Caught in the Crossfire: How the Threat of Hedge Fund Activism Affects Creditors

Abstract

Firms under the threat of hedge fund activism on average experience significant losses of outstanding bondholder wealth: bond yield and default probability rise while price drops and ratings deteriorate. They receive inferior terms when initiating new loans. The observed patterns are more prominent in firms with weak creditor rights protection, high leverage, and significant improvement in stock performance without accompanying real improvements. These findings are consistent with the manifestation of agency conflicts. Share repurchases funded by cash, asset sales, and new debt issuance elevate share price, increasing the cost of intervention for activists but jeopardizing the interest of existing bondholders.

Keywords: Hedge fund activism, corporate governance, shareholder-bondholder conflict

JEL Classification: G34, G23, G32, G12