Myopic Investor Myth Debunked: The Long-term Efficacy of Hedge Fund Activism in the Boardroom Shane Goodwin Spears School of Business Oklahoma State University Ramesh Rao Spears School of Business Oklahoma State University Abstract Over the past two decades, hedge fund activism has emerged as new form of corporate governance mechanism that brings about operational, financial and governance reforms to a corporation. Many prominent business executives and legal scholars are convinced that the American economy will suffer unless hedge fund activism with its perceived short-termism agenda is significantly restricted. Shareholder activists and their proponents claim they function as a disciplinary mechanism to monitor management and are instrumental in mitigating the agency conflict between managers and shareholders. We find statistically meaningful empirical evidence to reject the anecdotal conventional wisdom that hedge fund activism is detrimental to the long term interests of companies and their long term shareholders. Moreover, our findings suggest that hedge funds generate substantial long term value for target firms and its long term shareholders when they function as a shareholder advocate to monitor management through active board engagement. JEL Classifications: D21, D22, D81, G12, G23, G32, G34, G35, G38, K22 Advocacy Shareholder
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Myopic Investor Myth Debunked:
The Long-term Efficacy of Hedge Fund Activism
in the Boardroom
Shane Goodwin
Spears School of Business
Oklahoma State University
Ramesh Rao
Spears School of Business
Oklahoma State University
Abstract
Over the past two decades, hedge fund activism has emerged as new form of corporate
governance mechanism that brings about operational, financial and governance reforms to a
corporation. Many prominent business executives and legal scholars are convinced that the
American economy will suffer unless hedge fund activism with its perceived short-termism
agenda is significantly restricted. Shareholder activists and their proponents claim they function
as a disciplinary mechanism to monitor management and are instrumental in mitigating the
agency conflict between managers and shareholders. We find statistically meaningful empirical
evidence to reject the anecdotal conventional wisdom that hedge fund activism is detrimental to
the long term interests of companies and their long term shareholders. Moreover, our findings
suggest that hedge funds generate substantial long term value for target firms and its long term
shareholders when they function as a shareholder advocate to monitor management through
Leo Strine, Chief Justice of the Delaware Supreme Court
Columbia Law Review, March 2014
Leo Strine, the Chief Justice of the Delaware Supreme Court, the country’s most
important arbiter of corporate law recently authored a 54-page article in the Columbia Law
Review with respect to his views about hedge funds and his belief that short-term investors are
detrimental to the long-term interests of American corporations, its long-term shareholders and
to society as a whole. Chief Justice Strine, many prominent business executives and legal
scholars are convinced that the American economy will suffer unless hedge fund activism with
its perceived short-termism agenda is significantly restricted. Shareholder activists and their
proponents claim they function as a disciplinary mechanism to monitor management and are
instrumental in mitigating the agency conflict between managers and shareholders.
In May 2014, the Delaware Court of Chancery denied Third Point, a well-known activist
hedge fund, the ability to increase its ownership above 10% in Sotheby’s. Third Point, the
company’s largest shareholder, sent a letter to Sotheby’s CEO in October 2013 expressing
concerns regarding the company’s strategic direction, shareholder misalignment and
recommended replacing the CEO. In response, Sotheby’s adopted a unique two-tier shareholder
rights plan1 (a poison pill) that purposely discriminated and severely punished any shareholder
that might have an agenda that conflicts with incumbent management2. Although the court
1 A shareholder rights plan, also known as a “poison pill”, is one of the most effective defense tactics available to publicly traded
corporations. A poison pill is designed to make a potential transaction extremely unattractive to a hostile party from an economic
perspective, compelling a suitor to negotiate with the target’s Board of Directors. A poison pill is effective because it dilutes the
economic interest of the hostile suitor in the target, making the transaction both economically unattractive and impractical if
pursued on a hostile basis. 2 The two-tier structure provided for a 10 percent trigger threshold for shareholders filing a Schedule 13D (for “active” investors)
and a 20 percent trigger for shareholders filing a Schedule 13G (available to “passive” investors). The rights plan also contained
a “qualifying offer” exception, which provided that the plan would not apply to an offer for all of Sotheby’s shares and expires in
one year unless it is approved by a shareholder vote.
2
viewed the two-tier trigger structure as “discriminatory” — differentiating between activist and
passive investors — the court found that Sotheby’s had a reasonable basis to believe that Third
Point posed a threat of exercising disproportionate control and influence over major decisions.
The court reached its decision notwithstanding the support from other large shareholders for
Third Point and despite the fact that Sotheby’s management and board owned less than 1% of the
company. Ironically and inexplicably, the court’s decision de facto authorized the incumbent
CEO and the board disproportionate control and influence over major decisions, notwithstanding
the objections of its shareholders.
Vice Chancellor Donald Parsons, Jr. stated in his opinion “…it’s important not to
overstate the way in which shareholders that file Schedule 13Ds differ from those who file
Schedule 13Gs.” The rationale for this decision coupled with the recent remarks by Chief Justice
Strine raise important policy questions about the value of hedge fund activism and its
disciplinary role as an active monitor of a firm’s management. In this paper, we suggest and
empirically test the following alternative hypothesis: hedge fund activism through board
representation is not detrimental to the long term operating performance of companies and does
not have an adverse effect on the target firm’s long term shareholders.
Agency conflict in publicly traded corporations with dispersed ownership is at the heart
of corporate governance literature, which focuses on mechanisms to discipline incumbent
management. One possible solution to mitigate agency cost is for shareholders to actively
monitor the firm’s management. However, while monitoring may reduce agency and improve
firm value, this effort is not without cost and the benefits from monitoring are enjoyed by all
shareholders (Grossman and Hart, 1980).
Shareholders that serve as active monitors of firm management to provide a disciplinary
mechanism is not a new concept. Earlier studies show that when institutional investors,
particularly mutual funds and pension funds, follow an activist agenda, they do not achieve
3
significant benefits for shareholders (Black (1998), Karpoff (2001), Romano (2001), and Gillan
and Starks (2007)). However, hedge funds have increasingly engaged in shareholder activism
and monitoring that differs fundamentally from previous activist efforts by other institutional
investors. Unlike mutual funds and pension funds, hedge funds are able to influence corporate
boards and managements due to key differences arising from their organizational form and the
incentive structures.
Hedge funds employ highly incentivized managers who manage large unregulated pools
of capital. Because they are not subject to regulation that governs mutual funds and pension
funds, they can hold highly concentrated positions in a small number of companies, and use
leverage and derivatives to extend their reach. In addition, hedge fund managers don’t
experience conflicts of interest since they are not beholden to the management of the firms
whose shares they hold. In sum, hedge funds are better positioned to act as informed monitors
than other institutional investors.
The growing literature with respect to shareholder activism identifies a significant
positive stock price reaction for targeted companies with the announcement of an activist
intervention ((Brav, Jiang and Kim, 2009), Clifford (2008) and Boyson and Mooradian (2011)).
Many critics of hedge fund activism concede that there are short-term positive value increases to
the target firm and its shareholders as a result of self-interested “myopic investors”. While this
“myopic investor” claim has been regularly invoked and has had considerable influence, its
supporters, including Chief Justice Strine, have thus far failed to support their position with
empirical evidence. However, the continued debate is about the long term efficacy on target
firms and the returns to all shareholders as result of hedge fund activism. Recent research by
Bebchuk, Brav and Jiang (2013) find statistically meaningful evidence that the operating
performance of target firms improves following activist interventions but no evidence to support
the claim that short-term improvement was at the expense of long-term performance.
4
The dataset used by Bebchuk, Brav and Jiang (2013) is consistent with the vast majority
of research with respect to shareholder activism. The sample of activist interventions is
primarily constructed from Schedule 13D filings, the mandatory federal securities law filings
under Section 13(d) of the 1934 Exchange Act. The law states that investors must file with the
SEC within 10 days of acquiring more than 5% of any class of securities of a publicly traded
company if they have an interest in influencing the management of the company. The
presumption is a shareholder that files a 13D is unequivocally motivated to change the strategic
direction of the company. However, we claim that is not always the case. In fact, some activist
campaigns are centered on corporate governance reforms (i.e., board declassification, removal of
shareholder rights plan, etc.) and not meaningful long-term strategic changes to the target firm.
We contend that any shareholder with sincere conviction to challenge the current strategic
direction of a firm would, ultimately, seek board representation if their demands were not
supported by the firm’s incumbent management. We view board representation as a signal of an
activist’s long term commitment to the firm. Additionally, board representation is a costly
endeavor that is not borne by all shareholders which further validates the activist’s credibility as
a long term shareholder of the firm.
The vast majority of shareholder activism literature is predicated on Schedule 13D
filings. However, we assert that the optimal dataset to empirically test the long-term effects of
shareholder activism should be based on board representation of target firms by a shareholder
activist. Therefore, we started with a much more expansive sample of activist interventions.
Figure I illustrates our comprehensive dataset of shareholder activist events, which includes
5,063 interventions from 1984-2013. Of those, 3,899 (77%) filed a 13D. However,
approximately 32% of all activist interventions were focused on board engagement, either
through a proxy contest (1,216) or a non-proxy contest dissident campaign that resulted in board
representation via private negotiations (418) with the target management team and its board of
5
directors. To be sure, over two-thirds (2/3) of activist interventions did not seek board
representation to actively monitor management. Moreover, GAMCO Asset Management, a
hedge fund founded by Mario Gabeli, has filed 478 13Ds since 1996. However, it has launched
only 18 proxy fights (3.8%) and won board representation only ten times (2.1%) to date. In
contrast, Carl Icahn has launched proxy fights and won board representation at eBay, Genzyme,
Time Warner and Yahoo! without filing a 13D.
Accordingly, we claim that there are numerous 13D filings of activist interventions that
otherwise include good performing companies with strong management that a dissident was not
compelled to seek board representation to actively monitor management and function as a
disciplinary mechanism. Additionally, there are over 90 activist interventions that led to board
representation without filing a 13D. Therefore, we assert that the optimal dataset to test
empirically the long-term effects of hedge fund activism should be based on board
representation of target firms by a shareholder activist and not merely the fact that a shareholder
crossed 5% ownership and might (not will) seek to influence strategic change at the target firm.
To be sure, an activist that is willing to incur significant financial cost that is not borne by all
shareholders, which Gantchev (2012) estimates is approximately $10 million per proxy contest,
has genuine conviction that the target firm requires strategic change that management is
unwilling to execute without shareholder interference.
We empirically test our manually constructed dataset of 448 activist interventions (the
“Treatment Group”) that resulted in at least one board seat granted to an activist hedge fund from
1996-2013 (see Table 1). A total of 843 board members (see Table 1) were elected at 398
unique target companies. This includes 225 unique activist hedge funds. Of the 448 activist
interventions in the Treatment Group, 243 (54%) target firms are still publicly-listed, 186 (42%)
were sold/merged and 19 (4%) target firms filed for bankruptcy. By compiling our own
6
database, we avoid some problems associated with survivorship bias, reporting selection bias,
and backfill, which are prevalent among other hedge fund databases.
To control for self-selection bias and endogeneity, we constructed a control group (the
“Control Group”) of all proxy fights campaigns that did not result in board representation during
the same period. Our dataset includes 595 target firms that experienced a proxy contest for
board representation. After we excluded certain events to reflect consistent sample parameters
with our Treatment Group, our Control Group includes 73 firms that were involved in a proxy
contest that the target firm incumbent management defeated the dissident shareholder during the
voting process. Therefore, we examined not only firms that granted at least one board seat to a
dissident shareholder and its ex post effects (the “Treatment Group”), but also companies that
were challenged by dissatisfied shareholders and did not suffer the ex post disciplinary effects by
the dissident (the “Control Group”).
During our investigation of abnormal returns during the review period, we employed
three standard methods used by financial economists for detecting stock return
performance. In particular, the study examines: first, whether the returns to targeted companies
were systematically lower than what would be expected given standard asset pricing models;
second, whether the returns to targeted companies were lower than those of the Control Group
that experienced a similar event; and, third, whether a portfolio based on taking positions in
activism targets and holding them for five years post the board seat grant date underperforms
relative to its risk characteristics. Additionally, we modeled an 18-year (1996-2013) buy-and-
hold abnormal returns (BHAR) portfolio of all shareholder activist interventions that resulted in
board representation and controlled for market risk, firm size and value tilt relative to the
Control Group.
Using the aforementioned financial and econometric models, we find no evidence that
target firms experience a “reversal of fortune” during the five-year period following the
7
intervention. The long-term underperformance asserted by supporters of the myopic activism
claim, and the resulting losses to long-term shareholders due to activist interventions, are not
found in the data.
Moreover, we find target firms that granted at least one board seat to an activist hedge
fund created positive abnormal returns (alpha) for all shareholders during short term event
windows and for a five year period ex post the activist joining the target firm board.
Additionally, those target firms increased certain operating performance measures that are
commonly used by financial economists, such as return on assets (ROA) and market value
relative to book value (Tobin’s Q) during the post event period. Further, the assertion that
myopically-focused activist investors only create value in the short-term at the expense of long-
term shareholders is not supported by the data. In fact, target firms that granted at least one
board seat to an activist hedge fund outperformed the Control Group with respect to firm
operating measures and positive abnormal returns for all shareholders during the five years ex
post the activist joining the board.
We find that target firms in our sample dataset underperformed their industry peers on
certain operating metrics prior to the activist intervention, which validates the value-oriented
characteristics of activist targets. However, those operating metrics progressively improved
during the review period subsequent to the board seat grant date. This is further evidence that
board representation by activist hedge funds lead to improved operating performance in the long
term. In contrast, target firms that won the proxy fight against the activist experienced
degradation in certain operating performance metrics compared to industry peers during the
review period.
Contrary to certain extant literature and to the prevailing narrative that activist hedge
funds frequently promote a “sell the company” agenda, we find that activists who seek board
representation do not promote such an objective. However, within two years of the dissident
8
shareholder joining the board, the CEO of the target firm had been replaced approximately 30%
of the time. Therefore, it is reasonable to assume from the data that hedge funds that seek board
representation are focused more on promoting change at the target firm via operating
improvements and changes to existing management rather than supporting a sale of the company
strategy. Our investigation and findings support the alternative hypothesis that hedge fund
activism is not detrimental to and does not have an adverse-effect on the long term interests of
target firms and their long term shareholders (see Graph 1 and Graph 2).
Our research fills the important void with respect to the long term efficacy of shareholder
activists serving as a disciplinary mechanism on the firm by actively seeking board
representation to monitor management. Additionally, we contribute to the literature regarding
shareholder activists as self-interested myopic investors at the expense of the long-term interest
of the company and its long term shareholders. Moreover, our findings have important policy
implications related to the ongoing debate on corporate governance and the rights and roles of
shareholders. Although some prominent legal commentators and presiding justices, such as
Chief Justice Strine, have called for restrictions on hedge fund activism because of its perceived
short-term orientation, our findings suggest that hedge fund activism generates substantial long
term value for target firms and its long term shareholders when they function as a shareholder
advocate to monitor management through active board engagement.
9
II. LITERATURE REVIEW
In this section, we review the extant literature with respect to shareholder activism. First,
we evaluate why shareholder activists are the optimal group to be effective monitors of firm
management to mitigate agency cost. Second, we will discuss why active board engagement is
the preferred path to create value rather than through passive shareholder proposals. Finally, we
will discuss how shareholders can intervene to effect change at a corporation via a proxy contest.
The separation of ownership and control in public firms gives rise to the possibility of
agency conflict between the firm’s managers and shareholders (Berle and Means (1932) and
Jensen and Meckling (1976)). To the extent that this agency cost is significant, it can have a
detrimental effect on shareholder value. The agency problem in publicly traded corporations
with dispersed ownership is at the heart of corporate governance literature, which focuses on
mechanisms to discipline incumbent management. One possible solution to mitigate agency cost
is for shareholders to actively monitor the firm’s management. However, while monitoring may
reduce agency and improve firm value, this effort is not without cost and the benefits from
monitoring are enjoyed by all shareholders (Grossman and Hart, 1980).
Shareholders that serve as active monitors of firm management to provide a disciplinary
mechanism is not a new concept. Gillan and Starks (2007) define shareholder activists as
“investors who, dissatisfied with some aspect of a company’s management or operations, try to
bring about change within the company without a change in control.” Tirole (2006) provides the
following definition: “Active monitoring consists in interfering with management in order to
increase the value of the investors’ claims.”
However, hedge funds have increasingly engaged in shareholder activism and monitoring
that differs fundamentally from previous activist efforts by other institutional investors. Earlier
10
studies show that when institutional investors, particularly mutual funds and pension funds,
follow an activist agenda, they do not achieve significant benefits for shareholders (Black
(1998), Karpoff (2001), Romano (2001), and Gillan and Starks (2007)). Unlike mutual funds
and pension funds, hedge funds are able to influence corporate boards and managements due to
key differences arising from their organizational form and the incentive structures.
Hedge funds employ highly incentivized managers who manage large unregulated pools
of capital. Because they are not subject to regulation that governs mutual funds and pension
funds, they can hold highly concentrated positions in a small number of companies, and use
leverage and derivatives to extend their reach. In addition, hedge fund managers don’t
experience conflicts of interest since they are not beholden to the management of the firms
whose shares they hold. In sum, hedge funds are better positioned to act as informed monitors
than other institutional investors.
Theory predicts that large shareholders should be effective monitors of the managers of
publicly listed firms, reducing the free-rider problem ((Shleifer and Vishny (1986) and Grossman
and Hart (1980)). Yet the evidence that large shareholders increase shareholder value is mixed.
In two recent surveys, Karpoff (2001) and Romano (2001) conclude that activism conducted by
large institutional shareholders (i.e., pension funds and mutual funds) has had little impact on
firm performance. Additionally, Karpoff, Malatesta, and Walkling (1996), Wahal (1996), and
Gillan and Starks (2000) report no persuasive evidence that shareholder proposals increase firm
values, improve operating performance or even influence firm policies. Therefore, hedge funds
are the best positioned to function as a shareholder advocates to monitor management through
active board engagement.
Brav, Jiang, Partnoy, and Thomas (2008) find that the announcement of hedge fund
11
activism generates abnormal returns of more than 7% in a short window around the
announcement. In addition, the authors document modest changes in operating performance
around the activism. Klein and Zur (2009) and Clifford (2007) also document significant
positive abnormal returns around the announcement of activism. Recent research by Bebchuk,
Brav and Jiang (2013) find statistically meaningful evidence that the operating performance of
target firms improves following activist interventions but no evidence to support the claim that
short-term improvement was at the expense of long-term performance.
When shareholders are dissatisfied with the performance of a corporation and its’ board
of directors, they can intervene via a proxy contest. The proxy contest process is a meticulously
regulated election mechanism which can be invoked when “one group, referred to as ‘dissidents’
or ‘insurgents’ attempt to obtain seats on the firm’s board of directors currently in the hands of
another group, referred to as ‘incumbents’ or ‘management’” (Dodd and Warner, 1983).
The objective is to displace incumbents with the dissidents’ preferred candidates in order
to bring about an overall improvement in enterprise financial performance and shareholder value.
Although dissident shareholders do not always obtain a majority of board seats, in many cases
they manage to capture some seats. Notwithstanding proxy contest outcome, there is evidence
that share price performance is positively and significantly associated with the proxy contest
process (Dodd and Warner, 1983).
Within three years of a proxy contest event, many publicly held firms experience major
changes including resignations of top management within one year of the contest followed by
sale or liquidation of the firm. Proxy contest shareholder gains derive largely from the dissident
linked sale of the corporation (DeAngelo and DeAngelo, 1989). These findings are consistent
with our investigation. Within two years of a dissident shareholder joining the board of a target
12
firm, the CEO resigned approximately 30% of the time and over the course of the five years 21%
of our target firms were sold/merged.
Mulherin and Poulsen (1998) determined that “on average, proxy contests create value.”
Research confirms that the bulk of shareholder wealth gains arise from firms that are acquired in
the period surrounding the contest. In contrast, management turnover in firms that are not
acquired results in a significant and positive effect on stock owners’ value proposition because
organizations engaged in management change out are more inclined to re-structure following a
proxy contest event.
The rate of management turnover for proxy contest challenged firms is much higher
compared to organizations not involved in proxy contest activity and is directly proportional to
the share of seats at the board won by proxy contenders. When the majority of seats are won by
proxy contesters, the highest management turnover is observed reflecting the importance of
intangible issues such as job security (Yen and Chen, 2005).
Bebchuk, Brav and Jiang (2013) found that contrary to the claim that hedge fund activists
adversely impact the long-term interests of organizations and their shareholders, there is
evidence that activist interventions lead to improved operating performance in the five years that
follow the interventions. Venkiteshwaran, Iyer and Rao (2010) conducted a detailed study of
hedge fund activist Carl Icahn’s 13D filings and subsequent firm performance and found
significant share price increases for the target companies (of about 10%) around the time Icahn
discloses his intentions publicly. Additionally, the author’s found a significant number (1/3) of
Icahn’s targets ended up being acquired or taken private within 18 months of his initial
investment. The shareholders of those companies earned abnormal returns of almost 25% from
the time of Icahn’s initial investment through the sale of the company. This finding is consistent
13
with the DeAngelo and DeAngelo (1989) research that shareholder gains derive largely from the
dissident linked sale of the corporation.
Our research fills the important void with respect to the long term efficacy of shareholder
activists serving as a disciplinary mechanism on the firm by actively seeking board
representation to monitor management. Additionally, we contribute to the literature regarding
shareholder activists as self-interested myopic investors at the expense of the long-term interest
of the company and its long term shareholders. Moreover, our findings have important policy
implications related to the ongoing debate on corporate governance and the rights and roles of
shareholders. Our findings suggest that hedge fund activism generates substantial long term
value for target firms and its long term shareholders when they function as a shareholder
advocate to monitor management through active board engagement.
14
III. DATA AND METHODOLOGY
There is no central database of activist hedge funds. Therefore, we constructed an
independent dataset of all activist interventions from 1984-2013 from various sources,
including Compustat, Capital IQ, FactSet, ISS Proxy Data, SharkRepellent and the SEC’s
EDGAR database. Additionally, our dataset includes Schedule 13D filings, the mandatory
federal securities law filings under Section 13(d) of the 1934 Exchange Act that investors must
file with the SEC within 10 days of acquiring more than 5% of any class of securities of a
publicly traded company if they have an interest in influencing the management of the
company. Our manually constructed database of shareholder activist events includes 5,063
interventions from 1984-2013 (see Figure I). Similar to Gillan and Starks (2007), we define
shareholder activist event as a purposeful intervention by “investors who, dissatisfied with some
aspect of a company’s management or operations, try to bring about change within the company
without a change in control.”
Our data collection comprised a multi-step procedure. The vast majority of shareholder
activism literature is predicated on Schedule 13D filings. However, we assert that the optimal
dataset to empirically test the long-term effects of shareholder activism should be based on
board representation of target firms by a shareholder activist. Therefore, we started with a
much more expansive sample of activist interventions. Our comprehensive dataset of
shareholder activist events includes 5,063 interventions from 1984-2013. Of those, 3,899
(77%) filed a 13D. However, approximately 32% of all activist interventions were focused on
board engagement, either through a proxy contest (1,216) or non-proxy contest dissident
campaigns that resulted in board representation via private negotiations (418) with the target
management team and board of directors. To be sure, over two-thirds (2/3) of activist
15
interventions did not seek board representation to actively monitor management. Moreover,
GAMCO Asset Management, a hedge fund founded by Mario Gabeli, has filed 478 13Ds since
1996. However, it has launched only 18 proxy fights (3.8%) and won board representation only
ten times (2.1%) to date. In contrast, Carl Icahn has launched proxy fights and won board
representation at eBay, Genzyme, Time Warner and Yahoo! without filing a 13D.
Accordingly, we claim that there are numerous 13D filings of activist interventions that
otherwise include good performing companies with strong management that an activist is not
compelled to seek board representation to actively monitor management and function as a
disciplinary mechanism. Additionally, there are over 90 activist interventions that led to board
representation without filing a 13D. Therefore, we assert that the optimal dataset to empirically
test the long-term effects of hedge fund activism should be based on board representation of
target firms by a shareholder activist and not merely the fact that a shareholder crossed 5%
ownership and might (not will) seek to influence strategic change at the target firm. To be sure,
an activist that is willing to incur significant financial cost that is not borne by all shareholders,
which Gantchev (2012) estimates is approximately $10 million per proxy contest, has genuine
conviction that the target firm requires strategic change that management is unwilling to
execute.
In our second step, we narrowed our time-frame from 1996-2013 and identified 1,039
activist interventions that resulted in board representation either through a proxy fight or private
negotiations. This sample set included 621 proxy fights and 418 activist interventions (non-
proxy contests) that resulted in board representation either through a settlement or concessions
between the target management and the dissident shareholder. Next, we excluded certain
events where: (1) the primary purpose of the filer is to be involved in the bankruptcy
16
reorganization or the financing of a distressed firm; and (2) the target is a closed-end fund or
other non-regular corporation. We excluded duplicate campaigns by multiple activists (i.e., the
wolf-pack) so the dataset includes information about the target firm only once with respect to a
specific campaign. If a target firm were to file for bankruptcy protection or liquidation, we
included financial information from the target firm up to the Chapter 11 or Chapter 7 filing
date. More specifically, the bankrupt firm would account for 100% loss as it relates to stock
return and portfolio analyses. In our final step, we included only hedge fund activist campaigns
at target firms with a market capitalization of $50 million or greater. Although, there are many
campaigns that are targeted at micro-cap companies, we determined that the trading liquidity
and financial data of these firms were not representative of the broader sample. Additionally,
we trimmed certain variables and financial data at the 1.0% and 99.0% in each tail to adjust for
outliers.
Our final dataset consists of 448 activist interventions (the “Treatment Group”) that
resulted in at least one board seat granted to an activist shareholder from 1996-2013 (see Table
1). A total of 843 board members were elected at 398 unique target companies. This includes
225 unique activist hedge funds. Of the 448 activist interventions in the Treatment Group, 243
(54%) target firms are still publicly-listed, 186 (42%) were sold/merged and 19 (4%) target
firms filed for bankruptcy. By compiling our own database, we avoid some problems
associated with survivorship bias, reporting selection bias, and backfill, which are prevalent
among other hedge fund databases. Table 4 provides descriptive statistics with respect to the
Treatment Group.
17
Table 2
As previously noted, extant literature determined that approximately 1/3 of certain
activist interventions led to a sale or merger of the target firm within 18 months of the
intervention. However, we find that hedge fund activists that seek board representation do not
promote a “sell the company” agenda consistent with other activist objectives. Table 3
illustrates that less than 7% of the target firms announced a sale of the company ex post the
dissident board seat grant date. Additionally, Table 3 highlights CEO changes at target firms
post a dissident joining the board after an activist campaign. Within two years of the
shareholder activist joining the board, the CEO had been replaced approximately 30% of the
time. Therefore, it is reasonable to assume from the data that hedge funds that seek board
representation are focused more on promoting change at the target firm via operating
improvements and changes to existing management rather than supporting a sale of the
company strategy.
Existing 243 54% Settled/Concessions Made 174 72%
Sold/Merged 186 42% Dissident 53 22%
Bankruptcy 19 4% Split 14 6%
Total 448 Total 241
Board Representation 235 52% Proxy Fight 241 54%
Board Control 69 15% Other Stockholder Campaign 165 37%
Maximize Shareholder Value 80 18% No Publicly Disclosed Activism 40 9%
No Publicly Disclosed Activism 40 9% Exempt Solicitation 2 0%
Other Activist Campaigns 24 5%
Total 448 Total 448
Proxy Fight WinnerCompany Status
Activism TypePrimary Campaign Type
18
Table 3
To control for self-selection bias and endogeneity, we constructed a control group (the
“Control Group”) of all proxy fights campaigns that did not result in board representation
during the same period. Our dataset includes 595 target firms that experienced a proxy contest
for board representation. After we excluded certain events to reflect consistent sample
parameters with our Treatment Group, our Control Group includes 73 firms that were involved
in a proxy contest that the target firm incumbent management defeated the dissident shareholder
during the voting process. Therefore, we examined not only firms that granted at least one
board seat to a dissident shareholder and its ex post effects (the “Treatment Group”), but also
companies that were challenged by dissatisfied shareholders and did not suffer the ex post
disciplinary effects by the dissident (the “Control Group”). Table 4 provides an overview of
certain characteristics the target firms and the respective shareholder activist tactics with respect
to each intervention for the Treatment Group (N=448) and the Control Group (N=73).
Timeframe
No. of
Target
Firms
% of Total
Board
Engagements
Timeframe
No. of
Target
Firms
% of Total
Board
Engagements
3-5 Years 19 4.2% 3-5 Years 36 8.0%
2-3 Years 17 3.8% 2-3 Years 27 6.0%
1-2 Years 27 6.0% 1-2 Years 46 10.3%
6-12 months 14 3.1% 6-12 months 37 8.3%
< Six (6) Months 17 3.8% < Six (6) Months 40 8.9%
Total 94 Total 186
CEO Change Ex Post Dissident Seat Date Announced Target Firm Sale or Divestiture
of Assets Ex Post Dissident Seat Date
20
Table 4
Descriptive Statistics of Dataset
Target Firm Characteristics Yes No Yes (%) No (%) Yes No Yes (%) No (%)
Classified Board 210 238 47% 53% 35 38 48% 52%
Cumulative Voting 34 414 8% 92% 3 70 4% 96%
Poison Pill Adopted in Response to Campaign 33 415 7% 93% 3 70 4% 96%
Poison Pill In Force Prior to Announcement 174 274 39% 61% 30 43 41% 59%
Shareholder Activist Tactics
13D Filer 400 48 89% 11% 47 26 64% 36%
Dissident Group Includes SharkWatch50 Member 261 187 58% 42% 38 35 52% 48%
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Graph I
Long Term Buy-and Hold Returns
Portfolio of Target Firms with Activist Board Representation
January 1, 1998 – December 31, 2013
-100
-50
0
50
100
150
200
250
300
350
400
450
Excess return on the market, value-weight return of all CRSP firms incorporated in the US and listed on the NYSE, AMEX, or NASDAQ.
S&P 500 Index
All Target Firms that granted at least one board seat to a dissident (N=448).
Economic Recessions
Cu
mu
lati
ve
Ret
urn
s
Years
Appendix
50
Graph II
Long Term Cumulative Market Adjusted Returns (MAR)
(Periods in Years)
Figure I
Data Collection Methodology
38.8%
21.7%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
Event +1 +2 +3 +4 +5
Years
All Target Firms that granted at least one board seat to an activist hedge fund: 38.8%Market Adjusted Excess Return after 5 years
from the board seat grant date
All Target Firms that WON the proxy fight against activist hedge fund: 21.7% Market Adjusted Excess Return after 5 years from
the Event date
Appendix Note: To control for self-selection bias and endogeneity, we constructed a control group (the “Control Group”) of all proxy fights campaigns that did not
result in a board representation during the same period. We used the market-adjusted return (MAR) model, which imposes the following joint
restrictions j=0 and j=1. Essentially, it includes market-wide factors but does not account for risk similar to the market model or CAPM.
The Control Group (N=73) is comprised of target firms that were involved in a proxy contest that the target firm incumbent management defeated the
dissident shareholder during the voting process. Therefore, we examined not only firms that granted at least one board seat to a dissident shareholder and its
ex post effects (the “Treatment Group”), but also companies that were challenged by dissatisfied shareholders and did not suffer the ex post disciplinary
effects by an activist hedge fund.
51
Figure 1
Data Collection Methodolgy
Notes:
There is no central database of activist hedge funds. Therefore, we constructed an independent dataset of all activist interventions from 1984-2013 from various sources. Our manually constructed database of shareholder activist events includes 5,063 interventions from 1984-2013. Similar to Gillan and Starks (2007), we
define shareholder activist event as a purposeful intervention by “investors who, dissatisfied with some aspect of a company’s management or operations, try to
bring about change within the company without a change in control.”
Our data collection comprised a multi-step procedure. Our comprehensive dataset of shareholder activist events includes 5,063 interventions from 1984-2013. Of those, 3,899 (77%) filed a 13D. However, approximately 32% of all activist interventions were focused on board engagement, either through a proxy contest
(1,216) or dissident campaigns that resulted in board representation via private negotiations (418) with the target management team and board of directors. In our
second step, we narrowed our time-frame from 1996-2013 and identified 1,039 activist interventions that resulted in board representation either through a proxy fight or private negotiations. This sample set included 621 proxy fights and 418 activist interventions (non-proxy contests) that resulted in board representation
either through a settlement or concessions between the target management and the dissident shareholder. Next, we excluded certain events and if a target firm were
to file for bankruptcy protection or liquidation, we included financial information from the target firm up to the Chapter 11 or Chapter 7 filing date.
Our final dataset consists of 448 activist interventions (the “Treatment Group”) that resulted in at least one board seat granted to an activist shareholder from 1996-2013 (see Table 1). A total of 843 board members (see Table 1) were elected at 398 unique target companies. This includes 225 unique dissident shareholders. Of
the 448 activist interventions in the Treatment Group, 243 (54%) target firms are still publicly-listed, 186 (42%) were sold/merged and 19 (4%) target firms filed
for bankruptcy. By compiling our own database, we avoid some problems associated with survivorship bias, reporting selection bias, and backfill, which are prevalent among other hedge fund databases. To control for self-selection bias and endogeneity, we constructed a Control Group from the set of all proxy fights
campaigns that did not result in a board representation during the same period (N=595). Similar to the primary sample set, we excluded certain events for
parameter consistency.
All Activist Events
1984-2013(N=5,063)
All Activist Events (Non-Proxy Contests) that resulted in Board
Representation
1996-2013(N=418)
All Proxy Contests1996-2013(N=1,216)
All Proxy Contests that resulted in Board Representation
1996-2013
(N=621)
All Activist Events that resulted in Board Representation
1996-2013 (N=1,039)
EXCLUDE SIC 6726 (Mutual Funds, etc), duplicate campaigns by multiple
Activists, Bankruptcy data post Filing Date, Missing data (N=300)
Treatment Group - Final Data Set
1996-2013(N=448 Firms)
(N=843 Board Members)
All Proxy Contests that did not result in Board Representation
1996-2013 (N=166 Firms)
Control Group - Final Data SetAll Proxy Contests MANAGEMENT
WON (Defeated Activist)1996-2013 (N=73 Firms)
All Proxy Contests that DID NOT result in Board Representation
1996-2013 (N=595)
EXCLUDE SIC 6726 (Mutual Funds, etc), duplicate campaigns by multiple
Activists, Bankruptcy data post Filing Date, Missing data (N=212)
CONTROL GROUP
FactSet
SharkRepellent
Compustat
ISS Proxy
S&P
CapIQ
CRSP
MergerMetrics
EDGAR Factiva
INCLUDE only activist campaigns by Hedge Funds at Target Firms with
Market Caps > $50mm
INCLUDE only activist campaigns by Hedge Funds at Target Firms with
Market Caps > $50mm
52
Table 1
Distribution of Shareholder Activist
Board Engagement Campaigns and Dissident Seats Granted
Board Engagements
(Completed)
Dissident Seats
Granted
Board Engagements
(Completed)
Dissident Seats
Granted
1996 1 1 - -
1997 2 2 2 2
1998 5 16 4 14
1999 14 28 6 10
2000 5 11 2 3
2001 26 54 6 11
2002 23 60 7 18
2003 25 57 10 17
2004 18 38 10 20
2005 23 59 15 46
2006 74 139 52 102
2007 68 128 52 95
2008 100 199 68 126
2009 90 166 49 86
2010 61 102 33 49
2011 51 88 34 55
2012 69 127 44 77
2013 84 179 54 112
Total 739 1454 448 843
All Board Engagements by Hedge Funds at
Target Firms with Market Caps over $50mmAll Board Engagements