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Hedge Funds in Corporate Governance and Corporate Control


Marcel Kahan


New York University School of Law; European Corporate Governance Institute

Edward B. Rock


University of Pennsylvania Law School


University of Pennsylvania Law Review, Vol. 155, p. 1021, 2007
U of Penn, Inst for Law & Econ Research Paper No. 06-16
NYU, Law and Economics Research Paper No. 06-37
ECGI - Law Working Paper No. 76/2006

Abstract:     
Hedge funds have become critical players in both corporate governance and corporate control. In this article, we document and examine the nature of hedge fund activism, how and why it differs from activism by traditional institutional investors, and its implications for corporate governance and regulatory reform. We argue that hedge fund activism differs from activism by traditional institutions in several ways: it is directed at significant changes in individual companies (rather than small, systemic changes), it entails higher costs, and it is strategic and ex ante (rather than intermittent and ex post). The reasons for these differences may lie in the incentive structures of hedge fund managers as well as in the fact that traditional institutions face regulatory barriers, political constraints, or conflicts of interest that make activism less profitable than it is for hedge funds. But the differences may also be due to the fact that traditional institutions pursue a diversification strategy that is difficult to combine with strategic activism.

Although hedge funds hold great promise as active shareholders, their intense involvement in corporate governance and control also potentially raises two kinds of problems: The interests of hedge funds sometimes diverge from those of their fellow shareholders; and the intensity of hedge fund activism imposes substantial stress that the regulatory system may not be able to withstand. The resulting problems, however, are relatively isolated and narrow, do not broadly undermine the value of hedge fund activism as a whole, and do not warrant major additional regulatory interventions.

The sharpest accusation leveled against activist funds is that activism is designed to achieve a short-term payoff at the expense of long-term profitability. Although we consider this a potentially serious problem that arguably pervades hedge fund activism, we conclude that a sufficient case for legal intervention has not been made. This conclusion results from the uncertainties about whether short-termism is in fact a real problem and how much hedge fund activism is driven by excessive short-termism. But, most importantly, it stems from our view that market forces and adaptive devices taken by companies individually are better designed than regulation to deal with the potential negative effects of hedge fund short-termism while preserving the positive effects of hedge-fund activism.

Number of Pages in PDF File: 73

Keywords: Corporations, Organizations, Hedge-Fund Activism, Corporate Governance, Hedge Funds, Securities Regulation, Short-Term Payoff

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Date posted: July 25, 2006 ; Last revised: May 21, 2009

Suggested Citation

Kahan, Marcel and Rock, Edward B., Hedge Funds in Corporate Governance and Corporate Control. University of Pennsylvania Law Review, Vol. 155, p. 1021, 2007; U of Penn, Inst for Law & Econ Research Paper No. 06-16; NYU, Law and Economics Research Paper No. 06-37; ECGI - Law Working Paper No. 76/2006. Available at SSRN: http://ssrn.com/abstract=919881

Contact Information

Marcel Kahan (Contact Author)
New York University School of Law ( email )
40 Washington Square South
New York, NY 10012-1099
United States
212-998-6268 (Phone)
212-995-4341 (Fax)
European Corporate Governance Institute ( email )
c/o ECARES ULB CP 114
B-1050 Brussels
Belgium
Edward B. Rock
University of Pennsylvania Law School ( email )
3501 Sansom Street
Philadelphia, PA 19104
United States
215-898-8631 (Phone)
215-573-2025 (Fax)
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