Corporate Governance and the New Hedge Fund Activism: an Empirical Analysis

Abstract

Hedge funds are not "normal" institutional investors. They launch proxy fights for corporate control. Their recent successes and "wolf pack" tactics have garnered headlines, but leave us with a question: what does hedge fund activism mean for corporate governance in the United States? This Article undertakes a legal, empirical, and theoretical study in an effort to answer this question. The heart of the Article is an empirical study of obtainable instances of hedge fund activism during 2005 and the 2006 proxy season. The Article starts by showing that the SEC opened the door to hedge fund activism when it stopped censoring most proxy material in 1992 and started allowing proxy "free communication" in 2000. The Article's empirical survey found over 50 instances of hedge fund activism, and also found the in terrorem effect of these examples to be considerable. The survey further found that the combination of "wolf pack" tactics and the increasing influence of activist proxy advisory firms (the recommendations of which many institutional investors follow automatically) have made hedge fund activists a real power in corporate governance. Despite some claims that hedge funds often hold short positions or are otherwise dangerously conflicted, the survey found very limited evidence for this; the survey also found that hedge funds have, in fact, disclosed these conflicts, though the proxy and Williams Act rules in this respect should be clarified. The Article then subjects these results to theoretical analysis using current nexus of contracts, shareholder primacy, director primacy, team production, connected contracts, and other theories, and finds none completely satisfactory. The Article concludes that an almost unprincipled balance-of-power political model best explains the hedge fund activism phenomenon. In the end, if these activities cause managements to review and reassess their strategies, corporate governance is improved.

Keywords: Corporation and Securities Law

JEL Classification: K22