Governance under the Gun: Spillover Effects of Hedge Fund Activism

Research Retrieved: March 2019
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Issue

Hedge funds perform an important corporate governance function by disciplining the management of both actual and potential target firms. Whereas most research thus far has focused on evaluating direct impacts, Gantchev, Gredil and Jotikasthira (2018) look beyond the first-order effects of hedge fund activism – and empirically illustrate that positive effects of activism spill over to non-targeted peer firms through mutual board members.

Key Findings

1. Positive spillovers: Non-targeted firms which share board members with firms that have recently been targets of hedge funds exhibit similar performance improvements as the actual target firms. The non-target firms adjust capital structure, payout policies, and investments for the better if the threat of activism becomes more salient to their board members.
2. Performance implications: These corporate policy changes are financially beneficial: firms with director connections to previous targets improve in sales turnover and profitability, despite the fact that these firms were not directly targeted.
3. Robust results: The results are not driven by industry trends or industry-level takeover threats – and a series of robustness tests suggest that the perceived threat is transmitted through board connections from targeted to non-targeted firms. This indirect effect generates a positive impact of hedge fund interventions beyond the most directly affected and intensively studied firms.

Meaning for Practice

This paper makes an important contribution in highlighting that the salience of takeover threats to board members alone can serve as disciplining mechanism. Thereby, the authors illustrate an important positive externality of hedge fund activism. Thus far, spillover effects to non-target firms have rarely been considered in debates on whether hedge fund activism helps or hurts the economy as a whole.