Costly Communication, Shareholder Activism, and Limits to Arbitrage

51 Pages Posted: 7 Nov 2005

See all articles by Michael Bradley

Michael Bradley

Duke University - Fuqua School of Business

Alon Brav

Duke University - Fuqua School of Business

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Wei Jiang

Columbia Business School - Finance and Economics

Date Written: November 2005

Abstract

Using a unique hand-collected dataset, we show that shareholder activism designed to open U.S. based closed-end funds has become more frequent since the SEC's reform of the proxy rules in 1992 (the 1992 Reform) that lifted restrictions on shareholder communication. We denote this activity activist arbitrage and distinguish it from the standard pure trading arbitrage. We document a dual relationship between activist arbitrage and funds' discounts: a high discount increases the probability of activist arbitrage, while a high probability of ex post activist arbitrage reduces the ex ante discount. We provide evidence that the ease of shareholder communication is a major determinant for the emergence of activist arbitrage. This holds for the time series - activist arbitrage has become much more common following the 1992 Reform - as well as for the cross section - activist arbitrage is more likely in funds that exhibit low costs of communication. Overall, our results provide direct evidence of the presence of arbitrage activities, but also demonstrate how costly communication leads to limits on arbitrage.

Keywords: Limits to Arbitrage, Communication, Shareholder Activism, Closed-End Funds

JEL Classification: G12, G23, G39

Suggested Citation

Bradley, Michael and Brav, Alon and Goldstein, Itay and Jiang, Wei, Costly Communication, Shareholder Activism, and Limits to Arbitrage (November 2005). AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=838165 or http://dx.doi.org/10.2139/ssrn.838165

Michael Bradley

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-8006 (Phone)
919-660-7971 (Fax)

Alon Brav

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-2908 (Phone)
919-684-2818 (Fax)

Itay Goldstein (Contact Author)

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Wei Jiang

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

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