Praveen Kumar is Professor of Finance at the University of Houston. This post is based on an article authored by Professor Kumar and Hadiye Aslan, Assistant Professor of Finance at Georgia State University, available here. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here), and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.
Whether intervention by activist investors, such as hedge funds, is beneficial or detrimental to the shareholders of target firms remains controversial. Proponents marshal considerable empirical evidence that hedge fund activism (HFA) is associated with significant medium-to-long-run improvements in targets’ cost and investment efficiency, profitability, productivity, and shareholder returns. Opponents, however, insist that HFA forces management to take myopic decisions that weaken firms in the longer run. The debate rages in academia, media, and has already featured in the 2016 presidential campaign.
Despite this intense interest, however, the research on the effects HFA has typically focused only on its impact on the performance of target firms. But targets of HFA do not exist in vacuum; they have industry competitors, suppliers, and customers. It is by now well known that HFA has a broad scope that often—simultaneously or sequentially—touches on virtually every major aspect of company management, including changes in product market strategy, negotiation tactics with suppliers and customers, and knowledge-based technical advice of production organization. In particular, HFA that improves target’s cost efficiency and product differentiation, and generally redesigns its competitive strategy, should have a significant impact on the target’s competitors (or rival firms). This prediction follows from basic principles of strategic interaction among firms in oligopolistic interaction. Indeed, the received theory of industrial organization provides the effects of cost improvements and product differentiation on rivals’ equilibrium profits and market shares.
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