Influencing Control: Jawboning in Risk Arbitrage

Wei Jiang is the Arthur F. Burns Professor of Free and Competitive Enterprise at Columbia Business School. This post is based on a discussion paper authored by Professor Jiang; Tao Li, Assistant Professor of Finance at Warwick Business School; and Danqing Mei, Ph.D. candidate in Finance at Columbia Business School. 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), and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

Our paper, Influencing Control: Jawboning in Risk Arbitrage, publicly available on SSRN, provides the first study on a relatively new phenomenon of “activist risk arbitrage,” in which activist shareholders wield their influence over corporate control changes by blending shareholder activism into an M&A arbitrage strategy. More specifically, the activist arbitrageurs attempt to block an announced M&A deal through public campaigns in order to extract better deal terms. Such activities have been on the rise since the early 2000s: they were observed in fewer than 1% of all M&A deals in early 2000s, rising to around 10% during the past few years. However, the academic literature has not formally analyzed the full process, characteristics, or the impact of the new risk arbitrage strategy on the market for corporate control. As shareholder activism launched by institutional investors becomes increasingly commonplace in corporate governance, its marriage with a popular, traditionally non-activist, arbitrage strategy is instructive. A signature of institutional investor activism has been that it strives to influence corporate policies and governance, but does not aim for control. The activist arbitrage strategy, by inserting shareholder activism into corporate control events, thus bridges the two by “influencing control.”

Our study builds on a comprehensive sample covering all 4,278 M&A deals between 2000 and 2014. The “activist arbitrage” subsample consists of 343 deals, manually composed to include all events where there was observed jawboning by outside shareholders after the initial announcement of an acquisition. The “passive-only arbitrage subsample” consisting of 2,549 deals involving disclosed passive risk arbitrageurs but without activism. The remainder 881 deals form the “no-arbitrage sample.”

The two forms of arbitrage share similarities as well as forming contrasts. On the one hand, both types of arbitrageurs prefer larger, friendly, deals and target companies with higher institutional ownership. On the other hand, activist arbitrageurs distinctly attack going-private deals, in which the acquirers are often the managers themselves (“MBOs”) and/or financial acquirers (such as private equity firms. Moreover, low announcement premium (controlling for deal characteristics) is an invitation to activists. Presumably in friendly deals and going private deals, the board and the management may not have gone all the way to extract from the acquirers better terms or to solicit competing bids. Therefore activist risk arbitrage is potentially an important form of governance in guarding investors’ interests during corporate control changes that are susceptible to management self-dealing or to other forms of conflict of interest.

Activist arbitrageurs earn higher average returns on their investment than passive ones, compensating for the “jaw pain” as well as for the assumption of higher risks—both legal and deal risks. We document an annualized return of 5-6% for passive risk arbitrageurs, while the annualized average return accrued to activist arbitrageurs is over 16% from post-deal announcement to resolution. Moreover, the emergence of an activist arbitrageur is good news to the target shareholders, as reflected in the 2.6% average abnormal return during the disclosure window.

By threatening to block an announced deal in order to extract a higher price from the current or potential buyers, activist arbitrageurs stand ready to assume a higher deal failure risk than passive arbitrageurs who simply vote their shares in favor of the deal. To the extent that activists, like passive risk arbitrageurs, are better off with completed than withdrawn deals ex post, they have an incentive to pick deals with low “inherent” deal failure risk, e.g., deals in which the targets (and/or acquirers) are determined to sell (and/or buy), such that a tough negotiation is more likely to lead to improved terms for the shareholders rather than a withdrawal. Such a selection effect is borne out in data. While the average deal completion rate of the activist arbitrage subsample is a modest 3.5 percentage points lower than that of the complement subsample, the impact of activists on the deal completion rate is estimated to be 17-18 percentage points lower once the unobserved heterogeneity in deal failure risk is accounted for. Relatedly, activists do not noticeably slow down the process toward deal resolution, adding two weeks’ time to a typical duration of 4-5 months from deal announcement to resolution.

Just as importantly, activist arbitrage significantly increases the sensitivity of deal completion to ex ante completion probability, where the latter is proxied by the proportion of price convergence toward the offered premium during the announcement window. Therefore, activist arbitrageurs are not only sophisticated in picking deals for which there is more room for improvement and deals with high ex ante probability of completion, but they also increase (decrease) the completion rate of deals that are welcomed (unfavored) by the market. Such a combination suggests a sustainable equilibrium in which activists do well for themselves while doing good for the shareholders in M&A targets.

For completeness, we also study the 47 deals during the same sample period where activists intervene on the acquirer side after an M&A announcement. The prime candidates for such interventions are large, stock deals with multiple bidders, common conditions identified by the M&A literature to be associated with over-paying. Activists succeed in slashing the paid premium or blocking the acquisition altogether: premiums paid to targets are lowered by 7 percentage points, and the deal completion rate is cut by 36-37 percentage points. To the extent that a large number of acquisitions of public targets seem to be value destructive for acquirer shareholders, especially when compounded with weak governance, activist arbitrageurs on the acquirer side constitute a powerful counterbalance.

The full paper is available for download here.

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