Threat of Hedge Fund Activism and Risky Investment

Abstract

I study the effect of a threat of hedge fund activism on corporate investment. I find that managers are less likely to undertake acquisitions when subject to a higher threat of activism. They decrease the number of risky, value-creating acquisitions undertaken by the firm. I present evidence that the results can be explained by the manager's exposure to firm-level risk. Hedge fund activists often pursue a restructuring of the target firms, which may increase the riskiness of the firm's assets and reduce the manager's incentives to take on new risky projects. Overall, my results demonstrate that activists can create ex-ante inefficiencies by altering the incentives-risk sharing tradeoff of the manager's compensation contract.

Keywords: Corporate Governance, Hedge Fund Activism, Shareholder Activism

JEL Classification: G14, G23, G32, G34