Obstructing Shareholder Coordination in Hedge Fund Activism

Nicole Boyson is Associate Professor of Finance at Northeastern University. This post is based on an article authored by Professor Boyson and Pegaret Pichler, Assistant Professor of Finance at Northeastern University. 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.

Many hedge funds follow a strategy of shareholder activism, acquiring a block of shares and then campaigning for changes in the target firm. Numerous studies have presented evidence that these campaigns can lead to both short- and long-run improvements in the values of target firms. In our paper, Obstructing Shareholder Coordination in Hedge Fund Activism, which has recently been made publicly available on SSRN, we examine hedge fund activism from a novel perspective. While prior literature has focused on the actions taken by the hedge fund activist in an attempt to increase firm value, it is silent on the impact of target firm defenses in response to activism. We attempt to fill this gap by examining defensive actions that target firms take in response to activism, with a particular focus on actions that impede coordination among shareholders.

Activist hedge funds typically acquire ownership stakes representing between 5-10% of the target firm’s total market capitalization. We argue that these relatively modest stakes are unlikely to permit activists to exert much control over the firms they target. Therefore, coordination with other large shareholders can be instrumental in achieving their activism goals. We document a variety of actions that target firms take to impede such coordination, including actions that limit the ability of shareholders to act together by written consent or call a special meeting, the adoption of supermajority voting rules, and the adoption of poison pills. The most common defense in this vein is the poison pill. At first glance, a poison pill may appear to be an unusual response to hedge fund activism, since poison pills are thought of as anti-takeover devices. However, we document that in addition to their traditional use as anti-takeover devices, poison pills also directly limit investor coordination. Indeed, since 2001, the number of firms that have adopted poison pills in response to hedge fund activism has increased, despite a general downtrend in pill adoption over this period.

Recently, hedge fund activists have expressed concern about the detrimental effect that a poison pill has on shareholder coordination. In a 2014 letter, Bill Ackman, the manager of hedge fund Pershing Square, notes that: “In recent years, the poison pill, a device originally designed to prevent acquisitions of control at below fair value, has begun to be used to shut down shareholder coordination and activist engagements.” [1] Carl Icahn, another well-known activist, agrees with this view, stating in a letter to the board of Navistar in 2012, “Indeed, rather than trying to effectively communicate with shareholders regarding these significant strategic decisions, you have sought to stifle even ordinary course shareholder communication and influence by recently adopting a poison pill.” [2]

Our paper presents two key findings about coordination-impeding resistance and hedge fund activism. First, target firms are more likely to resist activism in ways that hinder shareholder coordination when the apparent potential for shareholder coordination is highest. Based on prior literature, we use two proxies to measure the potential for shareholder coordination: the target firm’s total Shapley value, which captures the relative importance of each voting shareholder in terms of his ability to have a pivotal vote in changing firm policy, and abnormal stock turnover just before the announcement of activism, as such turnover may be due to stock purchases by other institutional investors who are willing to coordinate with the activist. The likelihood of coordination-impeding resistance is significantly positively related to both of these proxies, indicating that target firms are more likely to take these actions when the perceived threat of coordination is highest.

Second, resistance that impedes shareholder coordination is associated with worse long-term stock performance, worse long-term operating performance, a lower likelihood that the target firm will be taken over, and a reduced probability that the hedge fund achieves stated activism goals such as payouts, asset sales, and management changes. The announcement of the resistance itself also generates a negative market reaction around the time of the announcement. By contrast, coordination-impeding resistance is associated with a significant increase in the likelihood that the activist obtains board representation. However, this increase is due almost entirely to campaigns in which board representation is not a stated goal of the campaign. Further, long-term operating performance after hedge funds achieve board representation does not improve when board representation follows coordination-impeding resistance. Therefore, despite a higher likelihood of board representation in response to coordination-impeding resistance, this board representation does not translate into better outcomes for target firm shareholders. This result is particularly striking given that hedge fund board representation without this type of resistance is associated with significant improvements in long-term operating performance.

Overall, our results imply that target firms have the ability to reduce the impact of shareholder coordination, and in so doing, diminish potential positive outcomes of activism.

The full paper is available for download here.

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