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E-MailNicole M. Boyson is Associate Professor of Finance and Pegaret Pichler is Assistant Professor of Finance at Northeastern University’s D’Amore-McKim School of Business. This post is based on a recent paper by Professors Boyson and Pichler. 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.
Numerous academic studies present evidence that hedge fund activism campaigns can lead to both short- and long-run improvements in the values of target firms. Despite this evidence, managers of target firms do not typically embrace the appearance of an activist, perhaps because dealing with activists is time consuming and can lead to disruptive operating changes or even takeovers. In our paper, Hostile Resistance to Hedge Fund Activism, available on SSRN, we examine defensive actions that target firms take in response to activism. We find that most actions taken to resist hedge fund activists, such as poison pill adoption, are identical to actions firms take in response to takeover threats. A poison pill states that if any shareholder, or group of shareholders, acquires more than a specified trigger percent of shares (typically 10 to 20%), all shareholders, excluding the triggering shareholders, may buy deeply discounted shares. Poison pills were originally designed to force prospective acquirers to negotiate with the board of a firm, rather than conduct a hostile takeover. A perhaps less well known aspect of the poison pill is that it also inhibits communication between large shareholders, since the stakes of individual shareholders who are perceived by the firm to be working together as a group can be aggregated for the purposes of determining whether the pill will be triggered. Other resistance measures taken by target firms, such as making it harder for shareholders to act by written consent and harder to call special meetings, also interfere with activists’ ability to coordinate with other shareholders to accomplish activism objectives.
We show that target firm managers are more likely to resist hedge fund activism when they are more vulnerable to loss of control: when insider ownership is low, when the hedge fund wants to make a bid for the firm, and when the hedge fund ownership is high. It is not surprising that a firm will put up defenses in these circumstances. However, hedge funds express an interest in bidding for target firms in only 6% of the campaigns, and the median activist toehold is only 8%. The vast majority of activist targets are thus not at immediate risk of being taken over, and given that defenses can be adopted quickly, takeover concerns can explain some, but do not explain most of the observed resistance. Consistent with the anti-coordination feature of the poison pill and other defenses, we show that managers also resist activists when the potential for a hedge fund to coordinate with other shareholders is high, and they resist in ways that impede this coordination. In most cases of resistance we are able to document ways in which the resistance directly impacts the hedge fund’s ability to act. For example, limits on special meetings are enacted in response to hedge fund plans to call special meetings, and the majority of poison pills have trigger percentages that are within 2% of hedge fund ownership. The latter restriction not only prevents a hedge fund from acquiring many more shares, but also inhibits coordination with any other shareholder who holds more than 2% of shares.
Hedge funds often counter target firm resistance by initiating proxy fights or lawsuits. Of note, proxy fights overtly enable shareholder coordination, and directly overcome the anti-coordination feature of poison pills. Activists are more likely to counter resist when exit is more costly (as measured by target firm liquidity) and when institutional ownership is greater. Counter resistance is costly for the activist, but based on our analysis, effective. When hedge funds do not counter resist, outcomes of activism are worse relative to non-resisting targets of the same hedge funds. By contrast, when hedge funds fight back, most outcomes do not differ from those of non-resisting targets.
The stock market does not like resistance to hedge fund activism that is unaccompanied by counter-resistance from the hedge fund. We document a -1.5% 3-day cumulative abnormal return (CAR) around the announcement of resistance, cutting the positive return to activism in half. However, for cases in which the hedge fund counter-resists, the market responds positively to the counter-resistance with a 3-day CAR of 1.9%.
Our analysis of activism outcomes indicates that these short-term market returns are justified. Target firms are 24% less likely to be acquired in the period following activism when the target firm resists and the hedge fund does not counter resist, relative to campaigns without target firm resistance. If the hedge fund counter resists, the likelihood of a takeover is not significantly different from the likelihood without resistance. Target firms are 30% less likely to agree to an activist’s demands for an asset sale, a capital structure change, an operational change, or a management related change, when the target firm resists and the hedge fund does not counter resist. If the hedge fund counter resists, the target firm is about 16% less likely to agree to one of these demands. Campaigns with target firm resistance and no hedge fund counter resistance exhibit worse 1 and 2 year changes in cash flows and return on assets, compared to campaigns without resistance. Campaigns with target firm resistance and hedge fund counter resistance have significantly better operating performance, compared to campaigns with resistance and no counter resistance. In fact, the performance of firms that resist and face counter-resistance is indistinguishable from that of non-resisting hedge fund targets. Appointment of a hedge fund representative to the target firm board stands out as the one outcome in which activists achieve success more frequently in the face of resistance, relative to cases in which the target firm does not resist. These appointments, however, are typically accompanied by restrictive settlement agreements, calling into question the extent to which they may be considered successes.
We rule out numerous alternative explanations for our results. The worse long-run performance following resistance without counter resistance is not due to mean reversion. Nor is it attributable to a reverse causality explanation, in which the managers who expect worse future performance are also those who choose to resist. If this were the case, then we would expect to find worse performance for all resisters, including those with counter resistance, and we do not. Worse performance is also not caused by hedge fund activists abandoning their campaigns in the face of resistance. Even those activists who do not counter resist maintain large ownership positions for extended periods following resistance.
Taken together, our results suggest that target firm resistance is not in shareholder interest. However, hedge fund activists can largely reverse this negative impact by engaging in counter resistance.
The full paper is available for download here.
