Hedge Fund Activism in the Corporate Bond Market: Evidence from Bondholderss Responses to Delay in Financial Reporting

Abstract

We investigate hedge fund activism in the corporate bond market. The empirical setting we use is the active enforcement of bondholders’ rights during 2003-07 triggered by issuers’ violation of a standard bond covenant requiring timely financial reporting. Specifically, we examine differences in target company characteristics, strategic trading behavior, and subsequent outcomes between hedge-fund-involved and non-hedge-fund-involved interventions. We find that hedge-fund-involved interventions are more likely to target companies with higher levels of cash holdings, but less likely to target companies with a higher bankruptcy probability and greater amount of private debt outstanding. Meanwhile, the late filers in hedge-fund-involved interventions are more likely to have liquid bonds and their later filings are more likely to be predicted (e.g., triggered by option backdating investigations). The empirical evidence from strategic trading and market reactions suggests that hedge-fund-involved interventions are associated with elevated bond trading frequency before late filing notifications and a wealth transfer from stockholders and non-intervening bondholders to intervening bondholders. However these results are not present for non-hedge-fund-involved interventions. Taken together, the empirical evidence suggests that hedge fund activism in the corporate bond market is primarily driven by short-term profit consideration.