Does Hedge Fund Activism Improve Investment Efficiency in US Firms?

Abstract

We examine the impact of hedge fund activism on investment efficiency in target firms. On average, investment expenditures become more responsive to growth opportunities after experiencing hedge fund activism. However, activism improves investment efficiency for only overinvested target firms by reducing their propensity to overinvest. Investment efficiency is associated with closer involvement of activist hedge funds through private settlements and board representations. Further, hedge fund activism does not significantly affect the investment efficiency of underinvested target firms. We find that managers’ hostile resistance to activism (managerial entrenchment) is positively associated with firms’ likelihood of underinvestment. Overall, our findings suggest that it is relatively easier for activist hedge funds to monitor assets-in-place and influence managers to reduce overinvestment. This reduction in overinvestment also creates a positive impact on firm value.