Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value?

Abstract

Numerous empirical studies have shown that hedge fund activism has led to enhanced returns to investors and increased firm performance. Nevertheless, leading figures in the corporate governance world have taken issue with these studies and have argued that hedge fund activism leads to long-term value destruction.

In this article, it is argued that an activist hedge fund creates long-term value by sending affirming signals to the board of directors (Board) that its executive management team may be making inefficient decisions and providing recommendations on how the company should proceed in light of these inefficiencies. These recommendations require the Board to review and question the direction executive management is taking the company and then choosing which path the company should take, the one recommended by executive management, the one recommended by the activist hedge fund or a combination of both. Critical to this argument is the existence of a Board that can act as an independent arbitrator in deciding whose recommendations should be followed.

In addition, the Article discusses the implications for shareholder voting when an activist hedge fund interacts with an independent Board. Finally, an explanation is given for why activist hedge funds do not provide recommendations that involve long-term investment.

Keywords: hedge funds, activism, corporate governance, corporate law, independence, board of directors