Abstract
This paper investigates whether activist investors' focus on short-term stock prices impedes their role in improving corporate governance. The model builds on the notion that both the act of intervention and the threat of an intervention can generate value for the target firm. While the effect of the activist's threat on the manager's effort and the expected firm value is increasing in the activist's ability, we demonstrate that an activist intervenes excessively when her ability to conduct a value-enhancing intervention is low, but intervenes insufficiently if her ability is high. Moreover, we show that an activist with higher ability finds it optimal to acquire stakes in multiple firms even when her capacity to conduct intervention is limited. While targeting multiple firms dilutes the effect of the activist's threat on each manager, it improves a skilful activist's profit by forcing her to substitute reduced managerial effort with more value-enhancing interventions in equilibrium, alleviating the problem of insufficient intervention. Finally, when facing an activist with low ability, short-term stock-based compensation to the manager disincentivizes effort. Activist short-termism reduces such perverse effect.
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