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Hedge Fund Activism, Corporate Governance, and Firm Performance

This paper is a first attempt to fill the gap between the widespread focus on hedge fund activism and the dearth of large sample empirical evidence and analysis of this new phenomenon. We construct a comprehensive database of 110 activist hedge funds, and then examine 374 events involving these funds during the period 2004 through 2005.

We find that a large majority of activist hedge funds are value investors targeting companies they believe are undervalued based on financial statement statistics. In roughly two thirds of the Schedule 13D filings in our sample, the fund states that the target company is undervalued. Our analysis of the targets financial statements further shows that targets resemble companies typically sought by value investors.

They have low market value relative to book value, are profitable with sound operating cash flows and tend not to be technology companies (as proxied by R&D expenditure). Targeted companies have more takeover defenses than average firms and enjoy higher trading liquidity than companies of comparable size and book-to-market ratio. Finally, relatively few targeted companies are in the top twenty percent of firms by market capitalization, which is not surprising given the much higher cost of amassing a 5% stake in a firm in the top size quintile (an average of $760 million).

We observe considerable heterogeneity in the degree of fund activism and range of activist techniques. Approximately 40% of all cases are hostile: they involve a threatened or actual proxy contest, takeover, or lawsuit. More than a quarter of cases involve multiple hedge funds acting as a block. Hedge funds report derivative positions in 13% of cases.

Hedge Fund Activism, Corporate Governance, and Firm Performance