Governing Corporations with Concentrated Ownership Structure: Can Hedge Funds Activism Play Any Role in Italy?

Against all odds, hedge fund activism occurs also in companies with concentrated ownership structure where the ultimate threat of a take-over has little chance to raise any concern among controlling shareholders. After summarizing the U.S. literature on the subject, this Article provides an in-depth description of hedge fund activism in Italy, and the plausible explanations for it based on the analysis of hand-collected data. The results are further tested through a comparison with hedge fund activism in Germany based on both legal and empirical analysis. While concluding that what apparently looks to be pure activism may in fact hide some form of relational investing to the benefit of hedge funds only, the Article also discusses the rationale and functioning of minimum board representation for minority shareholders through slate voting – a uniquely distinctive feature of the Italian corporate governance system that turns out to be a key-factor in future shareholder activism with the unprecedented increasing engagement of institutional investors. This article builds on an earlier and shorter paper - Governing Corporations with Concentrated Ownership Structure: Can Hedge Fund Activism Play Any Role in Italy? - which was presented at the 2009 Annual Conferences of the Canadian Law and Economics Association, University of Toronto, October 2-3, 2009, and of the Italian Society for Law and Economics, Universita degli Studi di Firenze, December 4-5, 2009. This earlier paper is available at: http://ssrn.com/abstract=1397562.

Research Summary This article examines the antecedents and outcomes of hedge fund activism in family versus nonfamily firms. We find that activist hedge funds are less likely to initiate campaigns against family firms than nonfamily firms, but the cumulative abnormal returns to announcements of campaigns against family firms exceed those of nonfamily firms. The presence of one or more family members on a firm's board of directors appears to be a key impediment to hedge fund activism in family firms. Additionally, activist hedge funds are more likely to use hostile tactics and demand more substantive changes in their campaigns against family firms than nonfamily firms. Together, these findings contribute to the agency theory‐based literatures on hedge fund activism, family firms, boards of directors, and corporate governance. Managerial Summary Activist hedge funds are a significant force in corporate governance, driving the companies they target to change their strategies, structures, and leadership. Family firms are prevalent and economically important, accounting for a third to a half of companies worldwide. This article compares hedge fund activism in family versus nonfamily firms. Activist hedge funds are about 41% less likely to initiate campaigns against family than nonfamily firms, but the average returns to successful activist hedge fund campaigns against family firms are about 2% higher than in nonfamily firms. These effects are especially pronounced when family members serve on a company's board of directors. Furthermore, activist hedge funds are more likely to use hostile tactics and demand more substantive changes in campaigns against family than nonfamily firms.

Observing information acquisition by various market participants can yield valuable insights into the goals and strategies of investors, firms, and regulators. My dissertation uses a unique dataset, which captures 'clicks' on companies' SEC filings, to answer three questions related to hedge fund activism. First, I use activist hedge funds' views of SEC filings to proxy for negotiations between those activists and firms. I find that negotiations are common and associated with governance changes. The second essay examines the reactions of firms to elevated activist hedge fund interest. We find that firms use shareholder rights plans ('poison pills') in an effort to discourage activists' share accumulation, and that such plans are successful at decreasing the probability 13D and DEF14A filings. Finally, hedge fund activism does not occur in isolation. The third essay examines spillover effects of hedge fund activism on the emissions of the target's peer firms. We find that while hedge fund activism targets decrease their emissions, their peers increase emissions, effectively negating the direct effect. This finding is particularly strong when peers are less likely to be subject to enforcement, and face more competitive pressures. Essay 1: A portion of hedge funds' engagement can be observed through their votes and regulatory filings. However, much of their communication occurs through direct interaction with management, which is not formally recorded. I use SEC EDGAR log file data to proxy for such engagements. This proxy indeed captures hedge fund interest: one hedge fund click more than doubles the probability of an activism event. Moreover, consistent with hedge fund clicks proxying for behind-the-scenes engagement, these clicks predict corporate governance changes, for example CEO and director turnover, even in the absence of a formal activist filing. I estimate that private activism constitutes at least 31% of all hedge fund activism, and potentially as much as 89%. Private activism is particularly likely when boards have more bargaining power, as proxied by a classified board or dual class share structure, and when directors have higher reputational concerns, as proxied by these individuals having more outside board seats. Essay 2: We provide the first systematic evidence of contractual innovation in the terms of poison pill plans. In response to the increase in hedge fund activism, pills have changed to include anti-activist provisions, such as low trigger thresholds and acting-in-concert provisions. Using unique data on hedge fund views of SEC filings as a proxy for the threat of activists' interventions, we show that hedge fund interest predicts pill adoptions. Moreover, the likelihood of a 13D filing declines after firms adopt "anti-activist" pills, suggesting that pills are effective in deterring activists. The results are particularly strong for "NOL" pills that, due to tax laws, have a five percent trigger. Our analysis has implications for understanding the modern dynamics of market discipline of managers in public corporations and evaluating policies that regulate defensive tactics. Essay 3: Existing research shows that hedge fund activism decreases target firms' emissions. However, we document a negative spillover effect from hedge fund activism: hedge fund activism leads to a 1.1 percent increase in emissions by industry rivals. Evidence suggests that the increase in emissions stems from a reduction in environmentally friendly practices rather than a drop in production. The increase is larger for rival firms closer to default, with low profitability, and those operating in a competitive environment. Collectively, these results are consistent with a product market channel, where industry rivals cut environmental expenditure to compete against a more efficient target firm. Accounting for this spillover effect, an additional activism campaign, on average, leads to an increase in emissions of 135 thousand pounds at the industry level, or 0.75 percent increased emissions. Overall, our findings highlight the importance of considering spillover effects when evaluating how shareholder activism affects other stakeholders.

'Activist' Hedge Funds: Creators of Lasting Wealth? What Do the Empirical Studies Really Say?

Gone Global: The International Diffusion of Hedge Fund Activism Outside the United States

Hedge fund activism refers to the phenomenon where hedge fund investors acquire a strict minority block of shares in a target firm and then attempt to pressure management for changes in corporate policies and governance with the aim to improve firm performance. This study provides an updated empirical analysis as well as a comprehensive survey of the academic finance research on hedge fund activism. Beginning in the early 1990s, shareholder engagement by activist hedge funds has evolved to become both an investment strategy and a remedy for poor corporate governance. Hedge funds represent a group of highly incentivized, value-driven investors who are relatively free from regulatory and structural barriers that have constrained the monitoring by other external investors. While traditional institutional investors have taken actions ex-post to preserve value or contain observed damage (such as taking the “Wall Street Walk”), hedge fund activists target underperforming firms in order to unlock value and profit from the improvement. Activist hedge funds also differ from corporate raiders that operated in the 1980s, as they tend to accumulate minority equity stakes and do not seek direct control. As a result, activists must win support from fellow shareholders via persuasion and influence, representing a hybrid internal-external role in a middle-ground form of corporate governance. Research on hedge fund activism centers on how it impacts the target company, its shareholders, other stakeholders, and the capital market as a whole. Opponents of hedge fund activism argue that activists focus narrowly on short-term financial performance, and such “short-termism” may be detrimental to the long-run value of target companies. The empirical evidence, however, supports the conclusion that interventions by activist hedge funds lead to improvements in target firms, on average, in terms of both short-term metrics, such as stock value appreciation, and long-term performance, including productivity, innovation, and governance. Overall, the evidence from the full body of the literature generally supports the view that hedge fund activism constitutes an important venue of corporate governance that is both influence-based and market-driven, placing activist hedge funds in a unique position to reduce the agency costs associated with the separation of ownership and control.

The Oxford Handbook of Hedge Funds provides a comprehensive look at the hedge fund industry from a global perspective. The chapters are organized into five main parts. After the introductory chapter in Part I, Part II begins in Chapter 2 with an analysis of the main factors that have affected the operation of hedge funds. Chapter 3 explains the concept of hedge fund flows. Chapter 4 examines hedge fund manager fees and contracts. Part III focuses on different types of hedge fund strategies. The broad array of strategies are summarized in Chapter 5. Chapter 6 empirically examines the performance of hedge fund strategies. Chapter 7 compares the strategies of hedge funds to private equity funds. Chapter 8 examines hedge fund herding. Chapter 9 examines hedge fund commodity trading advisors and leverage. Chapter 10 examines financial technology in hedge fund strategies. In Part IV, hedge fund activism in the US is examined in Chapter 11. The US and international literature on hedge fund activism is reviewed in different perspectives in Chapters 12 and 13. Case studies are provided in Chapter 14. The impact of activism on large company innovation is discussed in Chapter 15. In Part V, Chapter 16 examines whether hedge funds may engage in misreporting and fraud. Chapter 17 reviews work on hedge fund misconduct and detection. Chapter 18 discusses compliance among hedge funds. Chapter 19 examines theoretical approaches to hedge fund regulation. Chapter 20 examines optimal taxation. Chapter 21 examines hedge funds from a political economy context.

Hedge funds and private equity increasingly play an important role in the financial services industry and corporate governance in Europe and the United States. Activist hedge funds and private equity firms have developed similar investment strategies that are designed to influence the corporate governance and organisational structure of publicly listed companies. A large number of hedge funds, for example, have adopted an investment strategy to accumulate large positions in publicly listed companies, using their ownership positions to engage in monitoring of management. Activist hedge funds often make direct interventions in the corporate governance of target firms, confronting management teams by demanding specific actions, such as changes in management, company capital structure, dividend policy and company strategy, in order to increase shareholder value. The investment strategy of private equity buyout funds is to target publicly listed companies which they can take private for a period of restructuring and governance changes. Eventually, the firm will either be returned as a publicly listed company or be sold to a strategic buyer or another investor. Activist hedge funds and private equity firms have recently come under scrutiny by regulators who are concerned about the effect of the strategies used by these funds on the companies in which they invest and the capital markets in which they operate. Existing accounts focus on the mechanisms in corporate law, taxation and labour law to address current practices of hedge fund and private equity firm managers. We examine the circumstances where direct government regulation could be supplemented with a mix of self-regulatory and co-regulatory strategies. We conclude by analysing the various regulatory responses to the propensity of activist hedge funds and private equity firms to act in concert and assess whether the reforms will have practical significance.

Hedge funds have gained significant importance in capital markets across the world and are a subject of constant media attention. However, due to the limited regulatory and disclosure requirements for hedge funds, there is a need for better understanding of these investment vehicles that have become a significant part of the financial services industry. The five articles in this special issue are aimed towards achieving this objective. These articles cover important topical areas related to hedge funds including response of hedge funds to recent financial crisis, modeling the risk-adjusted performance of hedge funds, role of hedge funds in corporate governance, design of optimal compensation contract for hedge fund managers, and examination of hedge funds’ activities in the primary lending market. I am now going to briefly describe each of the articles included in this issue. In the first paper titled “The Financial Crisis and Hedge Fund Returns”, author Nicolas P.B. Bollen asks an important question: Can we learn something about the onset of financial crisis from the changes in strategies and cross-sectional return distribution of hedge funds? Bollen finds intriguing answers to this question. There is a substantial increase in the explanatory power from linear factor models during the crisis period for two reasons. First, hedge funds move away from idiosyncratic strategies to investing in more liquid assets using traditional investment strategies. Second, there is an increase in the correlation across different asset markets in the wake of the financial crisis. Moreover, Bollen shows discontinuity in hedge fund returns, suggesting that funds avoid reporting losses during the financial crisis to prevent large-scale withdrawal by investors. The findings in this paper should be important in understanding the systemic risk and operational risk associated with hedge fund activities.

Intense Hedge Fund Activists

Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value?

Hedge Funds and Governance Targets

This study seeks to extend hedge fund activism research to a country where the ownership structure is dominated by large major shareholders. Until now, studies about hedge fund activism mainly treated countries with dispersed ownership structures. Using an event study with 133 German hedge fund events between January 2000 and April 2008, we found that hedge fund activism shows significant positive short–term abnormal returns, which do not hold in the long term. It showed that family shareholders have a significant influence on the success of hedge fund activism. Moreover, it could be measured that hedge fund activism is especially successful if it tries to force the company to sell assets. This study provides empirical support for the influence of the ownership structure on the success of hedge fund activism. It indicates that large major shareholders impact hedge fund activism.

Activist Directors and Agency Costs: What Happens When an Activist Director Goes on the Board?

Hedge Fund Activism and Long-Term Firm Value