Hedge fund activism may improve companies’ financial performance by increasing profitability and market returns – but will these improvements last over time?
Our analysis indicates that targeted firms experience immediate and consistent job losses, rising from 4.5% in year one to 7% by year five. Research and development spending also declines by 6-9 % between year one and five.
Impact on Value
Hedge fund activists frequently advocate for changes that can improve firm value. Unfortunately, their impact can vary widely depending on various factors – including type and implementation of activist demands. In this study we utilize DiD regressions to explore activist activism’s effect on various measures of firm performance using matched sample of firms targeted by hedge fund activists with controls for firm size, industry and year fixed effects.
Analysis includes measures of fundamental firm metrics and performance measures such as growth, market share, profitability and capital spending as well as measures of human capital such as cancellation rates for stock options and R&D expenditures. Results reveal that firms targeted by activist hedge funds typically experience short-lived increases in stock price as well as overall improvement of company value; these positive effects are partially mitigated by negative changes to innovation, operating cash flow and R&D expenditures.
Impact on Profitability
We use agency theory to examine which perspective is more correct when it comes to activist investments from hedge funds: long-term custodianship or short-term plunder? Greenwood & Schor (2009) and Klein & Zur (2010) both raise this debate, so herein, we test each perspective using agency theory.
Difference-in-difference (DiD) analysis allows us to measure the impact of activist interventions on firm fundamentals and performance metrics, as shown in Table 7. We compare target firms against their respective control firms to assess this DiD analysis.
Our results reveal that being targeted by activists increases a firm’s profitability one and two years postintervention, consistent with the view that activists enhance shareholder value by encouraging managers to return cash back to shareholders through dividend payments or buybacks rather than invest it on potentially value-decreasing investments. Targeted firms also refocus their innovation activities after being attacked by activist investors; increasing patent quantity and quality as well as prioritizing technological areas essential to their core competencies.
Impact on Reputation
Hedge fund activism affects not only shareholders, but also employees and creditors of a firm; as a result, activist activities may have wide-reaching and long-lasting effects on its performance that could manifest themselves both through financial measures of success as well as nonfinancial indicators of performance.
Prior research indicates that hedge fund activism improves firm performance, with most improvements attributable to changes in corporate governance (Bansal and DesJardine 2014; Brav Jiang and Kim 2022). Here, we employ difference-in-difference regressions (DiDs) regressions to analyze its effects on innovation, production, and social performance of firms.
Our empirical results reveal that targeted firms suffer three broad sets of negative consequences after an activist campaign: increased value and profitability but lower operating cash flow, R&D expenditure, and corporate social responsibility (CSR). Our evidence shows these negative consequences are related more closely to efforts taken by management to satisfy activist demands than directly caused by activism itself.
Impact on Management
Hedge fund activism often generates considerable debate. Some see these shareholders as effective leaders who reorient management toward shareholder interests, while others view them as short-term predators looking to raise stock prices quickly before leaving before any long-term effects become clear.
Our study investigates the competing impacts of activism on firm performance and management, using differences-in-difference (DiD) analysis to explore these effects. Activist ownership results in significant increases to market value and profits immediately, but at a long-term cost to targeted firms as operating cash flow declines, investment spending decreases, as well as CSP declining significantly.
Our results also show that managers of targeted firms may attempt to offset decreases in operating cash flow with reduced investments expenditures, possibly decreasing innovation by decreasing incentives and resources available for R&D.
