Still Running Away from the Evidence: A Reply to Wachtell Lipton’s Review of Empirical Work

In a 17-page memorandum issued by the law firm of Wachtell Lipton (Wachtell), Empiricism and Experience; Activism and Short-Termism; the Real World of Business, the firm’s founder Martin Lipton put forward new criticism of our empirical study, The Long-Term Effects of Hedge Fund Activism. Lipton’s critique is based on a review of a large number of works which, he asserts, back up empirically the view that our study questions. Following our examination of each of the studies noted by Lipton, this post responds to Lipton’s empirical review. We show that Lipton’s review fails to identify any empirical evidence that is inconsistent with our findings or backs the claim of Wachtell that our study questions.

Our study shows that the myopic activisms claim that Lipton and his firm have long asserted—the claim that that interventions by activist hedge funds are in the long term detrimental to the involved companies and their long-term shareholders—is not supported by the data. Seeking to cast doubt on the validity of our finding, Lipton’s memorandum cites twenty-seven works by academics or policymakers, and asserts that these studies demonstrate that our conclusion—that the myopic activism claims is not supported by the data—is “patently false.” In this post, we explain that this assertion is not supported by the cited studies; most of the studies are not even related to the subject of the consequences of hedge fund activism, and those that are related to it do not provide evidence contradicting our findings.

Below we begin with discussing the relevant background and then review the cited studies and explain why, in contrast to the impression Lipton’s memo seeks to make, they do not provide an empirical basis for the myopic activists view. Instead of running away from the empirical evidence, while constantly shooting back, Wachtell Lipton should accept that its myopic activists claim is not supported by the data. Indeed, as one of us plans to discuss in a separate post, despite its repeated attacks on our study, Wachtell is shifting its position toward avoiding reliance on the myopic activism claim in its opposition to hedge fun activism, and this shift should lead Wachtell and its clients to rethink their attitude to hedge funds activists.

Background: The Wachtell Challenge and First Attempt to Run Away from the Evidence

Act I: The Wachtell Challenge

Wachtell has been a highly successful advisor to boards seeking to “defend vigorously” against interventions by activist hedge funds (see Wachtell’s memo Dealing With Activist Hedge Funds for a brief outline of its approach). As part of its effort to put forward a policy basis for the opposition to hedge fund activism, Martin Lipton has long been an active advocate of the “myopic activism claim” concerning the detrimental long-term effects that activist interventions have for targeted companies and their shareholders.

In a debate that Martin Lipton had with Bebchuk last November, Bebchuk noted that he was engaged in a co-authored empirical study of the myopic activists claim. In his Bite the Apple memo, Martin Lipton issued in February a challenge for the research project that we were carrying out. He argued that “if Professor Bebchuk is truly interested in meaningful research to determine the impact of an activist attack,” our research study should examine the following:

“[F]or companies that are the subject of hedge fund activism and remain independent, what is the impact on their operational performance and stock price performance relative to the benchmark, not just in the short period after announcement of the activist interest, but after a 24-month period.”

We subsequently released an empirical study that met this challenge. Analyzing the full universe of approximately 2,000 interventions by activist hedge funds during the period 1994–2007, our study finds that the asserted long-term declines in shareholder wealth and operating performance are not supported by the data. (The results of our study are summarized in a post on the Forum here and in a WSJ op-ed article here.)

Act II: Wachtell Lipton’s Initial Attack on Our Study

If Wachtell were “truly interested in meaningful research to determine the impact of an activist attack,” it could have been expected to welcome the arrival of a study that provides a systematic analysis of the very kind it said would be worthwhile. Instead, it has been repeatedly attacking our study and, by contrast to its earlier view, casting doubt on the value of doing any subsequent empirical analysis of Wachtell’s initial attack came in two memos, Current Thoughts about Activism and The Bebchuk Syllogism. These memos attempted to raise methodological questions about our findings and inferences. In a subsequent post, Don’t Run Away from the Evidence: A Reply to Wachtell Lipton, we addressed these criticisms and showed that they are unwarranted and cannot provide a basis for Wachtell’s appeals for disregarding our empirical findings and for relying on anecdotes and reported experiences.

Wachtell, however, did not give up; it came back with a new line of criticism.

The New Attack:

In addition to showing that the myopic activists claim is not supported by the data we study, our paper also notes that other work has also not provided empirical support for this claim. Lipton’s new memo focuses not on what we do in our study but on our assessment that there is currently no empirical support for the myopic activisms claim. Lipton marshals a large number of works that, Lipton asserts, provide empirical backing to the myopic activists claim and thereby demonstrate that our assessment is “patently false.” However, as detailed below, despite the large number of works reviewed by Lipton, he fails to identify a single paper that provides evidence that interventions by activist hedge funds are followed in the long term by declines in shareholder wealth or operating performance.

In particular, Lipton’s review cites seven works that do not provide any empirical evidence but only discuss empirical work by others; sixteen papers that provide empirical evidence on corporate governance topics other than the aftermath of activist interventions and thus do not speak to the empirical validity of the myopic activist claims; and four works that empirically examine the aftermath of activist interventions but do not contradict our findings or show the validity of the myopic activists claim. We discuss these three categories of cited works below. (In string citations below, we list works cited in the order in which they are cited in the course of the Lipton review.)

Non-empirical papers:

Seven of the works cited by Lipton—Dallas (2012), Bair (2011), Macey and Buckberg (2009), Romano (2001), Masouros (2012), Kay (2012), and Strine (2010)—do not themselves provide empirical evidence but rather discuss or note empirical work by others. These studies thus cannot be regarded as providing themselves any empirical evidence regarding the validity of the myopic activists claim.

Empirical paper on issues other than the aftermath of activist interventions:

The majority of the papers cited by Lipton are empirical papers in the corporate governance area that focus on issues other than what follows activists interventions or, as Lipton put it, “[F]or companies that are the subject of hedge fund activism and remain independent, what is the impact on their operational performance and stock price performance relative to the benchmark … after a 24-month period.” In particular, Lipton cites the following sixteen studies on other corporate governance topics:

• Five papers—Wahal (1996), Dos Santos and Song (2008), Ingraham and Koyfman (2013), Prevost and Rao (2000), and Karpoff, Malatesta and Walkling (1996)—that present empirical analyses of precatory shareholder proposals under rule 14a-8; hedge fund activists generally do not submit such precatory proposals and activism via the submission of such precatory proposals is significantly different from hedge fund activism.
• Five papers—Johnson, Karpoff and Yi (2013), Johnson and Rao (2001), Kacperczyk (2009), Ferreira, Kershaw, Kirchmaier and Schuster (2012), and Pugh, Page and Jahera (1992)—present an empirical analysis of the association between antitakeover provisions, which insulate boards from shareholder intervention, and corporate outcomes.
• Three works—Burns, Kedia and Lipson (2010), Bushee (2001), and Bushee (1998)—present economic analyses of the relationship of the investment horizons of investors (most of which are mutual funds and not hedge fund activists) with corporate outcomes and behavior.
• Two papers—Mizik (2010) and Graham, Harvey and Rajgopal (2006)—focus on myopic decisions by insiders, which might be due to factors other than hedge fund activism such as short-term pay packages.
• Finally, one work—He and Tian (2013)—focusses on the association between coverage by stock analysts and innovation.

Some of the above studies could be relevant for assessing alternative grounds for the insulation of boards that Lipton advocates. For example, even if interventions by activist hedge funds have beneficial consequences, to the extent that the mere fear of such interventions leads insiders to engage in detrimental short-termism, and the relationship between antitakeover provisions and firm value is worth examining. While reviewing the relationship between antitakeover provisions and firm value is beyond the scope of this post, one of us conducts such a review elsewhere (see The Myth that Insulating Boards Serves Long-Term Value, section III.C) and shows that, overall, the evidence is consistent with the view that antitakeover provisions are associated with lower firm value and worse firm performance. For the purposes of this post, however, the critical point is that studies concerning the relationship between antitakeover provisions and corporate outcomes, as well as the other studies listed above, do not provide empirical evidence on the validity of the myopic activists claim.

Empirical studies on the aftermath of activist hedge fund interventions:

Finally, Lipton refers to three empirical papers that focus on the aftermath of interventions by hedge fund activists, with three of these studies published in the first half of the 1990s and analyze data from the 1980s and the 1970s:

• Ikenberry and Lakonishok (1993), which examine proxy contests during 1968-1988;
• Fleming (1995), which examines actual and threatened proxy contests during 1977-1988; and
• Borstadt and Zwirlein (1992), which examines proxy fights during the period 1962-1986.

These studies thus focus on activism in an earlier era—the area of hostile takeovers in which, unlike activist efforts in the past two decades, dissident efforts were largely focused on facilitating a takeover. Moreover, a close review of the above three studies indicates that even these studies do not support Wachtell’s negative view of dissident activity in general. For example, while Fleming (1995) identifies a subset of contests with negative abnormal returns, he documents “shareholder value gains in the full sample of proxy contests” that the study shows to be long-lasting. Finally, and importantly, we note that a recent study of proxy contests (Fos (2013)) examines data from the current era and reaches conclusions that support activism.

In addition to the above studies from the first half of the 1990s using 1980s and 1970s data, Lipton notes one paper that focuses on hedge fund activism in the modern era—Greenwood and Schor (2009). This study does not question that activism on average increases shareholder wealth but only suggests that those gains are driven by companies that are acquired. Moreover, the study does not examine the effect of activism on operating performance, and thus cannot does not contradict our finding that companies that remain independent have 3, 4, and 5 years out operating performance that is superior to the performance at the time of the intervention.

While Lipton includes in his review even a significant number of unrelated papers and three papers on hedge fund activism from the first half of the 1990s, he fails to include in his review several recent papers on hedge fund activism on the modern era. These papers (some of which are widely cited) include Brav et. al. (2008), Boyson and Mooradian (2009), Clifford (2008), Klein and Zur (2009), Brav et. al. (2009), Becht et. al. (2009), and Brav et. al. (2013). None of these papers provides evidence supporting Lipton’s myopic activists claim.

The Continuing Appeal for Reliance on the view of Corporate Leaders and Advisers

While most of Lipton’s memorandum is devoted to throwing at us a large citations to other academic works, Lipton concludes by repeating the appeal he made in his earlier memos criticizing our study for placing substantial weight on the reported experience of corporate leaders and advisers.

In our earlier response post, we pointed out that the reported experiences on which Lipton is willing to rely seem to be ones from company leaders and their advisors. He does not seem to be willing to place any reliance on the reported experience of the leaders of hedge fund and their advisors, which are also sometimes made with confidence and passion. We stressed in our earlier response post that economists commonly prefer objective empirical evidence over unverifiable reports of affected individuals. Moreover, with respect to the myopic activists claim, given that shareholder wealth and operating performance can be measured using standard databases, the claim can be subject to a direct and rigorous and empirical testing. Thus, there is little reason to rely on the reported impressions of corporate leaders and advisors.

In sum, the examination of empirical studies noted in Lipton’s recent review, which fails to identify a single study that documents that activist interventions tend to be followed by declines in shareholder wealth and operating performance, highlights that it is untenable for Wachtell to continue asserting that its myopic activists claim is backed by empirical evidence. This claim is not backed by the evidence.