'Activist' Hedge Funds: Creators of Lasting Wealth? What Do the Empirical Studies Really Say?

Abstract

Activist hedge funds for some time now have cultivated a revamped reputation as guardians of value for shareholders. Having been criticized and lambasted for their short-term vision and their actions deemed prejudicial to the long-term health of companies, hedge funds have now found in some academic circles new champions of their wisdom and their enduring contribution to shareholder wealth.

This advocacy research has triggered an important debate in the American corporate/financial world, one with consequences for, and ramifications into, the role of board of directors, the nature of shareholding, and the very concept of the business corporation. The issue has much relevance for Canada.

The terms of the debate run as follows: Are board of directors responsible for, and capable of, steering companies in the long-term interest of the company? Or, are there lasting benefits from “activist funds” bullying the board into taking actions these activists deem desirable and, if so, what are the consequences for other stakeholders and for the very nature of board governance?

Simply stated, would a form of “direct democracy” whereby shareholders have a say in all important decisions of the company, by-passing the board of directors they have elected, lead to better corporate performance? That is the implicit claim of “activist hedge funds”.

Of course, observers who have a close, practical, acquaintance with the actions and behaviour of “activist hedge funds” usually take a dim view of these players, their short-term horizon, insatiable greed and nasty tactics.

Leo Strine, now the Chief Justice of the Delaware Supreme Court (but formerly of the Delaware Chancery Court where he oversaw hundreds of corporate court cases), writes with characteristic irony:

“The world will be made a better place when corporations become direct democracies subject to immediate influence on many levels from a stockholder majority comprised not of those whose money is ultimately at stake, but of the money manager agents who wield the end-users’ money to buy and sell stocks for their benefit.” (Strine, 2014) and he continues…

Ideology can be blinding, even apparently when one’s secular faith involves the simple creed that those who own stocks are presumptively selfless while those who manage corporations are presumptively selfish and untrustworthy. (Strine, 2014).

But, that’s exactly what some academics, foremost among them activist professor Lucian Bebchuck of the Harvard Law School, try to demonstrate. Having assembled reams of data and statistics, they claim they can prove that hedge funds are not “myopic activists”, but on the contrary bring to corporations they target performance benefits which last long after they have exited the target company.

Bebchuk has been a prominent advocate of all measures that strip boards of directors of their “excessive” powers. He led a campaign to eliminate staggered boards and other anti-takeover measures. He became embroiled in a bitter feud with Marin Lipton, the lawyer who originated the “poison pill” defense against unwanted take-overs. Lipton, also an observer with a wealth of practical experience with takeovers, argued that Bebchuk’s position was only making it easier for activist hedge funds to carry successful campaigns against boards of directors and force companies to take steps beneficial to share price in the short term but detrimental to the health of the company in the longer term. Stung by this argument, Bebchuk set out to prove that activist hedge funds were actually a good thing for all concerned.

He and his fellow researchers have recently published the results of a large empirical study on the topic. Bebchuk even wrote an op-ed in the Wall Street Journal (August 8th 2013) to herald their findings.

Keywords: hedge funds, activism, bebchuk, lipton, activist investors, value creation, value transfer