Why is Hedge Fund Activism Procyclical?

Burkart, Mike; Dasgupta, Amil

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Why is Hedge Fund Activism Procyclical?

CEPR Discussion Paper No. DP9409

29 Pages Posted: 3 Apr 2013

See all articles by Mike Burkart

Mike Burkart

Swedish House of Finance; London School of Economics and Political Science, Department of Finance; Finance Theory Group (FTG); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Amil Dasgupta

London School of Economics (LSE); European Corporate Governance Institute (ECGI)

There are 2 versions of this paper

Date Written: March 2013

Abstract

We provide a theoretical model to explain the procyclicality of hedge fund activism. In our model, hedge funds which compete to retain investor flows excessively increase the net leverage of target firms in order to deliver high short-term payouts and signal their ability. Such excessive leverage leads to debt overhang in economic downturns, thereby destroying incentives for activism and engendering procyclicality. Our model thus provides a theoretical explanation that links the procyclicality of hedge fund activism with increases in the leverage or payouts ratios of target firms. In addition, the model generates several new testable implications and reconciles seemingly contradictory evidence on the wealth effects of activism for shareholders and bondholders.

Keywords: Career concerns, Corporate governance, Hedge funds, Shareholder activism

JEL Classification: G23, G34

Suggested Citation: Suggested Citation

Burkart, Mike C. and Dasgupta, Amil, Why is Hedge Fund Activism Procyclical? (March 2013). CEPR Discussion Paper No. DP9409, Available at SSRN: https://ssrn.com/abstract=2244089