23. 213 sought board seats. 21 While activists rarely pierce the 5% threshold in large firms.when comparing my sample to those in similar papers. if activism does simply represent disguised passive investing. M&A. I compared my sample to two sources: Puustinen (2007)’s sample and hedge fund consulting firm Hedge Fund Solutions’s database. 19 . even if the sample were biased towards hedge funds whose activist investments perform quite well.19 As evidence against backfill bias. 20 Of the 46 firms with long-term return data. In fact.
upon realizing the firm’s true value. This devotion to updating their goals indicates that hedge funds take care to convey honest information.14 - .24 After collecting information on these investments. the SEC and target firms use the courts to enforce truthful disclosures. Steel Partners II (2005). which implies that these funds do differentiate passive from activist investments. Passive institutional investors who acquire at least 5%. funds might take advantage of Schedule 13D’s immediate disclosure.23 Second.. Third.” Should we believe them? First. 23 See. however.g. Montgomery Medical Ventures. of a company’s stock may file a Schedule 13G with the SEC. in searching Bloomberg news for certain randomly chosen passive investments. e. I calculate the target firm’s return in excess of 22 Passive investors acquiring at least 20%.4% of passive Schedule 13Ds. Clifford (2008) argues that hedge funds exercise extreme caution to avoid filing any misleading disclosures. SEC vs. some elaboration is in order. . And finally. bid up its price.22 But sometimes these firms will instead file a Schedule 13D. Fourth. Second. LP (1996) and Ronson Corp v. They may wish to communicate their investment thesis so that other investors. each hedge fund in my sample announces either passive or activist intentions at least once. citing conversations with hedge fund managers. hedge funds subsequently announce activist intentions. 24 For example. The strongest evidence for this proposition comes from the hedge funds themselves: many filings announce that they are holding the stock for “investment purposes only. but less than 20%. Sweren (2008) documents excess returns after hedge funds file Schedule 13Fs. So why might a hedge fund file a Schedule 13D rather than a Schedule 13G? First. I find almost no such instances of 20%+ passive positions.Because this is the first paper to suggest that many Schedule 13D filings might harbor passive intentions. I pulled share price histories from the Center for Research in Security Prices (CRSP). using the more rigorous Schedule 13D safeguards the hedge fund against liability. I find that after 32. I found no evidence that the hedge funds engaged any attempts to change the target firms. must file a Schedule 13D. While this might bias my Schedule 13D sample towards large passive firms.
Unfortunately. First. 2004. presumably smaller firms. I describe the event study method more fully in Appendix A. Section III: Hedge Fund Activism Before turning to the results. with low Tobin’s q. I could only obtain Compustat data dating back to January 1. I use abnormal q to proxy for undervaluation. I also calculate abnormal margins. A low Tobin’s q implies undervaluation. I calculate industry-adjusted statistics to better analyze a target firm’s idiosyncratic performance. abnormal return on equity (“ROE”). I describe the firms which activist hedge funds target. I calculate the firm-specific component (denoted abnormal q) as the percentage difference between the firm’s Tobin’s q and the median of its industry peers. I calculate these variables by hand using firm-level data from Compustat. This might bias my findings. The analysis excludes firms for which CRSP lacks data—most likely small. unlisted firms.25 While hedge funds target relatively profitable firms overall. I use accounting data pulled from Bloomberg. I use two types of data on target fundamentals. their activist efforts target less profitable firms than do their passive Tobin’s q equals the firm’s market value divided by its replacement value—measured as the market value of debt plus equity divided by the book value of debt plus equity. 25 . following Ang and Chen (2006) and Puustinen (2007).15 - . Both Bloomberg and Compustat were missing data for several firms. and abnormal leverage. this section elaborates on the differences between activism and passive investing. where the firm-specific component (denoted abnormal) is the difference between the firm’s value and the median value of its industry peers. Second. they target undervalued firms. For example. using the GICS industry classification.the market model measured against the CRSP value-weighted NYSE/Amex/Nasdaq index. all results are robust to the use of the Fama French factors. While unreported. First. In general.
including definitions. and *** refer to statistical significance at the 10%. While hedge funds target overall profitable firms.7 17.9 3.3 12.1 -0.5 20.1 13.0 0.1 -4. and active investments not seeking board seats.6% more undervalued.7 -0.1 16.1 9.2 -11. and corporate governance.9 8.7 1.2 15.1 8.7 -0. active investments seeking board seats.0 1. Table D-1 adds more information. passive investments.6 157 (2) Board Seats Other 891.0 8.0 -5. I describe five main categories: business strategy. sale. *. Second.4 22.Table I Target Firm Characteristics The table reports the characteristics of hedge funds' targets.5 -0.4 17.0 9. All data is winsorized at the 10% level.4 1.2 9.4 22. capital structure.3 303 Passive 654.7 7.7 12.4 -1.6 3.7 0.1 -29. we should first describe the ex-ante differences in the two samples. I discuss heterogeneity among activists’ strategies.5 23. activist targets are 29.0 0.3 2. (A) Activists Target Undervalued Firms Before we can measure activist investments against a passive benchmark.4 -0.0 -1. Measured by Abnormal q.0 16.0 -1.6 9. Relative to passive targets.4 1.7 22.8 14.6 10. the average activist target is 16.1 3. All variables refer to the trailing twelve months prior to the Schedule 13D. (1) Activism Activist Market Cap Tobin's q Abnormal q EBITDA Margin Abnormal Margin Return on Assets Return on Equity Abnormal ROE Leverage Abnormal Leverage Payout Ratio Cash/Assets N= 757.3 -2.2 24.9 * * *** * ** * ** Board 636.7 12. relative to the median firm in its industry.5 5. 5%.7 -5. **. M&A.3 16.0% more undervalued (t = -3.0 -4.2 19.8 11. Column 2 compares activist investments seeking board seats to other activist investments.6 -16. Column 1 compares activist investments to passive investments.5 *** *** *** *** *** *** ** * efforts.1 -6.1 146 Diff -255. Column 1 shows that hedge funds go activist in undervalued and underperforming firms. In Appendix D.16 - . and 1% levels.4 0.1 1. they go active in the .8 10.2 -1.7 -11.0 1.5 -22.68).3 1.0 -2. Table I reports summary statistics for active investments.5 492 Diff 102.
because he considers all Schedule 13Ds to be “active. Relative to passive targets. however. and 2.7% higher ROE than the median firm in its industry.0% lower ROE (t = 2. 26 I calculate margins as EBITDA divided by sales.4% lower ROE (t = 1.1% lower margins (t = 4.49) and 0.1% lower margins (t = 1. The average activist target has 3.42). I categorized the investments into five broad strategies: (1) “Business Strategy” activism. the table provides moderate evidence that hedge funds try to unlock value in underperforming target firms.28 This might be explained by his methodology. Consistent with the literature. .least profitable ones.17 - . like acquisitions or spinoffs. it seems they seek board seats to improve underperforming firms. (2) “M&A” activism.59). they have 1.34).” he includes some passive investments.2 lower Tobin’s q (t = 2.0% higher margins and 0. (2008). these passive investments might lift the observed profitability.26 Activist targets also hoard assets. They are also less profitable. 28 See Boyson and Mooradian (2008). (B) Activists Use Different Strategies Activists tailor their strategy to each target. Compared to other activist investments.49). those seeking board seats are even more undervalued. 27 I calculate payout ratio as common dividends divided by net income.13). Clifford (2008) finds that active targets are more profitable than passive targets.9% more cash per dollar in assets (t = 1. with 0.0% lower ROA (t = 1. and 6. which seeks to maximize value through extraordinary transactions. 1. 2. I calculate ROE as EBITDA divided by the book value of equity.27 Overall.71). From the hedge funds’ SEC filings.49). Column 2 shows that within activist investments. and Klein and Zur (2008). This evidence refutes the alternate hypothesis that activists seek board seats to associate themselves with successful firms. Instead. While these results resemble most prior studies. I calculate ROA as EBITDA divided by book value of assets.1% lower ROA (t = 2.47). hedge funds seek board seats in the most troubled companies. which attempts to improve the firm’s competitive strategy and capital allocation. they have 1. Relative to passive targets. with 5.7% lower payout ratios (t = 0. Brav et al.
04 Sale Coeff.51 -0.04 ** -1.72 -0.24 *** 2.60 *** -6.30 1. hedge funds most frequently use M&A and Sale activism (130 times each) and least frequently use business strategy activism (75 times).21 4. Table II Logit Analysis By Strategy Using a logit regression. I improve on Brav et al.61 * -1.67 *** -6.14 0.71 0. In my sample. active or passive. -0. business strategy and sale activism correlate the least. and (5) “Corporate Governance” activism.01 .13).46 547 0.75 547 0. we should expect each strategy to target firms with particular weaknesses.78 -0.34 1. at 7%. Bus Strat t -stat Coeff.85 -0.13 10.33 1. While correlations among the strategies vary from 15% to 37%. 5%.61 -1. which tries to influence leverage or payout policies.22).22 0.42 * -1. All data is winsorized at the 10% level.03 * -21.79 * 1.18 - .39 0. Market Cap Tobin's q Growth Margin Leverage Cash/Assets Constant No.14 0. which demands that the firm sell itself.51 -1.21 *** -5.41 ** 2. This way.76 *** 547 t -stat -1.89 0.02 -0. Business strategy activism targets poorly performing companies with lower sales growth (t = -1.07 0.03 Cap Struc t -stat Coeff. the table reports the liklihood that activists target firms with various characteristics. I elaborate on these categories by excerpting from SEC filings. and *** represent statistical significance at the 10%.04 *** 2. Table II shows a logit regression that uses firm characteristics to predict the hedge fund’s strategy. In Appendix B.43 -2.07 1.06 *** M&A t -stat Coeff.06 9.11 -0.06 Corp Gov t -stat Coeff.06 -0.05 0.29 *** -2.76 -0.31 0.57 -2. and Pseudo-R 2 0. This supports the hypothesis that business strategy and sale activism seek mutually exclusive goals—where one builds long-term businesses. 0.14 547 3. Targets are also larger (t = 3.04 -0.25 547 * 1.43 ** 1.50 -0.20 0. I distinguish between activism which improves companies through capital allocation and activism which improves companies through corporate transactions.42 1.06 *** -5.35 1.(3) “Sale” activism. the other quickly sells them. and 1% levels. (4) “Capital Structure” activism.19 * 1. which addresses the firm’s governance policies.33 -1. The dependent variable is a dummy equal to one if the hedge fund targets the firm with a particular activist strategy.33) and lower margins (t = -1.00 0.02 -3.78 -15. *.43 0.13 0.62 0.78 -2. (2008) by separating what they call “business strategy” into business strategy and M&A.41 0.22 0.07 -0.19 -1.17 1.78 0. The sample population includes all hedge fund investments. 0.03 -56.66 -4. **.43 -2. 0. If activist strategies truly differ.
1 *** 1.41). Column 1 and Column 2 present odds ratios from logistic regressions that predict which strategies seek board seats and which strategies win board seats.92 0.29 Corporate governance activism targets firms with excess cash (t = 1.33 -0. 5%.02 perhaps because large companies struggle to allocate capital among their many divisions.3 1.89 and t = -1.59 0. *.2 1.Table III Board Seats By Strategy The table present the logistic regression odds ratios that each strategy (1) seeks board seats and (2) wins board seats. and Pseudo-R 2 2.06). Sale activism targets smaller companies (t = -1. Capital structure activism targets healthy firms. Table III describes the frequency with which each strategy seeks board seats.04). and *** indicate statistical significance at the 10%. and 1% levels.40 1.89 2.78).29 0.01 1.99 0.5 1. M&A activism targets large companies (t = 2.1 0.7 * 316 z -stat 2.43). perhaps because they are easier to sell in whole.60 0.59)—probably to nurse businesses back to profitability—while M&A activism nominates directors least frequently (z = 0. business strategy activism wins board seats most 29 I measure leverage as long-term debt divided by total assets.9 ** 1.89)—probably because the hedge funds anticipate exiting after quick flips. M&A and sale activism target undervalued companies (t = -0.51).61) with lots of cash on hand (t = 2.61 0.9 1. Similarly.3 155 (2) Win Logit z -stat 0. likely following Jensen’s (1986) hypothesis that misaligned managers hoard assets. They also have low existing leverage (t = -1. Targets enjoy very high margins (t = 2. Business strategy activism nominates directors most frequently (z = 2.3 1. **. (1) Board Logit Odds Bus Strategy M&A Advice Sale Cap Structure Corp Gov No.04 Odds 1. . perhaps because larger firms have underperforming divisions rife for spinoffs. which can increase their payout. The dependent variable is a dummy set equal to 1 if the activist sought or won a board seat.19 - .
Thus.20 - . however.29). activist investments which seek board seats. with good news. In this section. they drive them back down. I use a dummy variable regression to compare activist filings to .often (z = 0. Having described activists’ methods. not the moral hazard problem—that is. Depending on the strategy they want to use.92). while M&A and sale activism succeed least often (z = 0. In fact. we should observe immediate excess returns. the market favors activist investments—and in particular. Second. First. Does this activism increase returns? Section IV: Short-Term Stock Returns Everyday in the stock market. Absent efficient markets. Investors may believe that hedge funds can access better information or conduct better analysis without adding any activist value.33 and z = -0. activists target undervalued firms with room to improve. like hedge funds advising on business strategy. like hedge funds seeking to sell the business. I now turn to the first research question. I find strong evidence that. They may reflect hedge funds solving the adverse selection problem. these short-term returns do not themselves prove that activism adds value. Particularly in efficient markets. and with bad news. they choose different targets. they bid up prices. targets prefer long-term partners. In summary. shareholders vote with their wallets. if activism adds value. Sweren (2008) documents short-term abnormal returns around hedge fund Schedule 13F filings. which convey no explicit activist intentions. these price swings presage actual changes in firms’ values. once shareholders discover hedge funds’ intentions. I compare activist filings to passive filings. using three tests. in the short-term. I argue that activism does add value beyond simple stock picking. the filings may signal target firms’ already good prospects without actually signaling that hedge funds will in fact improve those prospects. This makes sense. to short-term speculators.
I report p -values for medians using the Wilcoxon Signed Rank Test.6% *** 77.7% *** 79.9% *** 149 (-2. Third.6% *** 57. 5%. Other Active Investments Board Seats (-30.2% *** 8.1% *** 5. the stock market responds favorably to activism.4% *** 194 (-2.6% *** 342 (-2.5% *** 3. **. Table D-2 shows more details. Passive Active (-30.4% *** 340 Difference (-30. underperforming target firms experience the largest excess returns.+2) 4.5% *** 149 Difference (-30. I also investigate heterogeneity across these returns.7% *** 67. In particular.3% *** (-2.+30) 1. like seeking board seats. I calculate excess returns over 61.1% * (-2. not simply to stock picking. controlling for target firm undervaluation and underperformance. *.+2) 1.9% *** 2.8% *** 8.6% *** 4. Again.21 - .6% *** 77. I identify events which isolate the activist signal from the passive investing signal.9% * . Panel B compares active investments seeking board seats to active investments that do not.+30) Median Average % Positive N= 12.7% *** 88. and 1% levels. Panel A compares activist investments to passive investments.9% *** 80.8% *** 45 No Board Seats (-30.and 5-day windows relative to the market model Table IV Short-Term Returns by Investment Type The table presents average daily returns around the schedule 13D filing in excess of the market model using the CRSP value-weighted index.9% *** 194 Passive (-30. Except for corporate governance activism. or activist strategies does the market judge most effective? Undervalued. all strategies enjoy abnormal returns.+2) 7. and *** indicate statistical significance at the 10%. Panel A: Active vs.7% * 2.+30) 10.7% * 5. Thus.7% *** 80.passive filings. activist instruments.+30) 8.8% *** 12. I investigate when activists add the most value—what target firm characteristics.+2) 4.+2) 2. I find evidence that the market favors investments which take active steps.8% *** 12. Finally.5% *** 17.4% *** 5. I find significant excess returns. I estimate parameters over the 200-day window prior to the Schedule 13D filing.0% *** Panel B: Board Seats vs.+30) 3.+30) Median Average % Positive N= 11. (A) Activism Exceeds Stock Picking Table IV reports the market’s reaction to activism. activist investments outperform—particularly when the hedge fund seeks board seats. I note that these returns have declined over time.9% *** 45 (-2. In Appendix D.+2) 3.
22 - 13 D 20 5 D D ay s ay s ay s ay s ay s .6% and passive positions by 2.In the Short-Run.6% of passive positions show positive returns (z = 8. Figure 1 plots the average excess return. Afterward. To test whether activism differs from stock picking. active positions jump by 4. and Klein and Zur (2008). This .9% and 4.6% over 30 days.96). from 30 days prior to the Schedule 13D filing date to 30 days afterward. Before the filing. Both active and passive investments experience positive and significant excess returns surrounding the filing date. using the CRSP value-weighted index. Active Investments Outperform Passive Over a 61-Day Event Window 20% Board 15% Active NoBoard 10% 5% Passive 0% -5% Fi lin g D ay s ay s ay s D 25 30 ay s ay s ay s D D ay s D D D D D -5 10 15 D -3 0 -2 5 -2 0 -1 0 -1 5 Figure 1. Clifford (2008). Over 61 days. 80. The dashed lines divide active positions into those in which the hedge fund sought board seats (long dashes) and those in which the hedge fund did not (short dashes). between 10 days to 1 day prior. Brav et al.37). active positions jump by 4.3% (t = 3. The results are consistent with Boyson and Mooradian (2008). the abnormal returns trend up to 13.91 and z = 3.4%. On filing day and the following day. (2008). Panel A in Table IV compares activist filings to passive filings. the chart plots the average excess return around the schedule 13D filing. For active (blue) and passive (red) hedge fund investments. from 30 days prior to the filing until 30 days afterward.4% of active positions and 57. activism outperforms by 8.1%.5% and passive positions by 1. Over 61 days.
1% (t = 1.33). board.0% 4. and no board investments. Within active investments. I elaborate on these dummy variable regressions.0% 8. Activist targets might differ from passive targets in a way that makes them more likely to outperform. those seeking board seats earn significantly higher returns. Still. measured by a dummy variable regression. board. Overall.In the Short-Run.0% 6. controlling for the target firm’s undervaluation and underperformance.23 - . these comparisons do not prove that activism adds value. The regression uses Tobin’s q to proxy for undervaluation and margins to 30 In Appendix A. passive. or no board investment. controlling for the possibility that activist investments might be more attractive ex-ante. Active Investments Outperform Passive Controlling For Undervaluation and Underperformance 10. The chart shows the average 5-day returns to active. it seems activism add value. controlling for Tobin's q and margins.0% 2. supports Clifford (2008)’s results.30 Figure 2 shows the excess returns to an average firm which a hedge fund targets for an active. I regresses the 5-day abnormal return on activism and board seat dummy variables. far from a controlled experiment. . In other words. these investments outperform by 5. passive.0% Active Passive Board No Board Figure 2. Over 61-days. hedge funds might simply call their best ideas “activist.” I use a dummy variable regression to compare activist to passive investments.0% 0.
To isolate these events. Thus. I also conducted basic news searches.2% 109 proxy for underperformance. the first time a hedge fund wins board seats.8% (t = 4. and (3) having already announced its intention to seek board seats.32 In addition.2% *** 6. I calculate abnormal returns around three events: (1) having previously filed a passive 13D.+30) Median Average % Positive N= 7. I calculate returns in excess of the market model using the CRSP value-weighted index.+2) 2. and 1% levels.Table V Abnormal Returns After 13D Filing Date The table presents average returns around events that occur after the initial Schedule 13D filing.3% 0.31 The results are robust to other models. it might convey some additional passive signal.0% *** 53 (2) First Board Seat (-30.+30) 5.6% *** 53 (-2. 5%. *. Because the activist has already disclosed a 5% stake in the target firm.9% *** 60. I report p -values for medians using the Wilcoxon Signed Rank Test.2% *** 4. activism adds value beyond stock picking.1% *** 48 (3) First Board Win (-30.3% *** 6. Table D-3 presents the regression results. I estimate parameters over the 200-day window prior to the event.71).+30) 6. the first time a hedge fund seeks board seats. this critique does not apply to incidents where activist hedge funds win board seats. (B) Purely Active Filings Show Excess Returns In addition to comparing returns around Schedule 13D filings.4% *** 66. **. But given that the hedge fund has already accumulated 5% of the company. however.2% *** 66. the only new information that these subsequent filings convey is the activist’s intention to improve the target firms. 31 32 In Appendix D.5% *** 8. this passive signal is of a small magnitude. and *** indicate statistical significance at the 10%. I isolate the activist signal in subsequent filings. (2) having previously filed an activist 13D.8% * 53. the first time a hedge fund announces activist intentions.+2) 1. because activist hedge funds cannot fully control whether they win board seats after they decide to seek them.24 - . If a hedge fund increased its exposure in any subsequent filing.4% *** 110 (-2.3% *** 73.+2) 0. filings in which the activist wins seats convey little information about hedge funds’ ability to pick stocks—only their ability to add value as activists.4% ** 48 (-2.2% (t = 1.4% *** 77. Activist investments outperform passive investments by 3. Further. I read each investment’s entire SEC trail. .78).5% *** 3. (1) First Action (-30. and board investments outperform other activist investments by 3.
(2) what instruments make an activist most effective.82).33 Figure 3 shows the returns over time. the firms outperform by 8. and 6. On average. Table VI analyzes (1) what characteristics make a firm most susceptible to improvement. respectively. and z = 3. Table D-4 reports more details.9%. having previously filed an activist 13D. 6. z = 2.and 5-day abnormal returns surrounding these events.2% (z = 3. Having previously filed a passive 13D. Over 61-days. Table V reports the 61.70.76. 13 D . 73.69 and z = 3. 60. and (3) what strategies add the most value. the green line shows the hedge fund's first time winning a seat. The dependent variable is the 5-day abnormal return 33 In Appendix D. z = 1.3%. the blue line shows the hedge fund's first activist intention.4%.80). respectively. and 66. not just the stock picking signal. Using a regression approach.Purely Active Filings Outperform After Initial Schedule 13D 10% 8% 6% 4% 2% 0% -2% ay s ay s ay s ay s ay s Fi lin g ay s ay s D ay s D ay s D ay s D ay s D ay s 30 D D D D D D D FirstActivist SeekBoard WinBoard -3 0 -2 5 -2 0 -1 5 -1 0 -5 5 15 20 Figure 3. the market reacts favorably to the activist signal.4% of target firms enjoy positive returns around each event (z = 3.6%. The table shows abnormal returns around events after the initial Schedule 13D. (C) Returns Differ By Strategy Just as important as average abnormal returns is the cross-sectional variation of those returns. Thus. the red line shows the hedge fund's first time seeking a board seat. and having previously filed board seat 13D.25 - 10 25 . Target funds earn positive and significant excess returns surrounding each event date.38.
49 *** 6.58 -0. M&A.00 -0.75 Coeff.77 -1.38 *** *** * ** ** *** * *** * surrounding the schedule 13D filing. and corporate governance.56 0. or launching an additional proxy fight. and 1% levels.63 7. All accounting variables are winsorized at the 10% level.23 ** -2. and *** indicate statistical significance at the 10%.41 2.93 ** -1. I express all non-dummy covariates as the deviation from the sample mean.07 0. and the firm’s debt-toassets ratio. capital structure.25 2.31 1.73 1.11 Coeff.26 - . I adapt the methodology in Brav et al. **. Column 3 regresses abnormal returns on dummy variables for those strategies. (1) Dependent Variable: Abnormal Returns Constant ln(MV) Abnormal q Abnormal Margin Leverage BoardWin Board Buyout Financing Proxy Bus Strategy M&A Sale Cap Structure Corp Governance Other No. providing private financing. including winning board seats. I suppress the intercept because of the dummy variables’ full span.69 4.22 0. t -stat 6. Column 1 regresses abnormal returns on target firm fundamentals.75 4. For interpretation purposes.34 112 (3) Activist Strategies t -stat -1.85 0.65 0.53 -0.26 4.87 3.17 1.68 1.53 -0. the firm’s industry-adjusted margins. In columns 2 and 3.30 0. we can interpret each dummy coefficient as the . and R 2 Target Fundamentals Coeff.22 -0.60 3.08 120 0. I include as regressors (1) the firm’s abnormal q. sale. All non-dummy covariates are expressed as the deviation from the sample average values.46 0.Table VI Cross-Sectional Variation of Short-Term Returns The dependent variable is the 5-day abnormal return around the Schedule 13D date. offering to buy the target firm.55 0.87 -0. And for all investments using activist strategies.51 -2. and (3) dummy variables for the various activist strategies. Column 2 regresses abnormal returns on dummy variables for those instruments. intercepts are suppressed .98 -0. -1. (2008). including business strategy. -6.64 6.30 17.92 -1.47 -2.26 32 (2) Activist Instruments t -stat -2. For all investments using activist instruments. 5%.99 1. the logarithm of market capitalization. and in Column 2 and Column 3. Thus. For all activist investments. (2) dummy variables for various activist instruments. *. seeking board seats.
3% (t = 1. hedge funds can add value to target firms. hedge funds put their own money on the line. Whereas prior literature has noted hedge funds’ tendency to drive returns by putting firms in play. (2008). Consistent with my earlier findings. the findings presented here identify an overlooked subtlety: rather than simply agitating for change.30).partial return for an average target firm when the hedge fund uses that dummy variable. which depends on what happens after the buyout. through board seats.7% additional returns (t = 0. not only do activists target undervalued and underperforming firms. activists earn the highest returns when targeting firms with low abnormal q (t = -1. I describe more fully this dummy variable regression. Both Column 2 and Column 3 include dummy variables which are not mutually exclusive. if a hedge fund uses both Business Strategy and M&A activism. Thus.34 Turning first to target firm fundamentals. This is what we should expect.87) and with low industry-adjusted margins (t = -2. In particular. these buyout offers generate large returns for shareholders. For example.99). for 11.7% + 1.27 - . seeking board seats generates average abnormal returns of 4. stock market returns no longer proxy for the hedge fund’s return. Still. But when the hedge fund does purchase the target. See Greenwood and Schor (2007) and Brav et al.6%). Thus. but they earn the highest returns while doing so. the market reaction indicates activists can improve underperforming firms. The market also responds very positively to hedge funds that offer to buy the entire firm. 34 35 In Appendix A. driving target prices up 17. too.75). the market seems to think that. .9% (t = 4.3% (= 2.35 Often these buyouts often push targets into another acquirer’s arms—making them a formidable weapon in the activist’s arsenal.22). I also find that activist instruments yield excess returns.0% total excess returns. as documented in Section III. they’re more likely to succeed at firms with more room to improve. we expect the total abnormal return to be 4. Hedge funds that win board seats generate 6. if activists do add value.
Perhaps due to improving governance. The bars show the 90% confidence interval.7% (t = 1.28 - . Additionally.4% excess returns (t = 4.73).53). these results contradict Boyson and Mooradian (2008). Indeed.03). I find that capital structure activism generates positive returns. which implies that activism can improve its targets. defined as the regression coefficients. the coefficients reflect activism’s effects. not just target firms’ fundamentals.9% (t = 1. This thoughtful variation provides further evidence that shareholders expect activism to generate . While consistent with Brav et al.31) and 2. this strategy has become less successful over time. who find that corporate governance activism generates large returns. This is due to their longer time frame. Business strategy and capital structure activism also generate significant abnormal returns of 2. The chart shows the average 5-day abnormal return for each strategy.In the Short-Run. These strategies generate statistically different returns (F = 4. Sale activism generates 7. Figure 4 shows the average return to each activist strategy. when I include investments from 2000 through 2003 by substituting regular data for the industry-adjusted data. because both Column 2 and Column 3 control for abnormal q and abnormal margin. (2008). Selling the Firm Generates Highest Returns Controlling for Undervaluation and Underperformance 10% 5% 0% -5% Business Strategy M&A Sale Capital Structure Corporate Governance Figure 4.
and constants are suppressed. The bar graph shows the number of Schedule 13Ds filed each year (right axis). I reject the hypothesis that annual returns equal each other (F = 2. (D) Returns Have Decreased Over Time Finally. as measured by the coefficients in a dummy variable regression that controls for Tobin's q and margins.1%. value. in 2001. The line graphs (left axis) show show the average 5-day returns by 13D year. To the contrary. the average firm earned 23. the blue lines plots the average activist returns to Schedule 13Ds filed each year (left axis).Short-Term Returns Decline Over Time As Investments Increase in umber 25% 20% 15% 10% 5% 0% -5% 20 04 20 00 20 01 20 02 20 03 20 05 20 06 20 07 20 08 180 150 120 90 Active Passive 60 30 0 Active Filings Passive Filings Figure 5. The blue line shows the average activist return. I measure how these returns have changed over time. I find that short-term activist returns have declined over time. The results are robust to other models. the average firm earned only 5. but in 2008. In Figure 5. All non-dummy covariates are expressed as the deviation from the sample mean. and the red line shows the average passive return.9%. . controlling for Tobin’s q and margins. Consistent with Puustinen (2007). I regress the 5-day abnormal returns against dummy variables for each filing year.14). they would not parse a hedge fund’s press releases to discern its intentions. if shareholders were purchasing simply on expectations of superior passive investing.29 - . The blue bar (right axis) shows the number of active Schedule 13Ds and the red bar (right axis) shows the number of passive Schedule 13Ds filed in my sample each year. returns have declined.
if activism fails to generate long-term excess returns. shareholders might begin to expect it. This section builds on that work to examine whether the weighing machine agrees. First. Thus. passive returns (red line) have not demonstrably improved. though. In addition. After all. Section V: Long-Term Stock Returns In the Intelligent Investor. activists may simply have lost their edge. investors are less surprised. Second. Activist investments outperform passive investments. In the long run it is a weighing machine. when hedge funds actually do intervene. “In the short run. Thus.30 - . In summary. Activism aimed at undervalued firms and attempts to sell target firms earn the highest returns. these returns have declined. as companies have learned to accept activism. Section IV argued that investors believe activism adds value. Recently. however. even if the hedge funds have already disclosed passive investments in the same targets.48). neither corporate shareholders nor hedge funds’ clients benefit. putting money to work in increasingly less attractive situations. outside observers might confuse true activism for passive investing. in fact. . as activism becomes more common. I find substantial evidence that activism adds value.” Using what Graham might consider an exit poll. In Section VI. investors applaud hedge funds’ activist intentions. Benjamin Graham (1973) writes. Finally. the market is a voting machine. As evidence against this hypothesis. hedge funds have shed their most aggressive tactics. however.This pattern suggests three interpretations. adjusting for undervaluation and underperformance. I find no evidence that activists have lost their ability to improve target firms. I cannot reject the null hypothesis that the coefficients all equal each other (F = 0. activism represents wasted energy at best and value destruction at worst.
I find strong evidence that activist investments. Again. as the activist continues to wage a campaign. Even excluding the 61-days surrounding the filing. if hedge funds could persistently pick winning stocks without improving them. the efficient markets hypothesis proves crucial to the argument. First. I compare activist filings to passive filings. activist investments outperform passive investments—particularly when the hedge fund seeks board seats. or activist strategies prove most effective? As in the short-run. not activist ability. At every point in time. activist investments earn significantly higher returns. I compare activist filings to passive filings. 2008).31 - . Second. underperforming target firms earn the highest long-term returns. the market should bid stock prices to a level reflecting the expected probability that the activist will succeed (Brav et al. If this were not the case—if the market price ever reached a level where further activism would not generate further abnormal returns—then the hedge fund would exit its position. particularly those which seek board seats. activist instruments. Thus. As in the short-term. Hedge funds . then abnormal returns might simply mark great passive investing. In this section. I also investigate heterogeneity across these returns. I investigate when activists add the most value—what target firm characteristics. then target firms should outperform their risk-adjusted benchmarks.If hedge fund activism improves its targets beyond the market’s pre-targeting expectations. using two tests. In particular. the market should continue to reward the effort. In addition. we should expect these investments to continue to outperform as the activism persists. however. activism appears to add long-term value. undervalued. Instead. Because success is never certain. outperform passive investments. likely because activism has rejuvenated them. I conclude that activists add value in the long-run. controlling for undervaluation and underperformance.
activist investments include all instances where a hedge fund announces an activist instrument or an activist strategy within 180 days of its Schedule 13D. we can isolate a hedge fund’s intentions. hedge funds revise their strategies numerous times. any observed effect. Long time horizons also complicate how we categorize activism. because this downward bias affects passive investments less than it affects activist investments. it is worth elaborating on the methods I will use.36 Even in spite of this. Further. Thus. whether positive or negative.5% of investments. passive investments have no catalyst. to better measure the reward to corporate shareholders (at the expense of the returns to hedge fund investors). The major obstacle to analyzing long-term returns is picking a time period. In particular. I analyze long-term returns along arbitrary windows. To most purely match the hedge fund’s behavior to the relevant investment period. or optimize targets’ capital structures. (2008) analyze hedge fund holding period returns—buying when hedge funds buy and selling when hedge funds sell—but this methodology (1) introduces error because we cannot perfectly measure these holding periods and (2) conflates hedge funds’ market timing ability with their activist ability.32 - . Finally. Instead. any observed difference between active and passive investments is similarly understated. is likely understated. Brav et al. this method should bias observed abnormal returns downward. Over 5 or even 61 days.earn excess returns when they sell target firms. I still find that active investments both generate positive abnormal returns and outperform passive investments. I distill my sample as follows: passive investments include all instances where a hedge fund never amends its passive Schedule 13D. however. . they have no holding period sensitivity. improve targets’ business strategies. I observe that these returns have declined over time. no 36 Unlike activist investments. To the extent activist hedge funds adopt different time frames for different investments. once target firms realize their potential. Before turning to the analysis. their abnormal returns should trend towards zero. but over 2 years. I find that hedge funds significantly change strategies in 79. Thus.
activist investments flourish while passive investments falter: activist investments increase an additional 8.2% *** (+1. In Appendix D. Consistent with short-term results.+24) 15.7% *** Difference (-1. activist investments earn 10.8% *** (+1. both activist and passive investments earn positive and significant excess returns.1% of passive investments show positive returns (z = 5.1% *** (-1.3% *** 21. Other Active Investments Board Seats (-1.5% 53.+24) 10.2% *** 75.8% * board seat investments include all activist investments where a hedge fund never seeks board seats. I calculate excess returns (1) from one month before the Schedule 13D until 24 months after and (2) from one month after the Schedule 13D until 24 months after.+24) 13.+24) 12.6% ** (+1. After the short-term reaction subsides.9% * Panel B: Board Seats vs.1% ** Passive (+1.Table VII Long-Term Returns by Investment Type The table presents average monthly returns around the Schedule 13D filing in excess of the market model using the CRSP value-weighted index.3% *** 60.3% excess returns and passive investments earn 2.0% ** Difference (-1.2% ** 16.3% 1.+24) Median Average % Positive 28.4% * 3. Passive Active (-1. and 1% levels.5% (z = 3. From one month before the Schedule 13D until one month after.6% *** 66.8% *** 58. 66.08).33 - .9% *** (+1. Table D-5 shows more details. and board seat investments include all activist investments where a hedge fund seeks a board seat within 180 days of its Schedule 13D. and *** indicate statistical significance at the 10%.70 and z = 2.4% *** No Board Seats (-1.0% *** 14. I estimate parameters over the 36 months prior to the Schedule 13D.5% *** 61. from one month after the Schedule 13D until 12 months after.7% 17.3% *** 66. Figure 6 plots the excess returns over time.+24) 9.+24) 6.+24) 18.87) while .1% *** 21. Panel A compares activist investments to passive investments.8% * 11. Panel B compares activist investments seeking board seats to activist investments that do not.8%.+24) 7. I report p -values for medians using the Wilcoxon Signed Rank Test. (A) Activism Exceeds Stock Picking Table VII measures long-term returns.+24) 10.2% *** 31.7% 55.6% 7.+24) Median Average % Positive 20. *. Over the entire 25-month period. **.9% * (+1. 5%.8% ** 13.1% *** 13.8% of activist investments and 55. Panel A: Active vs.+24) 5.
16). The increasing returns imply that over two years.5% excess returns (z = 5. These results are consistent with Boyson and Mooradian (2008). This makes sense. (2008).29).55) while passive investments earn 1. to the extent activists do improve their targets. By estimating target firms’ factor loadings . In contrast. Over a longer window.In the Long-Run. passive investors’ subsequent actions matter very little. from one month after the Schedule 13D until 24 months after. As passive investing reveals itself all at once. the strategy is not investible because certain investments reveal their activism after the event date. activism might carry more risk than passive investing. For active (blue) and passive (red) hedge fund investments. activist investments earn 13. It’s also worth noting that this activist momentum is not a free lunch. from 1 month prior to the filing until 24 months afterward. so should returns. First. Brav et al. the market continues to receive positive information.34 - . these changes play out slowly over time—and so should returns.5% (z = 0. Active Investments Outperform Passive Over 25-month Event Window 40% Board 30% 20% 10% Passive 0% -10% -1 13 M D on F t 1 ilinh M g on th 3 M on th s 6 M on th s 9 M on th s 12 M on th s 15 M on th s 18 M on th s 21 M on th s 24 M on th s Active NoBoard Figure 6. Additionally. passive investments fall 0. and Klein and Zur (2008). the chart plots the average excess return around the schedule 13D filing.4% (z = -0. The dashed lines divide active positions into those in which hedge funds sought board seats (long dashes) and those in which hedge funds did not (short dashes).
0% 0. I compare activist returns to passive returns.28). Panel A in Table VII shows that over 25 months. . 11. I use a dummy variable regression to control for the possibility that hedge funds might go activist in more attractive targets. I underestimate the target firms’ risk and thus their benchmark returns. What looks like excess risk-adjusted returns relative to the stocks’ prior risk might actually represent nothing more than benchmark returns relative to the stocks’ current risk.0% 20. passive. To more cleanly distinguish activism from stock picking. Overall.57) and by 13.9% over the full period (t = 1.9% comes after the short-term reaction (t = 1.8% after the short-term reaction (t = 1. The chart shows the average 25-month returns to active.35 - . before the hedge funds launch their activism.0% Active Passive Board No Board Figure 7. Of this outperformance. Active Investments Outperform Passive Controlling For Undervaluation and Underperformance 40.61).In the Long-Run. activism outperforms passive investing by 17. activism seems to add value. To test whether activist hedge funds do more than pick stocks. and no board investments. board. measured by a dummy variable regression. controlling for Tobin's q and margins.6% (t = 2.0% 10. Panel B shows that board seat activism outperforms other activism by 16. I regress the 25-month return on dummy variables for activism and board seat activism.0% 30.31).
Column 3 regresses abnormal returns on dummy variables for those strategies. (B) Returns Differ By Strategy As with short-term returns.72 * 1.60 0.16 -1.17). and 1% levels.48 13. intercepts are suppressed .08 * *** ** controlling for Tobin’s q and margins.88 -0.63 -0. For all activist investments.91 0. *.38 0. **. and R 2 Target Fundamentals Coeff. All non-dummy covariates are expressed as the deviation from the sample average values.46 -0. And for all investments using activist strategies. (2) activist instruments.31 3.67 0.14 -20. . and *** indicate statistical significance at the 10%. and board investments outperform other activism by 18.87 -48. All accounting variables are winsorized at the 10% level. 5%. and (3) activist strategies.6% (t = 1.14 ** 0. In columns 2 and 3.94 -8. Table D-6 shows the underlying regression. (1) Dependent Variable: Abnormal Returns Constant ln(MV) Abnormal q Abnormal Margin Leverage BoardWin Board Buyout Financing Proxy Law Bus Strategy M&A Sale Cap Structure Corp Governance Other No.16 -1.14 0.88 0. Activism outperforms passive investing by 18.04 243 t -stat 1.59).42 0.70 0.93 -8.37 The results are robust to other models.36 - .65 -1.31 -1. activists earn larger returns from undervalued targets and underperforming targets.82 -14. Turning first to target firm fundamentals.12 -0. -23. activism adds value beyond stock picking. Consistent with short-term 37 In Appendix D. In Table VIII.62 12.86 -15. Thus.84 -51.Table VIII Cross-Sectional Variation of Long-Term Returns The dependent variable is the 25-month abnormal return around the Schedule 13D date.21 (3) Activist Strategies Coeff.93 0.56 -0.68 39.91 -10. Column 2 regresses abnormal returns on dummy variables for those instruments. I regress 25-month abnormal returns on (1) target firm fundamentals.10 * -0.45 -0. 8. -16.47 -1.04 0.29 101 t -stat -1. Column 1 regresses abnormal returns on target firm fundamentals.71 -0.4% (t = 2. I investigate the conditions that make activism most effective.01 90 (2) Activist Instruments t -stat *** -2.11 ** -1. For all investments using activist instruments.03 Coeff.90 4.
respectively.16) and -48. winning adds 6. by seeking board seats.91).7% (t = -1. board seats continue to drive value in the long-run. Proxy fights and lawsuits generate moderately significant negative returns of -14. This result contradicts short-term returns—where shareholders applaud the news that a hedge fund has won a board contest. In fact.12).4% (t = 0. they ensure that management hears their message. To corroborate that sample size plays a role.3% of cases the hedge fund voluntarily withdraws its request. As expected. of all failed board contests in my sample. Consistent with short-run expectations.37 - . in 28. The evidence supports the hypothesis that activists do their best work turning around unloved. With respect to activist instruments.65) and low abnormal margins (t = -1. First. investments that seek board seats earn 39. the effect becomes positive. this finding strongly supports the hypothesis that activists can add value.9% (t = -1. far exceeding any other activist instrument. those which win board seats actually underperform those which do not win board seats by 20. When I increase the sample by substituting Tobin’s q for abnormal q and substituting margin for abnormal margin.38 Second. within investments that seek board seats.31). the hedge fund might be running into a brick wall—a stubborn management team that refuses to cooperate with value-increasing propositions.9% excess returns (t = 3. Over 25-months. But this contradiction is not very robust.returns. making the investment a success. this coefficient is biased by hedge funds that withdraw their requests after management cooperates. activists perform best when firms have low abnormal q (t = -1. in unreported results I run the new regression for the 2004-2008 period and for the 2000-2008 period. In these hostile situations. unprofitable target firms. Alternatively. . Contrary to expectations.0% (t = -1.40) to investment returns. the longer period shows a larger coefficient on winning board seats. After removing withdrawn board seats 38 Part of this increase is due to reduced precision in the covariates. activist hedge funds might distract management from running the firm. this coefficient is biased because the regression excludes investments initiated from 2000 through 2003.88).
defined as the regression coefficients.9% (t = -0.38 - .46).5% (t = 0. The bars show the 90% confidence interval. it appears activists use board seats as a bargaining chip. multiple activist strategies earn positive returns. Thus. Instead. Figure 8 shows the average return per strategy. The chart shows the average 25-day abnormal return for each strategy. investments which change the target’s business strategy and capital structure perform very well. corporate governance activism underperforms the market by 8. however. . In fact. not necessarily returns. When broadening the sample by substituting Tobin’s q for abnormal q and margin for abnormal margin.Many Strategies Generate High Returns Controlling for Undervaluation and Underperformance 40% 20% 0% -20% -40% Business Strategy M&A Sale Capital Structure Corporate Governance Figure 8. In addition to activist instruments.57). this effect disappears.20). As in the short-run.9% excess returns (t = 0. the effect of winning becomes positive.28).71). dropping the board contest once management acquiesces to their demands.9% excess returns (t = 0. from the original model. if strategies differ. Winning board seats increases returns by 7. they should differ in fundamental performance.2% (t = 0. Also consistent with short-run expectations. different strategies’ returns are statistically indistinguishable from one another (F = 0.67) and 12. earning 13. respectively. This does not itself disprove the hypothesis that activists follow different strategies. corporate governance activism outperforms by 9.
I remove both successful and failed sales. in unreported results. who asymmetrically remove only successful sales.39 - 18 M . Most shockingly. generates no long-term returns. By eliminating the bias from failed sales. The long dashes show only investments which were subsequently sold. from 1 month prior to the filing until 24 months afterward.48).3% with t = 0. This result is most likely due to failed sales. which generated the highest short-term returns. The chart plots active investments only. Unlike Greenwood and Schor. I re-run the event study excluding those firms which the hedge funds try to sell. sale activism. successful sales earn positive returns (9. I run the same regression with a dummy variable set to one if the company was sold. Sale 10% 0% -1 13 M D on F th 1 ilin M g on th 3 M on th s M on th s M on th s on th s on th s on th s on th s M 21 24 on th s M M M 6 9 12 15 Figure 9. As expected. The short dashes excludes any investment which was sold as well as any investment in which the activist sought a sale but failed. To counter this effect. those remaining unsold will dramatically underperform. this better measures . To test Greenwood and Schor’s (2008) hypothesis that activists add value exclusively by putting firms in play.Activism Adds Value Beyond Selling Companies But Selling Generates Very High Returns 40% Sold Firms All Firms 30% 20% All Firms ex. The solid line includes all active investments. Especially if activists try to sell wounded companies. The chart plots the average excess return around the schedule 13D filing.
returns have declined over time. the average investment earned 23. and the red line plots the average passive return. (C) Returns Have Decreased Over Time Finally. Figure 9 shows that while they underperform firms which were sold. The blue line plots the average active return. I reject the hypothesis that annual returns equal each other (F = 2. I regress the 25-month abnormal returns against dummy variables for each filing year. and in 2007 the average investment earned only 7. In stark contrast to Greenwood and Schor.3% returns over 25 months (t = 5. To the contrary. This result differs from Greenwood and Schor both because I exclude failed sales and because my sample includes more experienced hedge funds. as measured by the coefficients in a dummy variable regression controlling for Tobin's q and margins. I measure how these returns have changed over time. The blue bar (right axis) shows the number of active Schedule 13Ds and the red bar (right axis) shows the number of passive Schedule 13Ds filed in my sample each year. Figure 10 plots the results over time. controlling for Tobin’s q and margins.79).56).6%. hedge funds’ ability to add value beyond selling the target. This pattern suggests the same three interpretations: (1) investors might . The line graphs (left axis) show show the average 25-month return by year.1%.Long-Term Returns Decline Over Time As Investments Increase in umber 175% 125% 75% 25% -25% 20 04 20 06 20 01 20 00 20 02 20 03 20 05 20 07 20 08 180 135 90 45 0 Active Passive Active Filings Passive Filings Figure 10. in 2001.40 - . these targets still generate 22. The results are robust to other models. I find that activism still generates significant excess returns.
Activist targets increase their leverage and payout ratios. activist investments outperform passive investments. . and return on equity. Both relative to passive targets and in absolute terms. activist targets sell themselves more frequently and for higher premiums. activists sell target firms. return on assets. Throughout. even adjusting for undervaluation and underperformance. Activism aimed at undervalued and underperforming firms earns the greatest excess returns. this section strengthens earlier results. activists improve profitability. Over the long-run. Fourth. Perhaps more importantly. As evidence against the second hypothesis. Third. I cannot reject the hypothesis that passive returns equal each other in every year (F = 0. Relative to passive targets. I also find evidence that activists use board seats to build long-term value—consistent with the evidence presented in Section III that business strategy activism most frequently seeks board seats while M&A activism least frequently seeks board seats. While passive target firms actually grow. In summary.27). these returns have declined. (2) activism might begin to look more like passive investing. however. Second. it also describes the levers activists pull to earn those returns. By adding further evidence that activism adds value. activist targets increase their margins.increasingly expect activism. often by disgorging cash.41 - . Section VI: Target Firm Fundamentals Having observed that activism earns greater returns than stock picking might imply. Recently. I find further evidence that activism adds value. activists optimize the capital structure. First. we now turn our attention to target firm fundamentals. activist target firms shrink dramatically. however. I document four non-mutually exclusive ways that activist hedge funds improve target firms. activists reduce firm size. and (3) activists might have lost their edge.
excess returns increase over two years. To the contrary.40 Second. activist targets are good performers. Thus. Identifying firms which outperform by accounting standards presents a more difficult task than identifying those which outperform stock market indices. it shouldn’t be well-performing firms but rather underperforming firms with more room to improve. If the market had predicted that target firms would improve. The companies expected to outperform should not be undervalued but rather overvalued to account for yet-unrealized profits. If active and passive targets come from the same underlying pools. As discussed earlier. Thus. for instance. First.42 - . And third. . the 39 As noted in Section III. activists target undervalued companies. then hedge fund activism must cause any outperformance by the activist group. excess returns should not rise over time but rather should equal zero. though.39 To the extent certain companies can improve more than others. 40 I find significantly negative correlations between initial levels and subsequent improvements.Before turning to the data. hedge funds don’t seem to simply pick stocks that everyone expects will increase profitability. by simply investing in stocks with high P/E ratios. a cautionary note is in order. Thus. there is no reason that even a passive hedge fund should not be able to consistently pick stocks whose profitability increases more than does the aggregate market. The beauty of financial markets lies in their ability to correctly price target firms’ fundamentals. not in their ability to equalize those fundamentals. In addition to arguments about target firms’ characteristics. I further debunk the stock picking hypothesis by comparing hedge funds’ active targets to the same hedge funds’ passive targets. Three factors mitigate this stock picking hypothesis. we must distinguish activist hedge funds’ ability to improve their targets’ performance from activist hedge funds’ ability to pick stocks that everyone expects will increase profitability. activists target wellperforming firms. but relative to the median firms in their industries. relative to passive targets. activist targets are poor performers. no efficient markets hypothesis governs accounting performance. a hedge fund’s portfolio might regularly outpace its peers in revenue growth.
54 0. hedge funds go active in more undervalued companies.92 -0. in target firms' trailing twelve months EBITDA divided by sales (Margin) .38 -2.08 1. **.33 2.43 - .02 8. For the reasons discussed above. and EBITDA divided by book value of equity (ROE) . While this might give activist investments more room to improve.11 *** 7. and 1% levels.84 -4.20 -1.27 2.28 8.48 2 yr 0. Additionally. 5%.29 1 yr -1. Because I nonetheless observe outperformance. I still observe that activist targets outperform.58 pools differ.87 -8. EBITDA divided by total assets (ROA) .80 ** 0. CEOs paid based on ROA might forgo projects with attractive IRRs if they drag down a firm’s overall returns.39 -2.44 0. from the date of the first Schedule 13D filing.21 0.73 2.86 -1.and 2-year increases.15 *** 16.97 2. Passive Active 1 yr Margin ROA ROE -0. .Table IX Profitability Improvement By Investment Type The table shows the 1.99 *** Panel B: Board Seats vs. Most noticeably. Panel A: Active vs. CEOs paid based on earnings growth might increase earnings by investing in projects with IRRs greater than zero but less than the firm’s WACC.76 2.70 Difference 1 yr 2 yr 0. All data is winsorized at the 10% level. All data from Bloomberg. this should handicap activist targets’ ability to outperform. after controlling for this effect.71 Difference 1 yr 2 yr 1. hedge funds go active in worse performing companies. (A) Activism Improves Profitability By improving target firms’ capital allocation and strategic positioning. this does not appear to be a problem.05 1. Management might fail to do so for many reasons.73 Passive 2 yr -3. Just as bad.41 6.11 *** 5.21 *** 4. and *** indicate statistical significance at the 10%.95 0.59 -0. For example.97 1.13 No Board Seats 1 yr 2 yr -1. *. Other Active Investments Board Seats 1 yr 2 yr Margin ROA ROE 0. hedge funds increase cash flow—and thus. firm value.
Active Investments Become More Profitable Controlling For Initial Levels Return on Assets
3.0% 2.0% 1.0% 0.0% -1.0% -2.0% Active Passive Board No Board 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% Active Passive Board No Board
Figure 11. The chart shows the average 2-year improvement in ROA and in margins for active, passive, board, and no board investments, controlling for Tobin's q and for the initial levels of each variable.
Table IX measures increased profitability in three ways: EBITDA margins, ROA, and ROE. The former two measures are particularly appropriate because they isolate core operational performance.41 Panel A shows that, while passive investments falter, activist targets improve their profitability in absolute terms. Further, over two years, activist targets improve their margins by 4.1% more than passive targets (t = 4.26), their ROA by 5.2% more (t = 4.49), and their ROE by 17.0% more (t = 4.07). Panel B shows similar, but less significant results for board seats; they improve margins and ROA. While they have little effect on ROE, this is because board seats decrease target firms’ leverage. Figure 11 dismisses the alternate hypothesis that this outperformance comes from stock picking. I regress the 2-year increase in ROA and in margins on dummy variables set to one for activist investments or board seat investments. I control for the Tobins’ q and for the initial value of each accounting metric. I express all non-dummy covariates as the deviation from the sample
ROE includes capital structure decisions. It equals ROA divided by one minus the debt-to-assets ratio.
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mean. We interpret the constant term as the profitability increase to an average passive target, and we interpret the dummy coefficient as the difference for an average active target.42 While the average passive firm becomes less profitable, with ROA falling by 1.2% (t = -1.70) and margins falling by 2.5% (t = -3.71), the average active firm becomes more profitable. The average active target increases its ROA by 3.0% more than the average passive target (t = 3.05), and the average active target increases its margins by 2.9% more (t = 2.76). Board seats show but less significant similar results. Overall, activists increase firms’ profitability. (B) Activism Optimizes Capital Structure By optimizing a firm’s capital structure, activists increase the cash flow to shareholders. First, by increasing leverage, and thus interest expense, activists can reduce taxes. Second, by disgorging cash otherwise earning at best middling returns, activists can increase the present discounted value of the firm’s equity cash flows. Management might fail to optimize the capital structure for many reasons. For example, because CEOs depend on the firms for their jobs, they might take more caution than shareholders might like before leveraging the firm. Table X tracks changes in target firms’ capital structures. Leverage refers to the debt-toassets ratio and payout measures dividends as a percent of net income. In addition to the average change in each ratio, the table also shows the percent of firms which increased these ratios. Panel A shows that activist targets increase their leverage and payout ratios more than passive targets. The results are much stronger over one-year horizons than two-year horizons. This makes sense; unlike profitability measures, which ideally increase over the years, these capital structure ratios fluctuate. Leverage naturally declines over time as firms pay down their debt, and payout ratios might bounce around with special dividends. Over one year, activist targets increase their leverage by 1.1% more than passive targets (t = 1.65) and increase their payout ratio by 4.5%
In Appendix D, Table D-7 contains the regression results.
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Table X Capital Structure Changes By Investment Type
The table shows the 1- and 2-year increases, from the date of the first Schedule 13D filing, in trailing twelve months debtto-assets (Leverage) and dividends divided by net income (Payout) . The chart shows both the mean difference in the ratio as well as the percent of firms which increased their ratios. All data from Bloomberg. All data is winsorized at the 10% level. *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels.
Panel A: Active Investments Lever Capital Structure More Than Passive Investments Active 1 yr Leverage % Increase Payout % Increase 0.64 43.6% 5.37 32.6% 2 yr 1.51 45.3% 0.53 18.5% 1 yr -0.45 35.4% 0.91 12.7% Passive 2 yr 1.56 42.2% 10.00 16.7% Difference 1 yr 2 yr 1.09 ** 8.2% 4.46 ** 19.9% *** -0.05 3.1% -9.47 ** 1.9%
Panel B: Board Investments Lever Capital Structure Less Than Non Board Investments Board Seats 1 yr 2 yr Leverage % Increase Payout % Increase -0.75 33.8% 7.36 26.7% 0.72 40.0% 0.76 17.6% No Board Seats 1 yr 2 yr 2.08 58.1% 3.58 40.0% 2.86 55.0% -0.75 20.0% Difference 1 yr 2 yr -2.83 ** -2.15 -24.2% ** -15.0% 3.78 -13.3% 1.51 -2.4%
more (t = 2.08). In addition, 8.2% more active firms increased their leverage than did passive firms (t = 1.25), and 19.9% more active firms increased their payout ratios than did passive firms (t = 2.38). Thus, activist targets lever up more than their passive peers. Panel B shows that investments seeking board seats take on 2.8% less leverage (t = 2.21) than other activist investments. Two mutually exclusive reasons might account for this observation. Most consistent with results elsewhere, activists might seek board seats to provide long-term strategic advice. In Section III, I showed that activists most frequently take board seats to advance business strategy goals and least frequently to advance M&A goals. These activists might focus their efforts on building value before taking on additional financial risk. Alternatively, activists might seek board seats when they anticipate management will otherwise dismiss their proposals. These stubborn, entrenched management teams might resist leverage.
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5% more than passive firms (t = 1. Thus.0% 0. passive. the average active firm increases both payout and leverage.4% (t = -0. . Thus. larger firms lead to greater compensation and greater job security. and leverage increases by 0. the initial value of each accounting metric. Payout increases by 2.26). not to stock picking. For CEOs.43 While the average passive firm marginally increases its payout by 2.83).Active Investments Increase Payout Controlling For Initial Levels and Initial Cash Payout Ratio 3.0% Active Passive Board No Board Figure 12.98). 43 In Appendix D.0% Leverage 2. once again.47 - .79) and decreases its leverage by 0. I control for Tobin’s q.0% 0. it appears activism earns some of its gains by disgorging cash and leveraging the capital structure. To grow the firm. (C) Activism Reduces Firm Size Activist shareholders also add value by counteracting management’s harmful tendency to build empires. and no board investments.0% 1. controlling for Tobin's q .0% Active Passive Board No Board -1. board. by divesting unprofitable assets activists can improve future returns. they might purchase assets which yield suboptimal returns.0% 2. initial levels of each variable. these results are due to activism.0% 1.3% (t = 1. and initial cash holdings. Table D-8 shows more detail. Figure 12 shows that. The chart shows the average 1-year change in payout ratio and in the debt-to-assets ratio for active.7% more than passive firms (t = 0. and the initial level of cash as a percentage of total assets.
0% more over two years (t = 1.4% 22.3% 50.6% 0. and 1% levels. **. measured by assets. they are also increasing profitability. from the date of the first Schedule 13D filing.3% more than passive firms over one year (t = 1.3% 11. active target firms actually shrink.8% more than passive targets over one year (t = -3. expressed as a percent change from their values in the year prior to activism.1% 1.1% *** -5. Similarly.0% *** -8.58) over two years.2% more than passive firms (t = -2.1% 2 yr -6.5% ** 5. sales.6% *** -4.0% -4.1% 27.04).23) and by 6.7% 30.2% Difference 1 yr 2 yr -4.8% -2.0% Difference 1 yr 2 yr -5.2% 1 yr 0. 5%.5% 5.0% 1.6% 26.4% 24. adjusted for core inflation.3% 20.4% -22. they appear to increase their cash by 11. active targets reduce their assets by 4. activist target firms are shrinking.1% Table XI examines this hypothesis.11). All data is winsorized at the 10% level.0% Panel B: Board Investments Shrink More Than Non-Board Investments Board Seats 1 yr 2 yr Assets Sales Cash -7.4% -8.and 2-year increases. On average. Each variable is expressed as a percentage of its value in the year prior to the Schedule 13D filing. activist targets reduce their sales by 4. in inflation-adjusted firm size.Table XI Agency Cost Reductions By Investment Type The table shows the 1. sales.9% No Board Seats 1 yr 2 yr -1.8% *** -6. It shows assets.6% more than other activist investments (t = -2. and *** indicate statistical significance at the 10%.36).0% -9.2% *** -1. and cash. While active targets also appear to reduce their cash by 8. *.6% -3. Panel A: Active Investments Shrink More Than Passive Investments Active 1 yr Assets Sales Cash -4.4% 0. All data from Bloomberg.6% more over two years (t = -2.0% 35.89) over one year and by 1.5% 0. and cash.80) over . Panel B shows that board seat investments shrink the most.48 - . but on the other hand.6% *** -10.4% more (t = 0. The inconsistent evidence likely reflects two conflicting forces: on one hand. Investments where activists seek board seats shrink their assets by 5.5% Passive 2 yr 0. Panel A shows that while passive target firms grow.
55) over two years. passive. controlling for Tobin's q and for the initial firm size.6% more (t = -2. this decreases agency costs. it appears that activist investments purposefully pare down. They also shrink their sales by 5.0% more (t = 1. As Jensen (1986) argues. Thus. active investments without board seats actually increase assets by 0.8%.34).4% more (t = -1.5% more (t = 1. effectively reduce firm size. while all investments grow their sales. The changes in sales show similar patterns. and no board investments. The chart shows the average 2-year change in assets and sales.0% 1. board. one year and by 10.12).04) over one year and by 8.0% -4. To isolate activism from stock picking.8% (t = 0.0% 2.44 While passive targets actually increase assets by 2. Figure 13 controls for differences Tobin’s q and in firm size. Taken together with the earlier evidence that activist firms increase profitability.0% Active Passive Board No Board Sales Growth Figure 13.81). Similarly.5% 0. 44 In Appendix D.97) over two years. Table D-9 shows more details. shrinking 4. particularly those with board seats.49 - .7%.0% 0.8% (t = 1. .Active Investments Reduce Assets Controlling For Initial Assets Asset Growth 4. active investments decrease assets by 1.1% more (t = -2.0% -2. rather than unintentionally shrink into irrelevance. but board seat investments decrease assets by 3.0% Active Passive Board No Board 6.49). adjusted for inflation. the activist investments seeking board seats grow the least. for active.0% 4. shrinking 4. activist investments.5% 3.
1% ** (D) Activism Sells Target Firms Finally.2% 21.50 - .9% 39. it measures the average premium those firms fetched. Panel A separates active investments from passive investments.8% *** 26. To capture the premium attributable to the activist. *. First.4% 57.2% 44.93) and on average sell them for 18. Within the first 6 months.7% *** 18. relative to their passive investments. 5%. Panel A shows that. activists sell 9. Panel A: Active Investments Sold More Frequently Active 6 mo % Sold Avg.0% *** 27.9% 33 Difference 6 mo -17. Thus.2% 20. Executive managers might fail to sell the firm.8% 47 Passive 6 mo 0.5% 9 Difference 6 mo 9.0% 0 24 mo 4. Table XII measures how well activists sell their targets.64).2% *** 24 mo 13. **. Over two years.0% 3 24 mo 10. because doing so imperils their job security.2% of their targets.7% more targets (t = 4. it measures the percent of targets which sell themselves. while passive investors sell none.3% * Panel B: Investments With Board Seats Sold Less Frequently.3% higher premiums (t = 1. even if it benefits shareholders. Premium umber Sold 9. and 1% levels.Table XII Target Firm Sales By Activism Type The table shows the percent of all firms which sold themselves and the average premiums they received.3% 16. activists add value by selling their targets to acquirers who values them more highly. Average premium is calculated from one month before the hedge fund files a Schedule 13D until the date on which the sale closes.8% 21 24 mo 30.4% 24 24 mo 17. I measure the total buy-and-hold gross return from one month before the Schedule 13D until the sale closes. activists both put their targets into play and market them better than do passive investors.1% *** 24 mo -19. hedge funds’ activist targets sell themselves more frequently and for higher prices. activist investors sell 13.9% 14 No Board Seats 6 mo 19.3% 31. and second. Panel B shows that when activists seek . Panel B separates active investments seeking baord seats from those which do not. But For Higher Prices Board Seats 6 mo % Sold Avg. Premium umber Sold 2. and *** indicate statistical significance at the 10%.
I describe the differences among the various activist strategies. I control for the dependent variable’s initial value. Table D-12.3% (t = 0. I regress the accounting statistics described earlier on dummy variables for each strategy.77). we interpret the coefficients on each dummy variable as that strategy’s partial effect on a firm with average characteristics. Again. I find strong evidence that different strategies work in different ways.91). Perhaps to remove distractions from building these businesses. Table D-11.45 Business strategy activism builds profitable businesses. all non-dummy covariates are expressed as the deviation from the sample mean.78) 45 In Appendix D. .10). When doing so. Over two years. But when they do sell. For all investments which use activist strategies. and Table D-13 show more detail.51 - . (E) Improvements Differ by Strategy If hedge fund activism. When applicable. To describe these strategies. this result is consistent with the interpretation that activists use board seats to build long-term businesses. they sell firms less frequently but for much higher prices. In particular. activists also reduce target firms’ payout ratios by 10. they demand a healthy premium— on average. and all constants are suppressed. activism unlocks substantial value by selling the target firm.8% less likely over two years (t = 3. they’re less likely to sell—in particular. 26. In total. rather than sheer luck. we should expect activists’ professed strategies to predict target firms’ improvements with reasonable accuracy.71) and margins increase 2. catalyzes these observed changes. Thus.board seats.9% (t = 2. In general. I run cross-sectional regressions like those in Section IV and Section V. 19. Figure 14 shows the key results. To facilitate interpretation. Table D-10. as described earlier in this section.1% larger (t = 2.0% (t = -1. ROA increases 6. This section tests that hypothesis. relative to passive investments. having built a strong business.
Panel A: Business Strategy Activism Improves ROA 12% F = 2.52 - .11 5% 0% -5% -10% Business Strategy M&A Sale Capital Structure Corporate Governance .39 10% 0% -10% -20% Business Strategy M&A Sale Capital Structure Corporate Governance Panel C: Corp Gov & Sale Activism Decrease Assets 10% F = 1.74 6% 0% -6% Business Strategy M&A Sale Capital Structure Corporate Governance Panel B: Capital Structure Activism Increases Payout 20% F = 1.
regressions control for the dependent variable's initial level. and sale activism sells them for higher prices. In Panel D.3 times more likely to sell themselves as those which do not (t = 1. Presumably due to increased profitability and lower payout ratios. it earns on average a 24. and Panel C show 90% confidence intervals and F statistics on the null hypothesis that all strategies generate equal improvements. I also show cross-sectional variation of firm sale statistics (Panel D). The red outlines (right axis) show a linear regression that regresses the average premium on the strategy dummies. and asset growth (Panel C). and all constants are suppressed.Panel D: M&A Activism Sells Firms Most Frequently Corporate Governance Activism Earns Highest Premiums 250% 50% 200% Sale Odds Ratio Sale Odds (left axis) 150% Sale Premium (right axis) 40% Averarge Premium 30% 100% 20% 50% 10% 0% Bus Strat M&A Sale CapStruc CorpGov 0% Figure 14.04). those in which the hedge fund uses a M&A-related strategy are 2. M&A and sale activism effectively push target firms to sell themselves.2% (t = -0. these dependent variables are regressed on dummy variables for each strategy. the blue bars (left axis) show the sale odds ratio from a logistic regression that regresses a dummy variable equal to one if the firm sold itself on strategy dummies. .77) and sales increase 4.53 - .14). For all activist investments which use activist strategies.2% (t = 0.5% over two years (t = -1.6% (t = 1. All non-dummy covariates are expressed as the deviation from the sample mean. reducing total assets by 4. Panel B.43). they often seek divestitures. Panel A. payout ratios (Panel B). These charts plot the results of cross-sectional regressions on various accounting metrics: ROA (Panel A). When a hedge fund demands that a target firm sell itself. When hedge funds fail to sell these firms.74). target firms’ assets increase 3.6% premium (t = 2. and leverage by 1. Where applicable. Within investments that use activist strategies. M&A activism sells firms more frequently.73).
I regress the changes in activist targets’ accounting measures on dummy variables for the Schedule 13D filing year. others want the firm to de-lever a precarious balance sheet. activists struggled. To summarize. Interestingly. towards the middle of the decade. and sell themselves more often and for richer valuations. perhaps reflecting heterogeneity even within the strategy—while some hedge funds want the firm to leverage itself.21). As Jensen (1986) argues. In addition. While I find that activists’ ability to reduce assets has changed over time (F = 2. I find no evidence that activists’ abilities have declined over time.8). activists regained their effectiveness.54 - . I find no support for the hypothesis that activist skill has declined. controlling for Tobin’s q and for the accounting variables’ initial levels.0% over two years (t = -1. I find much more significant evidence that . activists were very effective at reducing firm size. management teams which ignore shareholder interests may seek to grow assets at the expense of profitability. I find manifold evidence that activism adds value. and towards the end of the decade.Capital structure activism increases cash to investors.71). activism adds value in the pattern we would expect given hedge funds’ stated strategies. leverage actually falls by 1. Target firms improve their profitability. it hasn’t decreased. Corporate governance activism reduces agency costs.10). Early in the decade.8% (t = -1. No other accounting measures provide any significant results. Activist hedge funds seem to take particular interest in reducing firm size when they distrust management. (F) Activist Ability Has ot Declined In unreported results. Target firms reduce their assets by 4. Thus.4% (t = 2. optimize their capital structure. reduce their potential agency costs. I conduct joint hypothesis tests on the null hypothesis that the yearly coefficients all equal one another. Nor do I find evidence that passive returns have changed over time. Target firms increase their payout ratio by 10.
optimizing capital structures.46 While this is in part due to my unique sample. Most notably. prior studies looked at the results in aggregate—so different strategies canceled each other out. increase payout. They improve profitability. or fixing corporate governance. focusing on improving business strategies. Brav et al. and I identify short-term events which contain only activist signals.. In particular. (2008).55 - . advising on M&A transactions. selling target firms. in particular. Activism earns substantial short-term and long-term returns by unlocking shareholder value. spin off assets. Section VII: Conclusion This paper argues that activist outperformance represents more than stock picking in disguise. I use several unique tests to distinguish activism from passive investing—I compare activist investments to passive investments. In contrast. activists revive struggling firms. This paper has focused on the returns to corporate shareholders. . sometimes at the expense of measuring the returns to hedge fund investors.activist hedge funds improve target firms than do previous studies. and Klein and Zur (2008). By comparing activist investments to passive investments while controlling for ex-ante differences in target firms. e. it is also because I dissect these improvements by strategy. I have made no adjustments for 46 See. Boyson and Mooradian (2008). Each test strongly supports the hypothesis that activism adds value. I control for ex-ante differences in target firms. I study activist instruments. Activists also tailor their approach to particular firms’ needs.g. The new evidence presented in this paper expands the existing literature on activism. while prior studies have shown that activist hedge funds earn excess returns. I isolate hedge fund activism from hedge fund investing. I present strong evidence they earn these returns by doing more than picking stocks. and sell target firms.
Given hedge funds’ ability to improve shareholders’ returns. why can hedge funds unlock value beyond management’s ability even though hedge funds invest in many companies. In particular. M&A. In a broader context. and corporate governance. Thus. the CEO benefits from other factors—like compensation. while managers devote their whole lives to just one firm? Most likely. further research might study whether it similarly benefits hedge funds’ limited partners. . perhaps corporate boards should encourage hedge funds to invest.56 - . Additionally. I show that agency costs detract from a firm’s value. I also present evidence that expert advice can turn around struggling firms. this is due to agency costs: whereas the hedge fund activists benefit from stock returns. and job security. Further research should investigate whether activist hedge funds follow any predictable patterns that corporate executives might mimic. Perhaps undervalued companies should more frequently hire outside consultants to revisit their policies on capital allocation.hedge fund fees. Perhaps corporate boards might increase their firms’ values by compensating their CEOs less like CEOs and more like hedge fund managers. capital structure. pride. while I have shown that activism benefits shareholders. this paper presents several lessons that might call corporate boards to activism themselves. Further research might investigate whether activists earn greater returns in firms where managers’ interests are most poorly aligned with shareholders’ interests.
and Rmt is return to the valued-weighted market portfolio in period t. The market model assumes we can measure risk by a firm’s correlation with the overall market. To A1 . over the event window.Appendix A: Statistical Methods (A) Event Studies This essay uses the event study methodology. First. I calculate these “counterfactual” returns using two popular models: the market model (Fama 1970) and the Fama French three factor model (Fama and French 1992). I assume the firm performed like other firms with similar risk levels. and the variance of ε it is assumed to be homoskedastic with a normal distribution. To determine how certain events affect security returns. α i represents the idiosyncratic risk associated with a specific company. Fama and French (1992) recommend augmenting the market model to include more possible risks—in particular. Both models assume that investments with greater risk offer greater reward. Rit = α i + β i Rmt + ε it E (ε it ) = 0 Var (ε it ) = σ ε i 2 In this model. the premiums and discounts awarded to firms based on their market capitalization and ratio of book value of equity to market value of equity (B/M). It also assumes asset returns follow a normal distribution (MacKinlay 1997). I compare observed returns to what they would have been without that event. Then. β i measures the security’s correlation with the overall market. Rit is the return to security i. Small firms tend to be more risky and participate more frequently and for longer periods of time in earnings downturns. over a measurement window. I calculate the firm’s risk. The error term ε it has an expected mean of zero. Companies with high B/M ratios often suffer low earnings yields on their assets.
To test for robustness. Fama and French suggest running time-series regressions to determine the premiums and discounts associated with market capitalizations and B/M ratios. Brav et al. where SMB represents the difference in returns on portfolios of small and big market capitalization equities. T-2 T-1 T0 T1 Estimation Window Event Window 1 See Puustinen (2007).incorporate these factors into the market model. α i is the intercept term. The two new terms represent the Fama French factors. In the diagram below. To estimate the parameters. T-2 and T-1 represent the start and end of the estimation period. most activism studies use the simpler market model. A2 . I run times-series regressions over an estimation window prior to the event. I check my results against the Fama French three factor model. They propose a three factor model: Rit = α i + β i Rmt + si SMBt + hi HMLt + υ it E (υ it ) = 0 Var (υ it ) = σ ε i 2 As before. Boyson and Mooradian (2008). I follow two steps. Rit is the return on security i and Rmt is the return on the value-weighted index at time t. and HML is the difference between returns of portfolios separated by B/M ratios (Fama and French 1992). and for monthly returns I run regressions over the 36 month window ending one month before the event. I report results using the market model.1 Thus. T0 represents the event day. First. and Klein and Zur (2008). T1 represents the end of the event window. respectively. In this study. (2008). Although these models are similar. for daily returns I run regressions over the 200 day window ending 10 days before the event.
t 2 ) = . For any two times t1 . CAR( t1 . and . t 2 . the paper will calculate the variance of the mean CAR . where and . I calculate abnormal returns (CARs) over the event window. I measure abnormal returns. such that approaches zero (Dasgupta. Abnormal returns simply equal actual returns minus expected returns . This equation holds when the estimation period length T is large.Second. where 200 represents estimation period’s length. Under the null hypothesis. I use the coefficient estimates from the time-series regression to estimate counterfactual returns over the event window. A3 . abnormal returns have conditional mean zero and conditional variance . and Mamingi 1997). This paper tests whether the mean CARs among a portfolio of activist investments differ significantly from zero. To test for statistical significance. To test returns over more than one day or one month. where N is the number of events. Laplante.
returns equal averages earns . Because I have suppressed the constant term. and the X ij ’s represent other covariates. For a passive target firm whose covariates equal sample averages. binary variables for various activist strategies. I express all nondummy covariates as the deviation from the mean. I conclude that activism generates significantly greater returns than passive investing. I use dummy variable regressions to measure the average partial returns on various binary variables—most frequently. Second. I use dummy variable regressions to analyze whether investments which I consider active enjoy greater returns or accounting outperformance than other investments. If γ is significantly greater than zero. First. An activist target firm whose covariates equal sample ^ greater returns. For example.(B) Dummy Variable Regressions This paper also makes extensive use of dummy variable regressions to analyze binary variables like an activist’s strategy. To do so. A4 . I use a regression of the form where Y i is the return to investment i. I use a regression of the form where Y i and the X ij ’s have the same interpretations. if firm i’s covariates equal the sample averages. I interpret as the average partial return to a target firm whose covariates equal the sample averages in which the activist hedge fund uses strategy j. I express all non-dummy covariates as the deviation from the mean.
and if a hedge fund targets firm i with strategy 2 and strategy 3. except and ’s equal zero. so we expect the return to be A5 . then all the all the ’s equal zero. equal one. and .
My answer was that Meister would fly anywhere at any time to meet the Board so they could “know” him (I did mention that the situation at Motorola is too serious for the Board to remain a country club). filed 27 March 2008. However. this section excerpts various hedge fund disclosures. After all. Why should it be different in Corporate America? I do however agree with you that this proxy fight is a distraction that Motorola at this junction can ill afford. We disagree. B1 . respectively. The next five sections describe business strategy activism. The first section below presents a typical letter announcing that a hedge fund will seek board seats. Warner replied summarily to this offer that Meister did not “qualify. how much can he eat at the Board meetings? On a positive side. then what possible reason is there for not putting Keith Meister on the Board. Mr. Carl Icahn wrote1: You stated during today’s conference call. Warner what does one have to do to qualify — lose $37 billion dollars? Mr. you failed to mention in your conference call that I told Mr. who has 145 million reasons to spend his time working toward the spin-off being accomplished. My offer to Motorola stills stands. energetic individual like Keith. they are certainly not denied information as to whether their representative acted in a grossly negligent fashion. head of the Nominating Committee called me and offered seats to two of my Nominees if I would drop the proxy fight. You have stated to the press that our request for information about what steps the Board actually took to correct the problem at Motorola is an unnecessary distraction. SEC Schedule 13D. “we discussed Board Nominees with Carl Icahn and we proposed two nominees and he declined.” Again this is only partially true. If as you have stated. and corporate governance activism.” I asked Mr. Investments Seeking Board Seats In a letter to Motorola. M&A activism. sale activism.Appendix B: Excerpted Hedge Fund Letters To elaborate on the distinctions among activist strategies.. Warner that I would gladly accept this offer if the Board would also accept Keith Meister. capital structure activism. having a highly intelligent. may well make this promise come true in a timely fashion. In a political election when constituents believe their representatives’ performance was inadequate. we all want to benefit the stockholders of Motorola. Warner then replied that the Board did not “know” Meister. It is true that Sandy Warner. We ask 1 Motorola Inc.
MMI Investments wrote3: We understand that BAX operations might be further improved. B2 . we believe. coupled with low-interest rates and a vibrant M&A market. but conclude that this is insufficient grounds to retain them.. are achieved via an organized process.the Board meet with Meister. It is imperative that the Company immediately focus on executing cost-cutting and restructuring initiatives in order to stem its current cash bleed. We believe BCO is currently in a brief cyclical window of robustness in world freight markets and strong earnings for BAX. we believe that by waiting until 2006 to divest BAX in the hope it will earn its cost of capital would be making a decision to trade the certainty of the currently robust M&A and freight markets for the uncertainty of BAX’s hypothetical ability to earn its cost of capital. Any concerns about losing key people during a sale process can be addressed with meaningful divestiture incentive bonuses. put egos aside and let’s get on with the urgent business at hand. Furthermore. Most divestitures today. will yield immense value to shareholders by creating a leaner. SEC Schedule 13D. Elliott believes that these initiatives. filed 20 April 2005. lease part or all of the corporate headquarters. if executed properly.. The depressed market capitalization of BCO far outweighs any benefit of holding BAX. SEC Schedule 13D. profitable company fit to navigate the intense competition of the future. Elliot Associates wrote2: Elliott is puzzled by the pace of cost-cutting and restructuring actions taken by the Company over the past two years. 2 3 Pier 1 Imports Inc. filed 9 April 2007. which includes a qualified investment banker with a board-approved mandate to approach qualified prospective buyers. “right-size” the corporate and divisional SG&A. M&A Activism In a letter to Brinks Co. This happens all the time and we would support such extra compensation for BAX executives in the event of a successful exit. Waiting for the buyers to come will likely result in no transaction. Business Strategy Activism In a letter to Pier 1 Imports. and add new independent members to the Board of Directors. Whereas we believe a sense of urgency is appropriate. the Company has reacted at a glacial pace to the intensified competitive landscape that has developed in the US home furnishing retail industry over the past five to ten years.. Brinks Co. We suggest Pier 1 close down a significant number of stores. whether that results in one or more transactions or a shut-down/liquidation.
P. Newcastle Partners wrote4: We were surprised to learn by press release of the rejection by Gehl Company (the “Company) of the offer made in a letter to you dated December 22. we were disappointed to see that you failed to return any of the phone calls made to you by the Interested Parties in connection with such offer.75 per share.. L. Common sense aside. Sale Activism: In a letter to Gehl Co. Instead of giving any consideration to the offer. The Board's rejection of the offer demonstrates the Board's lack of dedication to pursuing the best interests of the stockholders of the Company and maximizing stockholder value. 2000 from Newcastle Partners. a phone call to the Interested Parties to address any questions or concerns of the Company's Board of Directors. or in any way seek any additional information about the offer.. given that the offer represented a 67% premium to the Company's then current market price of $10. (collectively. we believe that the offer warranted. The Board's rejection of the offer. Instead. If there are concerns with any of the standard conditions contained in the offer. filed 29 June 2007. We would welcome the opportunity to discuss this or present further details to the Board.00 per share in cash. for $18. We believe that BCO has such an occasion at this moment: a win-win transaction for exiting an undesirable subsidiary and funding a legacy liability. Steel Partners wrote5: We commend management for its efforts that have resulted in improved operating margins and a simplified capital structure. and CIC Equity Partners. We also recognize and commend the 4 5 Gehl Co. clearly indicates to us that the offer was not given serious consideration by the Board. SEC Schedule 13D. Inc. Ikon Office Solutions. Ltd. the "Interested Parties") to acquire the Company. The offer was summarily rejected with no indication that the Board consulted with an investment banking firm or relied on a "fairness opinion" to justify the rejection. B3 . We conclude that it is crucial for the future of BCO that a buyer is sought promptly.It is rare in life or business that the sun.. filed 20 March 2001. which rejection was announced in a press release only a few hours after it was delivered to you. we invite the Board to contact either of the undersigned to directly address such concerns in a productive manner. it appears that the Board spent their time preparing a press release attempting to belittle the ALL CASH offer. as described in such letter. SEC Schedule 13D. at minimum. and a highly favorable environment in which to do so. moon and stars all align. Capital Structure Activism In a letter to Ikon Office Solutions.
B4 . the Company should be in a position to self tender for at least $850 million of common stock. we believe that the Company's common stock continues to trade below its intrinsic value and your balance sheet remains highly inefficient. This represents a 20% premium to the 20-day closing average of the shares.50 a share. Steel would commit not to tender into this offer. We believe it will be well received by the shareholders who desire liquidity. Importantly. filed 14 February 2005. in the course of our investigation.Company for expanding the Company's existing share repurchase program. or approximately 39% of its outstanding shares at the aforementioned price per share. we believe this refinancing is highly achievable in a short period of time. Based on our discussions with several leading investment banks. As a long term shareholder.) Irik. the junior subordinated units that you hold are completely out of the money and hold little potential for receiving any future value. It is time for you to step down from your role as CEO and director so that you can do what you do best: retreat to your waterfront mansion in the Hamptons where you can play tennis and hobnob with 6 Star Gas Partners LP. Third Point Capital wrote6: Sadly. The proposed recapitalization would provide immediate liquidity at a meaningful premium to the current share price for your shareholders who elect to tender. We therefore recommend that the Company capitalize on its operating momentum and utilize the strength of its balance sheet to pursue a public recapitalization at $17. at this point. However. A review of your record reveals years of value destruction and strategic blunders which have led us to dub you one of the most dangerous and incompetent executives in America. fees for your cronies and to insulate you from the numerous lawsuits that you personally face due to your prior alleged fabrications." One can only pity the poor student who suffers the indignity of attaching your name to his academic record. I have known you personally for many years and thus what I am about to say may seem harsh. Corporate Governance Activism In a letter to Steel Gas Partners. misstatements and broken promises. It seems that Star Gas can only serve as your personal "honey pot" from which to extract salary for yourself and family members. With the Company's excess cash and a conservative debt financing package. but is said with some authority. (I was amused to learn. SEC Schedule 13D. It would also be accretive immediately. that at Cornell University there is an "Irik Sevin Scholarship. your ineptitude is not limited to your failure to communicate with bond and unit holders. in addition to lowering the Company's cost of capital and enhancing its EPS growth. and more so in the long term. this recapitalization would result in a strong and flexible balance sheet that would support the Company's long term strategic vision.
The matter of repairing the mess you have created should be left to professional management and those that have an economic stake in the outcome. B5 .your fellow socialites.
from 30 days prior to each investment until 30 days after. Figure C1 plots active returns against passive returns. In this section. For funds above the 45° line. This does not appear to be the case. activist investments outperformed. For all funds above In Short-Run.Appendix C: Hedge Fund Heterogeneity Because it requires substantial skill to improve a firm beyond the management team’s ability (or willingness). Especially because 13D Monitor selectively chose the hedge funds for my sample. C1 . I look for outliers in any particular fund’s activist or passive investments. I find no evidence that outliers have distorted my results. For each hedge fund with at least three activist investments and three passive investments. (2) long-term returns. Most Funds' Active Investments Exceed Passive Investments Results ot Driven By Outliers 40% Cannell 30% A ctive Exces s Return Ramius Icahn Elliot Shamrock FEF Stilwell Third Ave Riley SAC Pershing Southeastern 20% Newcastle Sandell JANA Third Point Harbinger 10% Greenlight Discovery DE Shaw Wynnefield Barington 0% -10% Nierenberg -20% -20% -10% 0% 10% 20% Passive Excess Return 30% 40% Figure C1. I analyze hedge fund heterogeneity in (1) short-term returns. we might expect substantial variation hedge funds’ activist success. For all hedge funds with at least three activist observations and three passive observations. Turning first to short-term returns. and (3) target firm improvements. the chart plots the fund's activist return aginst its passive return. it is worth investigating whether certain outlier funds unduly influence the aggregate outcomes.
active investments outperform passive investments. the short-term outliers have disappeared. For each hedge fund with at least three activist investments and three passive investments. activist investments outperformed. from one month prior to the investment until 24 months after. Further. this adds comfort that my prior results were not skewed by outliers. In C2 . active investments outperformed passive investments. I use the same method to next analyze long-term returns. the 45° line. Cannell Capital’s high flying short-run returns have fallen back to earth. I find few outliers. Figure C2 plots hedge funds’ active excess returns against passive excess return. from one month before each investment until 24 months after.9% of the 23 funds. the chart plots the fund's activist return aginst its passive return. the more the activist investments outperformed (or underperformed). a fund’s activist investments outperformed its passive investments. For funds above the 45° line. Most Funds' Active Investments Exceed Passive Investments Results ot Driven By Outliers 120% SCSF 100% 80% A ctive Excess Return Steel SAC 60% 40% 20% 0% -20% -40% -40% Barington Nierenberg Southeastern Wynnefield FEF JANA Ramius Elliot Riley Icahn Cannell ValueAct Third Point Discovery -20% 0% 20% 40% 60% Passive Excess Return 80% 100% 120% Figure C2. For 73.In Long-Run. and both Nierenberg and SAC migrate above the 45° line as their activist investments outperform their passive investments over two years. If above the 45° line. Interestingly. The greater the distance from the 45° line. Coupled with the strong median outperformance.
fact, for 76.5% of the 17 funds, activist investments outperformed passive investments over the period. This median outperformance adds more comfort that my prior results were not skewed by outliers. While SCSF appears to be a positive outlier, its 109.4% activist return is driven by only four investments. Thus, few outliers coupled with strong median outperformance give no reason to question the earlier results. Finally, I turn to heterogeneity in target firm improvements. Figure A3 repeats the above analysis for changes in ROA (Panel A), leverage (Panel B), and assets (Panel C). Due to a scarcity of observations, I analyze the change in ROA for any fund with at least two activist and two passive observations, but I analyze the change in leverage and the change in assets for any fund with at least three activist and three passive observations. Turning first to profitability, as expected, in 63.6% of hedge funds, their activist targets improve ROA, and in 90.9% of investments, their passive targets reduce ROA. For 81.8% of hedge funds, activist target firms’ ROA increase more than passive target firms’ ROA. While firms above the line show much more variance than those below the line, the distribution gives no reason to suspect that outlier funds have skewed the results, especially given the dramatic median outperformance. Leverage shows a similar pattern. As expected, in 57.1% of hedge funds, their activist targets increase leverage, and in 57.1% of hedge funds, their passive targets reduce leverage. For 71.4% of hedge funds, activist target firms’ leverage increases more than passive target firms’ leverage. Both due to the strong median performance, and because there appear to be no clear outliers, I find no reason to reject the long-term results discussed earlier. Finally, analyzing the change in assets lends further strength to my earlier conclusions. As expected, activist investments grow more slowly than passive investments; for 69.6% of hedge funds, activist targets reduce total assets, and for 65.2% of hedge funds, their passive
Panel A: 82% of Hedge Funds Improve ROA
ValueAct Third Point
Active ROA Increase
-2% 0% Passive ROA Increase
Panel B: 71% of Hedge Funds Increase Leverage
Wynnefield Steel ValueAct
3% Active Leverage Increase
0% 1% 2% Passive Leverage Increase
Panel C: 74% of Hedge Funds Reduce Assets
10% Active Asset Growth
Nierenberg SAC ValueAct Third Point
Cannell Barington SCSF Ramius Wynnefield
Stilwell Southeastern Highland Riley Discovery
0% Passive Asset Growth
Figure C3. For various hedge funds, the chart plots changes in ROA, leverage, and assets for activist and passive investments in Panel A, Panel B, and Panel C, respectively. Panel A includes all hedge funds with at least two activist and passive observations. Panel B and Panel C, which had more observations, include all hedge funds with at least three activist and passive observations.
targets increase total assets. In a sample of 23 hedge funds, in 73.9% of funds, activist targets shrink more than passive targets. Thus, I find strong evidence to support the earlier conclusions that hedge funds reduce assets in their activist investments. To give more details about the funds comprising my sample, Table C-1 describes each fund’s investments by strategy and by instrument. To summarize, despite using a sample comprised of hand-picked hedge funds, I find no evidence that any particular hedge funds have skewed my results. To the contrary, examining returns and improvements on a fund-by-fund level has only strengthened my earlier conclusions.
4% Activist Strategies Capital Corp Sale Structure Governance 19. the table shows how many filings each fund made over the time period.0% 0.3% 66.4% 59.0% 0.0% 12.7% 4.2% 70.4% 16.1% 11.3% 22.3% 16.7% 20.3% 38.4% 8.1% 20.4% 4.8% 4.5% 50.0% 22.4% 11.0% 7.0% 0.0% 0.3% 16.0% 5.4% 22.7% 0.8% Lawsuit 3.0% 22.0% 80.0% 33.7% 0.1% 7.0% 33.4% 0.2% 17.0% 17.0% 0.9% 0.8% 0.0% 12.0% 0.0% 33.6% 52.0% 0.8% 10.7% 3.1% 11.0% 13.9% 14.7% Win Board 23.3% 0.7% 0.0% 11.2% 22.2% 22.1% 0.0% 0.3% 33.0% 0.9% 2.0% 0.0% 21.8% 12.1% 22.0% 5.7% 0.0% 40.9% 28.2% 5.0% 11.7% 42.0% .0% 33.0% 0.5% 28.0% 4.0% 0.3% 37.0% 20.3% 25.0% 0.8% 13.4% 56.4% 0.2% 5.5% 34.3% 14.3% 14. what percentage of that fund's investments fall into each strategy category.6% 11.3% 0.0% 18.6% 22.0% 11.0% 11.7% 0.0% 0.0% 0.0% 11.0% 33.0% 42.0% 14.0% 8.3% 12.0% 0.0% 5.2% 50.4% 25.6% 60.0% 16.4% 11.7% 13.7% 0.7% 8.7% 20.8% 11.0% 0.0% 3.3% 50.3% 0. For each fund.1% 16.0% 14.0% 10.0% 0.0% 13.8% 24.0% 0.3% 33.0% 33.3% 13.8% 21.0% 22.2% 29.3% 12.1% 54.3% 0.3% 21.0% 0.0% 77.5% 35.0% 8.7% 8.7% 20.9% 10.0% 5.4% 4.7% 18.7% 8.9% 29.0% 0.9% 2.0% 0.0% 50.4% 16.1% 20.5% 14.0% 0.4% 37.7% 16.0% 14.0% 37.7% 9.5% 5.3% 47.0% 7.7% Activist Instruments Proxy Buyout Fight 9.5% 23.7% 7.7% 4.4% 0.1% 5.0% 0.7% 62.3% 51.2% 40. and what percentage of that fund's investments fall into each instrument category.0% 9.0% 0.0% 33.3% 16.1% 21.5% 16.1% 33.2% 46.0% 0.4% 7.1% 0.7% 9.0% 21.5% 20.0% 42.2% 100.2% 66.8% 33.4% Any Instrument 37.1% 13.0% 20.0% 12.0% 42.0% 0.1% 0.7% 0.7% 13.0% 15.1% 5.7% 22.0% 80.3% 14.6% 10.3% 70.0% 46.0% 0.0% 22.0% 30.5% 45.3% 16.9% 0.0% 13.0% 55.1% 40.7% 66.3% 25.3% 33.0% 22.0% 29.3% 0.0% 60.5% 14.0% 0.0% 17.0% 40.0% 0.7% 33.7% 40.5% 25.0% 40.9% 26.2% 25.1% 24.0% 0.0% 0.3% 5.0% 0.1% 0.6% 0.0% 0.4% 4.7% 33.0% 0.0% 9.1% 30.3% 0.0% 26.6% 20.7% 8.0% 35.0% 60.0% 17.3% 70.4% 15.1% 25.0% 16.9% 16.9% 35.4% 38.3% 100.7% 71.2% 5.7% 5.0% 0.0% 40.0% 0.0% 0.0% 0.0% 21.0% 27.8% 47.2% 2.7% 0.0% 0.1% 17.1% 0.0% 60.1% 16.0% 13.6% 29.1% 23.5% 14.3% 0.3% 11.8% 88.0% 0.0% 76.3% 6.7% 8.0% 11.5% 45.6% 71.7% 27.0% 14.5% 30.7% 2.7% 2.3% 22.0% 0.0% 18.0% 26.0% 17.4% 45.7% 10.2% 25.0% 5.0% 0.3% 41.0% 11.4% 7.4% 0.Table C-1 Hedge Fund Sample This table describes the hedge funds in my sample.5% 55.0% 7.8% 56.5% 20.6% 0.0% 0.0% 0.6% 33.2% 100.1% 0.0% 56.0% 10.1% 4.3% 0.1% 7.0% 44.8% 13.3% 71.0% 0.0% 8.1% 0.1% 30.0% 44.0% 25.0% 0.7% 66.3% 53.0% 44.5% 2.3% 0.0% 16.0% 0.0% 0.8% 55.0% 8.6% 27.9% 6.0% 0.0% 0.4% 21.0% 16.9% 20.2% 15.9% 14.1% 33.9% 24.1% 0.3% 57.4% 0.2% 0.8% 4.3% 29.5% 2.0% 0.1% 38.0% Seek Board 37.0% 8.0% 16.5% 18.0% 9.1% 0.9% 4.3% 0.8% Any Strategy 33.3% 11.7% 0.1% 0.2% 70.1% 44.3% 8.5% 50.7% 16.3% 0.7% 0.9% 38.0% 13.3% 18.3% 15.0% 20.0% 40.2% 33.0% 15.3% 55.0% 18.4% 8.2% 0.0% 5.0% 14.0% 6.0% 0.3% 2.0% 0.0% 6.3% 14.2% 0.1% 0.0% 0.1% 10.5% 7.0% 7.0% 16.0% 0.7% 29.7% 13.1% 20.4% 20.4% 37. Total Filings Steel Partners ValueAct Capital Ramius Capital Carl Icahn Third Point Farallon Wynnefield Capital Harbinger Capital Riley Invetment Mgmt Financial Edge Fund Blum Capital Barington Capital Canell Capital JANA Partners SCSF Equities Shamrock Activist Fund Discovery Group Elliot Associates Joseph Stilwell Newcastle Partners Southeastern Asset Mgmt MMI Investments SAC Capital Highland Capital Nierenberg Investment Third Avenue Mgmt DE Shaw Sandell Asset Mgmt Clinton Group Costa Brava David M Knott Greenlight Capital Cresecendo Breeden Capital Pershing Square Blue Harbor New Mountain Vantage Relational Investors Total 51 49 39 37 37 35 29 24 24 23 22 20 20 18 18 17 15 15 15 14 14 13 13 12 12 12 11 10 9 9 9 9 8 7 7 6 5 5 718 Business Strategy 3.3% 6.7% 27.5% 53.7% 39.4% 24.
Appendix D: Unreported Regressions and Additional Analysis .
1 12.68 1.5 -0.1 1.6 3.4 1.0 2. and *** refer to statistical significance at the 10%.0 7.9 1. Column 2.8 0. Growth is the firm's one-year sales growth.5 16.6 0.9 0.6 -16.3 2.1 20.5 -0.8 0.5 -1.9 1.7 20. Return on Equity is the firm's EBITDA divided by the book value of equity.63 1.4 9.1 16.5 20.9 8.2 -1.6 14.34 0.42 0.1 0. P/E Ratio is the firm's trailing twelve months price-to-earnings ratio.5 4.3 19.47 3.3 -34.6 34.9 19.7 0. All data is winsorized at the 10% level.3 8.3 1.0 6.0 10.9 81.4 22.8 -0.71 1.22 0.5 StDev 814. Return on Assets is the firm's EBITDA divided by its assets.9 3.7 -0.3 3.9 8.2 -1.6 15. and Column 5 report means.40 1. medians. Passive Targets (1) Active Mean Market Cap Tobin's q Abnormal q P/E Ratio Growth Margin Abnormal Margin Return on Assets Return on Equity Abnormal ROE Leverage Abnormal Leverage Payout Ratio Dividend Yield Cash/Assets Capex/Assets R&D/Assets 757.1 1.49 0.1 0. Column 4.3 13.9 StDev 888.0 1.3 4. Payout Ratio is the firm's common dividends divided by net income. Capex/Assets is the firm's capital expenditures divided by total assets. Abnormal Leverage is the firm's leverage less its industry median.7 -0.7 8. 5%.8 19.3 19.8 3. **.0 6.5 7. Column 3 and Column 6 report the differences in means and associated t -statistics.55 1.0 0.2 9. and standard deviations.89 1.30 * * . All variables refer to the trailing twelve months prior to the Schedule 13D and are from Bloomberg or Compustat. Dividend Yield is the firm's total dividends divided by market capitalizatoin.23 1.2 2.7 1.9 1.4 18.7 12.Table D-1 Characteristics of Target Companies The table reports the characteristics of hedge funds' targets.8 1.9 18.84 1.5 0.8 16.1 3.9 (2) Passive Median 270.36 0.1 9.9 10.8 0.4 16.8 9.1 15.0 17.8 11. Panel B separates activist investments which seek board seats from activist investments which do not.8 -0. Abnormal q is the target firm's Tobin's q as a percent of its industry's median Tobin's q .3 * * *** * * ** * ** (3) Difference t -stat 1.5 1.5 16. *.4 9.2 15.7 Mean 102.6 Mean 654.7 -0.0 0.1 -0.3 -0. Column 1.2 34.8 18. Panel A: Active vs.0 7.4 -1.6 9.1 -29. Cash/Assets is the firm's cash and cash equivalents divded by total assets.0 0. Abnormal ROE is the firm's ROE less its industry median ROE.8 1.0 -2. and 1% levels.8 74. Panel A separates activist investments from passive investments. Margin is the firm's EBITDA divided by sales.49 2. Tobin's q is the ratio of market value of equity plus long-term debt over book-value of equity plus long-term debt.0 8.1 0.0 0. Abnormal Margin is the firm's margin less its industry median margin.2 Median 329.8 2.0 16.00 0.9 8.4 22.2 15. Leverage is the firm's debt-to-assets ratio. and R&D/Assets is the firm's R&D expense divided by total assets.4 -4.1 0.0 0.9 16.1 1.8 -0.7 22. Market Cap is market capitalization.
4 8.3 0.3 15.8 11.0 17.07 2.8 1.4 -0.2 1.21 0.49 2.3 1.85 0.6 Mean -255.6 15.8 2.4 0.2 -42.8 0.10 1.9 1.25 0.5 23.8 16.9 10.8 16.0 25.5 16.95 *** *** *** *** *** ** .7 0.2 6.9 17.0 -5.5 5.0 Median 253.3 -2.1 -6.1 17.44 2.5 0.1 8.9 14.8 10.1 -0.3 0.1 -4.4 0.5 18.2 -11.5 13.9 -1.4 1.5 2.0 StDev 926.7 72.0 0.8 36.5 17.7 12.13 3.66 0.4 4. Active Investments Which Do Not (4) Board Seats Mean Market Cap Tobin's q Abnormal q P/E Ratio Growth Margin Abnormal Margin Return on Assets Return on Equity Abnormal ROE Leverage Abnormal Leverage Payout Ratio Dividend Yield Cash/Assets Capex/Assets R&D/Assets 636.54 4.8 76.93 2.3 (5) No Board Seats Median 472.0 -5.8 7.54 2.6 18.5 3.0 6.6 5.5 8.1 0.1 5.2 19.4 33.7 17.0 17.6 7.6 16.0 -0.2 1.6 16.4 17.1 4.6 16.3 20.6 Mean 891.Panel B: Active Investments Seeking Board Seats vs.7 -2.35 0.3 0.5 -22.4 18.9 -5.6 -0.59 0.9 -0.0 0.0 0.47 1.0 1.0 9.8 2.8 1.2 24.0 0.0 9.0 -4.7 17.8 StDev 837.6 8.7 -0.1 6.10 0.7 -11.0 1.5 -29.7 9.8 6.0 0.3 1.5 13.0 -1.0 0.7 0.9 7.3 *** *** (6) Difference t -stat 2.7 7.2 1.0 6.0 0.2 19.5 1.0 -0.
7% * 3.8% 4. Panel A compares active investments to passive investments.3% 35.7% *** 79.6% *** 4.8% *** 25.76 340 (+0.0% 16.7% 2.6% 5.5% *** 67.8% *** 17.09 45 (+0.1% *** 7.6% *** 16.3% *** 4.5% 1.8% 59.5% 12.+30) -8.6% *** 19. and *** indicate statistical significance at the 10%.0% *** 11.+2) (+0.2% -5.8% *** 24. z-statistic N= -21.+30) -23.Table D-2 Short-Term Returns by Investment Type The table presents average daily excess returns around the Schedule 13D filing for various event windows.1% 31.40 4.0% 29.2% -0.4% *** 9.7% 38.5% *** 69.0% -0.1% 7.2% *** 2.6% -3.41 3.+2) Difference (+0.9% 1.+2) -3.7% * 2.0% *** 2.6% 5.37 342 (-2.3% -10.2% *** 14.8% 5.1% 4.2% 44.6% 11.+30) (-2. *.2% 8.1% 3.0% *** 14. estimating parameters over the 200 day window prior to the Schedule 13D.+2) (+0.8% 7.6% 5.1% * 2.+2) -6.+2) Difference (+0.5% 30.27 6.9% *** 3.3% *** 23.9% 10. I report p -values for medians using the Wilcoxon Signed Rank Test.95 340 Passive (+0.4% 51.00 3.8% 0.4% *** 10.6% 40.8% *** 9.50 8.4% 53.6% 11.3% *** 3. I measure returns in excess of the market model using the value-weighted CRSP NYSE/Amex/Nasdaq index.+2) -7.+30) -33.04 7.8% 4. Panel A: Active Investments Perform Better Than Passive Investments Active (-30.9% 4.1% *** 10.98 3.+2) -7.8% *** 64.00 6. z-statistic N= -13.+30) -12.8% *** 4.6% *** 57.7% *** 57.61 194 (+0.9% 1.+2) -3.2% *** 4.7% *** 88.91 194 (-2.1% *** 8.76 194 (+0.1% ** 4.6% *** 71.16 3.6% 19.3% 2.7% *** 67.39 45 (-30.6% *** 8.9% *** 7.+30) 8.6% *** 77.8% *** 7.90 5.+30) -24.9% *** 6.26 340 (-30. **.66 7.1% 2. Panel B further splits active investments into those which seek board seats and those which do not.9% * 3.4% *** 10.82 5.3% 5.48 45 (-2.3% 9.7% 7.15 149 No Board Seats (-2.5% *** 29.+30) -13.3% 7.1% 2.99 149 (+0.5% 0.+2) -5.2% -2.+30) 5% 25% Median 75% 95% Average % Positive Patel z-statistic Non par.6% *** 77.5% *** 1.16 7.0% *** 9.5% 0.9% *** 5.4% *** 3.7% 3.8% *** Panel B: Active Investments Seeking Board Seats Perform Better Than Active Investments That Do Not Board Seats (-30.77 8.8% *** 16. 5%.6% 21.8% 25.9% *** 80.7% *** 80.1% 12.4% 4.98 45 (+0.7% 0.7% 21.89 5.1% *** 8.+30) 5% 25% Median 75% 95% Average % Positive Patel z-statistic Non par.6% *** 77.0% *** 15.7% *** 73.1% 0.3% 0.9% *** 9.7% -1.6% 17.+2) -5.+30) (-2.75 194 (-30.9% 5.81 149 (+0.70 149 (-30.2% * .6% *** 75. and 1% levels.9% 4.7% 1.8% 6.0% -0.4% 10.+30) 1.04 3.+2) -7.5% *** 13.2% 12.9% *** 16.
93 ** -1.13 -0. t -stat 5. a dummy set to one for board investments.14 -0. 3.09 3. *.55 *** 6. t -stat 5. t -stat 2. Panel A controls for abnormal q and abnormal margin and Panel B controls for Tobin's q and margin. 5%.65 *** 6. and R Coeff.37 0.71 162 0. and 1% levels.45 -2.11 Panel B: Non-Adjusted Variables (3) Dependent Variable: Abnormal Returns Constant Tobin's q Margin Active Board 2 No. All dummies refer only to information contained in the initial schedule 13D filing.23 ** -2. and R Activism Coeff. Panel A: Industry-Adjusted Variables (1) Dependent Variable: Abnormal Returns Constant Abnormal q Abnormal Margin Active Board 2 No.03 -0.15 290 Activism t -stat *** 5.58 3.45 1.45 *** 5.15 ** 1.46 -0. **.24 122 0.23 2.38 *** -2.07 .75 *** 4. Controlling For Undervaluatoin The dependent variable is the abnormal return during the 5 days around the Schedule 13D filing date.97 * -1.56 *** 3.09 ** -1.06 (4) Board Seats Coeff. a dummy set to one for activist investments. and *** indicate statistical significance at the 10%.69 -2.Table D-3 Short-Term Returns By Type.78 441 0.07 (2) Board Seats Coeff. Column 1 and Column 3 regress all abnormal returns on Active .96 -0.07 ** -2. All nondummy variables are winsorized at the 10% level and are expressed as the deviation from the sample average values.41 3.15 -0.07 -1. Column 2 and Column 4 regress abnormal returns from exclusively active investments on Board .02 -0.
56 48 (-30.7% 21.+30) -13.49 53 (+0.4% *** 66. *.3% 6.5% *** 6.+2) -3.2% 5.3% 2.3% *** 71.4% *** 3.75 2.6% *** 3.+2) -9.0% 26.82 110 (3) First Board Win (-2.+30) 5% 25% Median 75% 95% Average % Positive Patel z-statistic Non par.6% * 10.1% 5.6% *** 17.2% *** 20.2% 1.0% 46.4% -4.+2) -3.3% 7. I report p -values for medians using the Wilcoxon Signed Rank Test.3% 8.5% 2. the hedge fund first wins board seats.3% 20. and *** indicate statistical significance at the 10%. having already announced its intention to seek board seats.8% *** 9.8% 2.7% 6.76 53 (-2.7% 25.38 3.2% *** 66. z-statistic N= -30.6% 3.4% -1.3% *** 73.5% 5.01 48 (+0.7% 35.+2) -5.4% ** 2. Column 1 analyzes schedule 13D/A filings in which.6% 0. having already filed a passive 13D.5% *** 11. estimating parameters over the 200 day window prior to the event.8% * 53.+30) -12.5% *** 77. (1) First Action (-30. **.+2) -2.5% *** 2. Column 3 analyzes schedule 13D/A filings or news stories in which.34 3.81 3.7% 4.1% *** 69.9% *** 60.1% 34.8% 0.7% *** 3.3% *** 66.4% *** 77. I measure returns in excess of market model using the value-weighted CRSP NYSE/Amex/Nasdaq index.1% *** 4.0% *** 5.41 0.3% 6.6% 8.3% *** 18. 5%.9% -2. a hedge fund first seeks board seats.63 1.5% 2.2% 0.1% 10.7% *** 8.78 109 (+0.+30) -29. in excess of the value-weighted market.69 1.2% -5.5% *** 51.7% *** 2. a hedge fund first announces activist intentions.2% 1.Table D-4 Abnormal Returns After 13D Filing Date The table presents average returns after the initial Schedule 13D filing. for various event windows.2% 2.5% -2.+30) -18.1% *** 4.05 109 (+0.21 2.6% 0.21 53 (-30.95 4.1% -6.3% 0.9% 5.3% 4. Column 2 analyzes schedule 13D/A filings or news stories in which.66 53 (+0.5% -1.+2) -7.4% 41.9% 7. having already announced activist intentions.0% 0.9% 6. and 1% levels.5% *** 20.2% 0.83 2.3% 2.8% 2.2% -2.+30) -23.01 48 (+0.80 3.7% -3.7% 13.1% -0.8% ** 61.8% *** 4.71 4.70 48 (2) First Board Seat (-2.2% *** 10.6% *** 4.76 110 .
6% 2.87 112 (-1.+6) -37.5% 53.54 216 Passive (+1.39 238 (+1.48 6.29 0.0% 19. Panel B further splits active investments into those which seek board seats and those which do not.3% *** 38.97 2.6% 95.1% 0.+6) -48.4% 58. **.84 1. 5%.8% ** 55.8% *** 8.1% 149.9% 114.+12) -53.5% 177.9% * Panel B: Active Investments Seeking Board Seats Perform Better Than Active Investments That Do Not Board Seats (-1.11 112 (+1.0% -0.3% -31.+12) (+1.6% 40.2% *** 4.4% 8.1% *** 57.Table D-5 Long-Term Returns by Investment Type The table presents average monthly excess returns around the Schedule 13D filing for various event windows.19 1.8% -24.6% *** 66.9% *** 56. estimating parameters over the 36 month window prior to the Schedule 13D.1% 64.5% ** 2. and 1% levels.2% -12.87 2.+24) 15.3% 21.7% *** 0.0% -8.67 2.08 227 (+1.1% 2.1% 7. *.5% -8.1% 9.8% 6.8% ** 16.7% -127.30 112 (+1.5% -0.89 1.3% 54.3% *** 53.2% -0.6% 11.2% 3.3% *** 58.4% *** 12.7% 31.3% 172.06 119 (-1.2% *** 7.+6) (+1.2% *** 19.+12) (+1.45 115 No Board Seats (+1.0% 2.7% 15.4% * 1.2% -0.7% * 13.1% 13.9% ** 11.9% 0.+24) Difference (+1.8% *** 58.+12) -89.19 3.1% *** 5.3% 45.7% -20.5% 11.5% 111.7% 150.8% 1.7% 4.4% ** 8.16 16.2% *** 75.9% *** 4.0% ** 3. Panel A compares active investments to passive investments.4% 116.2% 47. Panel A: Active Investments Perform Better Than Paassive Investments Active (-1.5% -30.8% 14.48 217 (+1.2% -18.3% 7.70 244 (+1.6% 18.9% 59.15 4.4% 49.87 239 9.8% * 17.1% *** 38.4% * 49. and *** indicate statistical significance at the 10%.0% *** 56.1% 30.1% 20.5% 6.4% 20.03 121 (+1.2% 21.+24) -153.29 218 (-1.9% -11.+24) Difference (+1.8% -20.5% 1.8% -13.43 5.6% 50.5% *** 61.6% 4.32 118 (+1.6% 175.14 119 (+1.7% 55.+6) (+1.3% *** 2.88 2.2% * 36.55 3.2% 125.2% 3.1% ** 1.6% ** 5.1% *** 22. I measure returns in excess of the market model using the value-weighted CRSP NYSE/Amex/Nasdaq index.3% 159.+24) 5% 25% Median 75% 95% Average % Positive Patel z-statistic Non par.6% 4.+24) 5% 25% Median 75% 95% Average % Positive Patel z-statistic Non par.5% *** 62.+24) -75.6% -19.+24) -154.7% 7.0% 7.58 239 13.5% -11.+24) -132.3% 8.5% *** 56.+24) -77.+6) -58.9% * 5.2% ** 4.9% *** 3.8% -0.08 2.+24) -144.2% *** 60.0% -10.57 0.4% *** 5.4% -24.3% 10. z-statistic N= -132. z-statistic N= -91.+6) -55.5% 75.3% *** 60.3% *** 66.8% ** 54.+24) (-1.8% * . I report p -values for medians using the Wilcoxon Signed Rank Test.+12) -106.2% 28.3% 5.+12) (+1.2% * 10.
90 -1.36 -2.45 150 (2) Board Seats t -stat 1.80 0. and R Activism Coeff.Table D-6 Long Term Returns By Type. 4.75 -1.11 2.86 -1.63 * 197 (4) Board Seats t -stat 1.24 0. *.87 -0.81 -14. Controlling For Undervaluatoin The dependent variable is the abnormal return during the 25 months around the Schedule 13D filing date. Column 1 and Column 3 regress all abnormal returns on Active .21 * -1. 7.01 ** 4. a dummy set to one for board investments. 6.79 18.59 -1.01 2. a dummy set to one for activist investments.03 Coeff. 5%. **.40 ** -0. All nondummy variables are winsorized at the 10% level and are expressed as the deviation from the sample average values.00 -1. Column 2 and Column 4 regress abnormal returns from exclusively active investments on Board .52 -1.32 251 t -stat 0.17 0. Panel A: Industry-Adjusted Variables (1) Dependent Variable: Abnormal Returns Constant Abnormal q Abnormal Margin Active Board 2 No. Panel A controls for abnormal q and abnormal margin and Panel B controls for Tobin's q and margin.01 1.60 -7. and 1% levels.25 1.59 0. and R Activism Coeff.45 0.07 * -0. 15.50 * -0.33 ** -11.04 . and *** indicate statistical significance at the 10%.67 -9.90 ** 18.35 ** 388 t -stat 0.03 Panel B: Non-Adjusted Variables (3) Dependent Variable: Abnormal Returns Constant Tobin's q Margin Active Board 2 No.04 Coeff.
70 1.16 0.24 -0. t -stat -2.06 -0. All regressions control for Tobin's q and for the initial ROA (Panel A) or EBITDA margins (Panel B). All nondummy variables are winsorized at the 10% level and are expressed as the deviation from the sample average values. Column 2 and Column 4 regress improvements for activist targets on Board .20 *** -2.61 2. t -stat -1.15 ** -1. and *** indicate statistical significance at the 10%. and R Activism Coeff.34 0. a dummy equal to one for activist investments. 1.Table D-7 Profitability Improvements.87 *** 2.46 0.26 Panel B: Margins (3) Dependent Variable: Abnormal Returns Constant Tobin's q Initial Level Active Board 2 No.10 .23 0.20 1. t -stat -0.05 108 0.73 -0.16 3.23 0. a dummy equal to one for board seat investments. and 1% levels. Panel A: Return On Assets (1) Dependent Variable: Abnormal Returns Constant Tobin's q Initial Level Active Board 2 No. 5%.03 *** 3.89 1. **.05 0.82 40 (2) Board Seats t -stat 0.13 (4) Board Seats Coeff.16 Coeff. Controlling For Stock Picking The dependent variable is the two-year increase in ROA (Panel A) and in EBITDA margins (Panel B). Column 1 and Column 3 regress improvements for all firms on Active .24 ** 0.76 105 0.24 -0. *.16 38 0. and R Activism Coeff.76 0.32 2.55 -1.12 ** -2.31 *** -4.51 -0.71 0.53 *** -3.
08 ** 92 (4) Board Seats t -stat 1.07 Panel B: Leverage (3) Dependent Variable: Abnormal Returns Constant Tobin's q Initial Level Cash Active Board 2 No.56 0. 4.43 * -0.86 0. *.70 0. and R Activism Coeff.07 -2.07 Coeff.68 -3.65 0.48 102 t -stat 1. the initial payout ratio (Panel A) or leverage (Panel B). 5%.54 * -1. 1.39 0. and *** indicate statistical significance at the 10%. and the initial cash divded by initial assets. Panel A: Payout (1) Dependent Variable: Abnormal Returns Constant Tobin's q Initial Level Cash Active Board 2 No.78 -1. All regressions control for Tobin's q.24 * -0. t -stat -0. a dummy equal to one for activist investments.05 ** -4. Controlling For Stock Picking The dependent variable is the two-year increase in payout ratio (Panel A) and in the debt-to-assets ratio (Panel B). Column 1 and Column 3 regress improvements for all firms on Active .79 -0.36 0.04 Coeff.05 *** -2.53 0.75 42 (2) Board Seats t -stat 1.50 1. All nondummy variables are winsorized at the 10% level and are expressed as the deviation from the sample average values.20 -1.30 -0.25 ** -1.08 -0. Column 2 and Column 4 regress improvements for activist targets on Board .11 -0.19 0.26 0.02 1.11 -1.45 * 2.06 .12 ** 10. a dummy equal to one for board seat investments.83 0. and 1% levels. and R Activism Coeff.98 222 0.37 -0.99 2.05 0. **.16 * 10.Table D-8 Capital Structure Changes.21 1.59 -0.83 0. 2.
63 494 0.75 *** 6.00 0. All nondummy variables are winsorized at the 10% level and are expressed as the deviation from the sample average values.15 ** 2.61 0. Panel A: Assets (1) Dependent Variable: Abnormal Returns Constant Tobin's q Initial Level Active Board 2 No. a dummy equal to one for activist investments.03 6. *. t -stat 2.19 -0.12 522 0.79 -0.85 0. and *** indicate statistical significance at the 10%.61 *** 4.81 8.09 Panel B: Sales (3) Dependent Variable: Abnormal Returns Constant Tobin's q Initial Level Active Board 2 No.42 * -1.75 0.66 0.03 -4.06 .89 -4. 5%.00 -1.56 ** -2. and R Activism Coeff. All regressions control for Tobin's q and for initial assets (Panel A) or initial sales (Panel B).90 *** 3.00 0. t -stat 0.06 (2) Board Seats Coeff.77 ** 1. and 1% levels.29 *** 3. a dummy equal to one for board seat investments.34 5. and R Activism Coeff.23 -1.82 -0.15 0.95 *** 3.30 244 0.Table D-9 Firm Size Reductions. t -stat 4. Column 1 and Column 3 regress improvements for all firms on Active .05 (4) Board Seats Coeff. Column 2 and Column 4 regress improvements for activist targets on Board .00 ** -1.67 5.49 256 0. Controlling For Undervaluatoin The dependent variable is the two-year increase in assets (Panel A) and in sales (Panel B). **. t -stat 4.
3 -0.62 0.2 ** 2.0 26 t -stat -2. and R 2 0.0 -1.81 -0.15 0. **. and R 2 -0.42 -0. and 1% levels. **.4 1.90 -1.50 EBITDA Margin Coeff -0.11 1.12 0.1 * -1.78 0.9 *** -0.71 -0.58 -1.86 0.8 10.0 ** -0. and 1% levels. The regressions control for the initial payout ratio or the leverage as well as the initial cash divided by assets.1 * -6.17 1.70 2.7 2.91 -0. considering only the sample of investments which announce activist strategies. and *** indicate statistical significance at the 10%. *.4 0.87 0. the constants are supressed. 5%. *.8 1.35 -1.6 64 . Return on Assets Coeff Initial Value Business Strategy M&A Advice Sale Capital Structure Corporate Governance Other No. Due to the full span of the dummy variables. The data is winsorized at the 10% level.1 1.3 0.Table D-10 Profitability Improvement By Strategy The table regresses the two-year change in (1) Return on Assets and (2) EBITDA margin on dummy variables for the various activist strategies. Payout Ratio Coeff Initial Value Cash Business Strategy M&A Advice Sale Capital Structure Corporate Governance Other No.13 0.22 0.11 1.11 0.39 -2. considering only the sample of investments which announce activist strategies.4 *** 6.2 1. The data is winsorized at the 10% level.4 ** 3. the constants are supressed.21 0.81 2.46 Table D-11 Capital Structure Changes By Strategy The table regresses the two-year change in (1) payout ratio and (2) leverage on dummy variables for the various activist strategies.4 ** 5.4 -0. Due to the full span of the dummy variables.73 1.0 ** 2.81 -0.8 * -10. The regressions control for the initial ROA or the initial margin.5 29 t -stat -2.11 1.22 -0.29 Coeff Leverage t -stat -1.11 1.0 21. 5%.7 -1.6 -3.32 0.47 -0.6 -2.55 -0.3 2.8 29 t -stat 0. and *** indicate statistical significance at the 10%.
8 40.21 0.68 -1.65 0.48 164 -2. and *** indicate statistical significance at the 10%. Column 1 presents R 2 .2 0.7 -4.65 2.23 1.06 Table D-13 Sale Efficiency By Activist Strategy Column 1 shows a logit model that predicts whether a target firm will sell itself.26 0.6 15. Both regressions include data only from investments which use activist strategies. In Column 1. (1) Odds of Sale Odds z -stat Bus Strategy M&A Sale Cap Struc Corp Gov Other No.6 ** 185 t -stat -2.6 -4. and Column 2 shows a regression that predicts the average premium those firms receive.27 ** 0.47 0. and R 2 0.83 0.0 ** 3.3 12. 5%.7 24.0 * 178 Sales t -stat -0.23 ** 2.06 1. the dependent variable is a dummy set to 1 if the firm sold itself .65 1.33 1.05 Coeff 0. and R 2 0. The data is winsorized at the 10% level.26 2.0 4.0 2. *.98 -0.9 3.62 0.14 1. The regressions control for the initial assets or sales.77 0. Due to the full span of the dummy variables.11 -1.62 0.6 -2.74 -0. and Column 2 presents Pseudo-R 2 .32 0.93 0. and 1% levels.04 1. **. I measure premium as the total return to shareholders from one month before the activist first files a Schedule 13D until the sale closes. In Column 2 the dependent variable is the average premium for each such sale.0 14.14 2.10 1.10 (2) Avg Premium Coeff t -stat 7.8 32 0.23 -0.23 -1.57 ** ** ** ** .26 -0. **.3 13.95 0.6 3. *. Assets Coeff Initial Value Business Strategy M&A Advice Sale Capital Structure Corporate Governance Other No. and 1% levels.5 * 2.43 0.Table D-12 Firm Size Reductions By Strategy The table regresses the two-year percentage change in (1) assets and (2) sales on dummy variables for the various activist strategies. and *** indicate statistical significance at the 10%. the constants are supressed.7 74. considering only the sample of investments which announce activist strategies. 5%.
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