Hedge Funds And Activism Mergers
Northeastern University – D’Amore-McKim School of Business
University of North Carolina Kenan-Flagler Business School
University of North Carolina Kenan-Flagler Business School
November 10, 2015
Northeastern U. D’Amore-McKim School of Business Research Paper No. 2677416
Abstract:
Activist hedge funds play a critical role in the market for corporate control. Activists foster acquisition activity at targeted firms through the intensity of their engagement with management and their prior record in activism mergers. Activism targets experience a six-to-eight times higher likelihood of receiving a takeover bid relative to firms in which the same activist hedge funds have passive ownership stakes. Further, failed takeover attempts of activism targets display significant long-term share price appreciation, reflecting substantial improvements in real operating and financial policies. Returns to both target and third-party bidder shareholders are higher when an activist is involved in the target firm. In contrast, activism mergers are associated with significantly lower target returns and lower completion rates when the bidder is the activist hedge fund. Our findings illustrate specific mechanisms through which hedge fund activism facilitates change of control transactions.
Hedge Funds And Activism Mergers – Introduction
In their survey of shareholder activism, Gillan and Starks (2007) define activists as “investors, who dissatisfied with some aspect of a company’s management or operations, try to bring about change within the company without a change in control” [emphasis added]. The recent literature has established that hedge fund activism helps improve the performance and governance of targeted firms (see Brav, Jiang, Partnoy, and Thomas, 2008; Becht, Franks, Mayer, and Rossi, 2008; Brav, Jiang, and Kim, 2015). Yet there is limited evidence on the precise mechanisms through which hedge fund activists help enhance shareholder value.
In this paper, we explore the role of hedge fund activism in corporate control transactions – which we call “merger activism” – with a focus on the ability of hedge funds to influence the likelihood that a bidder will target a firm involved in an activist campaign. Merger activism has become an increasingly common strategy employed by activists in recent years. One-fifth of all firms targeted by hedge fund activists over 2000-2012 receive a takeover bid within two years, and since 2007 this proportion has risen by 24%. Thus, in the case of hedge fund activism, rather than being two distinct means of shareholder intervention (as sometimes discussed in the theoretical literature, e.g. Maug, 1998), monitoring by activist investors and takeovers are closely interrelated. We study the nature of this relationship in this paper.
We are not the first to examine the link between hedge fund activism and takeovers. Using data from 1993 to 2006, Greenwood and Schor (2009) find that firms targeted by hedge fund activists are about three times as likely to be acquired over the following eighteen months. Among all firms targeted by hedge funds, only those that are eventually acquired exhibit long-term share price outperformance, suggesting that activism adds value only when targeted firms are ultimately acquired. Greenwood and Schor (2009) conclude that hedge fund activism puts firms “in play” to be acquired but that “the scope for hedge fund activism to have pervasive effects on corporate governance is limited”.
Although Greenwood and Schor (2009) document an important link between activism and takeovers, they are silent on the precise channels through which this link arises. For example, it is possible that hedge fund activists select stocks that would have been takeover targets anyway or time their campaigns in advance of merger waves. Alternatively, it may be that a hedge fund campaign simply draws the attention of potential bidders to a particular target. Finally, it could be that the post-intervention actions of hedge fund activists help improve the target, making it a more attractive takeover candidate to prospective bidders.
Our paper studies the specific mechanisms through which hedge fund activism promotes merger activity. We use a comprehensive hand-collected sample of 1,899 activism campaigns over 2000-2012 and a merger sample of 3,357 transactions over 2000-2014. We start by documenting that firms targeted by hedge fund activists face a substantially higher likelihood of receiving takeover bids. In our sample, over 34% of activism targets receive a merger proposal within the next 24 months, relative to other firms that receive merger proposals only 5% of the time. However, in almost 30% of activism mergers, the activist enters after the merger announcement but before its completion. To isolate campaigns where the activist has the potential to influence the probability of a takeover bid, we exclude such cases of activist merger arbitrage1 and focus on the remaining instances where a merger bid is announced within 2 years after a hedge fund initiates an activist campaign.
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