Governance by Persuasion: Hedge Fund Activism and Market-based Shareholder Influence

137 Pages Posted: 3 Nov 2021 Last revised: 10 Jan 2022

See all articles by Alon Brav

Alon Brav

Duke University - Fuqua School of Business; European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Wei Jiang

Emory University Goizueta Business School; ECGI; NBER

Rongchen Li

Columbia University - Columbia Business School

Date Written: December 10, 2021

Abstract

Hedge fund activism refers to the phenomenon where hedge fund investors acquire a strict minority block of shares in a target firm and then attempt to pressure management for changes in corporate policies and governance with the aim to improve firm performance. This study provides an updated empirical analysis as well as a comprehensive survey of the academic finance research on hedge fund activism. We review the development, current state, and potential future trends beginning with the institutional background in which hedge fund activists operate, activists' objectives, tactics, and the selection of target companies. Various firm outcomes are also discussed, with a focus on the financial and operating performance of targeted firms, the dynamics of engagement with fellow investors, and the impact on other stakeholders.

Beginning in the early 1990s, shareholder engagement by activist hedge funds has evolved to become both an investment strategy and a remedy for poor corporate governance. Hedge funds represent a group of highly incentivized, value-driven investors who are relatively free from regulatory and structural barriers that have constrained the monitoring by other external investors. While traditional institutional investors have taken actions ex post to preserve value or contain observed damage (such as taking the "Wall Street Walk"), hedge fund activists target under-performing firms in order to unlock value and profit from the improvement. Activist hedge funds also differ from corporate raiders that operated in the 1980s, as they tend to accumulate strict minority equity stakes and do not seek direct control. As a result, activists must win support from fellow shareholders via persuasion and influence, representing a hybrid internal-external role in a middle-ground form of corporate governance.

Research on hedge fund activism performed and reviewed in this study centers on how it impacts the target company, its shareholders, other stakeholders, and the capital market as a whole. Opponents of hedge fund activism argue that activists focus narrowly on short-term financial performance, and such "short-termism" may be detrimental to the long-run value of target companies. The empirical evidence, however, supports the conclusion that interventions by activist hedge funds lead to improvements in target firms, on average, in terms of both short-term metrics, such as stock value appreciation, and long-term performance, including productivity, innovation, and governance.

Overall, the evidence from the full body of the literature generally supports the view that hedge fund activism constitutes an important venue of corporate governance that is both influence-based and market-driven, placing activist hedge funds in a unique position to reduce the agency costs associated with the separation of ownership and control.

Keywords: Hedge funds, shareholder activism, corporate governance, institutional investors

JEL Classification: G14, G23, G3, K22

Suggested Citation

Brav, Alon and Jiang, Wei and Li, Rongchen, Governance by Persuasion: Hedge Fund Activism and Market-based Shareholder Influence (December 10, 2021). European Corporate Governance Institute – Finance Working Paper No. 797/2021, Available at SSRN: https://ssrn.com/abstract=3955116. or http://dx.doi.org/10.2139/ssrn.3955116

Alon Brav (Contact Author)

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Durham, NC 27708-0120
United States
919-660-2908 (Phone)
919-684-2818 (Fax)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Wei Jiang

Emory University Goizueta Business School ( email )

1300 Clifton Rd
Atlanta, GA 30322
United States

ECGI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Rongchen Li

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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