Hedge Fund Activism and Internal Capital Markets

Abstract

Hedge fund activism improves the internal capital allocation efficiency of multi-division firms. Targeted conglomerates increase segment investment while reducing each division's reliance on its own cash flow, primarily for divisions with the best investment opportunities within the firm. Consequently, the sensitivity of a division's investment to its own cash flow becomes similar to its sensitivity to cash flows from other divisions. Such changes are stronger when the firm is ex-ante financially constrained, and when the CEO is replaced or payout is increased soon after being targeted. These effects persist in the long-run and are accompanied by diminished diversification discounts.

Keywords: Hedge Fund, Hedge Fund Activism, Shareholder Activism, Corporate Governance, Internal Capital Market, Resource Allocation, Diversification

JEL Classification: G23, G31, G32, G34