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: their bond yields rise while prices fall and ratings deteriorate. Under-threat firms receive inferior terms when initiating new loans. These observations are more prominent in firms with weaker creditor rights protection and firms that experience more significant improvement in stock performance without accompanying real improvements. These findings are consistent with the manifestation of agency problems. Share repurchases funded by cash, investment cutbacks, and new debt issuances elevate share price, which increases the cost of intervention for activists but jeopardizes the interest of existing bondholders.

Keywords: hedge fund activism, credit market outcomes, corporate governance, shareholder-bondholder conflict

JEL Classification: G34, G32, G23, G12