We find that high reputation activists initiate 3.5 times as many campaigns and extract 85% more settlements from targets, and that reputation-building incentives explain 20% of campaign initiations and 19% of proxy fights. Our estimates indicate these reputation effects combine to nearly double the value that activism adds for target shareholders.
Activists capture only a small fraction of the value they create in target firms while paying substantial private costs associated with rapidly acquiring shares, proposing and campaigning for desired changes in firm policy, and potentially organizing a proxy fight (Gantchev, 2013). In a static setting, this free rider problem suggests activist campaigns should be rare and unsuccessful.
We do so by estimating a dynamic model in which target managers settle more frequently with high reputation activists instead of risking a proxy fight that has negative career consequences (Fos and Tsoutsoura, 2014). These settlements provide incentives for activists to invest in reputation by incurring the costs of initiating campaigns and proxy fights.
Blockholders’ incentives to intervene in corporate governance are weakened by free-rider problems and high costs of activism. Theory suggests activists may recoup expenses through informed trading of target firms’ stock when stocks are liquid. We show that stock liquidity increases the probability of activism, but less so for potentially overvalued firms where privately informed blockholders may have greater incentives to sell their stake than to intervene. We also document that activists accumulate more stocks in targets the more liquid is the stock. We conclude that liquidity helps overcome the free-rider problem and induces activism via pre-activism accumulation of target firms’ shares.
We run probit regressions and find a statistically and economically significant positive effect of stock liquidity on the probability of activism. The results imply that a discrete increase in liquidity from the 10th to the 90th percentile more than doubles the likelihood of activism. Importantly, the positive effect of liquidity that we estimate is purely driven by cross-sectional differences in liquidity since we carefully control for its time-variation in our regression specifications.
The purpose of the model is to estimate the probability that an observation with particular characteristics will fall into a specific one of the categories.
JFE 2016, Hadiye Aslan (Georgia State), Praveen Kumar (Houston)
We examine the product market spillover effects of hedge fund activism (HFA) on the industry rivals of target firms. HFA has negative real and stockholder wealth effects on the average rival firm. The effects on rivals' product market performance is commensurate with post-activism improvements in target’s productivity, cost and capital allocation efficiency, and product differentiation.
Financially constrained rivals accommodate these improvements but those facing high intervention threat respond effectively to them. The spillover effects are strengthened in less concentrated and low entry barrier industries. The results are robust to the alternative hypothesis of strategic target selection by hedge funds.