Hedge Fund Activism

This paper examines a large, nearly universal sample of hedge fund activism between January 1, 2003 and December 31, 2005. Hedge fund activism is when a hedge fund files a 13D filing after taking an initial stake of 5 percent or more in the company, and clearly states in the filing’s “purpose” section that it intends to proactively influence management’s future decisions. We find that hedge funds have engaged in successful and profitable activist campaigns against a large group of publicly-traded companies. Over 60 percent of the time, they are successful in getting existing management to acquiesce to their demands, be it representation on the firm’s board, a change in strategic operations, share repurchases by the firm, scuttling an existing merger proposal, or being acquired by another firm (sometimes the hedge fund itself). We also present evidence that the paradigm of shareholder activism does not apply to hedge funds. First, unlike previous studies on blockholder activism, hedge funds target profitable and healthy firms, firms with above-average cash holdings. Second, they earn significantly higher abnormal stock returns around the initial 13D filing date than a sample of control firm. Third, they do not improve the accounting performances of firms in the year after the initial purchase – in fact, both EPS and ROA decline in the fiscal year after the activism. Fourth, they appear to extract cash from the firm through increasing the debt capacity of the target firm and paying themselves higher dividends. Examination of proxy fights and threats accompanying the activist campaign suggests that hedge fund managers achieve their goals by posing a credible threat of engaging the target in a costly proxy solicitation contest.