Activism Mergers

Nicole M. Boyson is Associate Professor of Finance at the D’Amore-McKim School of Business at Northeastern University; Nickolay Gantchev is Associate Professor at the Cox School of Business Southern Methodist University; and Anil Shivdasani is Professor of Finance at the University of North Carolina Kenan-Flagler Business School. This post is based on a recent article, forthcoming in the The Journal of Financial Economics, by Professor Boyson, Professor Gantchev, and Professor Shivdasani. 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 surge in shareholder activism in recent years has promoted fierce debate over the consequences of activism for targeted companies and their shareholders. Of particular interest has been the question of whether shareholder activism has helped improve the long-term shareholder value of targeted companies. Although several studies argue that hedge fund activism improves the performance of targets, exactly how hedge fund activists enhance shareholder value remains an unresolved issue.

In our new article, Activism Mergers, published in The Journal of Financial Economics, we highlight the critical role that hedge fund activism plays in corporate control transactions. Although shareholder activism and corporate takeovers have historically been viewed as mutually exclusive channels for disciplining management, activist involvement in takeover situations has become increasingly common in recent years. We analyze over 2,000 activism campaigns and over 3,200 M&A transactions between 2000-2014 and find that the probability that an activist target will merge has increased over time, from 20% over 2000–2006 to 25% after 2007. Thus, instead of being two distinct means of shareholder intervention, activism and takeovers appear to be closely interrelated.

Not only has activist involvement in takeover situations become increasingly common in recent years, but also shareholder returns in activism campaigns are closely linked to whether targeted companies receive takeover offers and whether they are eventually sold. Indeed, in the absence of takeover activity for firms involved in activist campaigns, there is no evidence of any long-term share price appreciation. Activist campaigns in which the target firm is acquired result in sizeable stock-price outperformance, with an average shareholder return of 37 percent over two years, adjusting for market-wide performance and company risk. In contrast, activism campaigns that do not result in a takeover offer lead to an average shareholder return of only 0.6 percent, a value indistinguishable from zero. Hence, our findings suggest that influencing takeover outcomes for the firms that activists target is a critical channel through which they generate long-term shareholder return outperformance.

Are activists simply good at picking firms that are attractive merger targets, or do they actually help attract bidders for the firm and facilitate higher acquisition premiums? To evaluate these alternatives, we control for the selection decisions of activist hedge funds and examine whether targets of hedge fund activism are more likely to receive takeover bids than firms in which the same hedge fund activist owns a purely passive stake. We find a six-to-eight times higher takeover likelihood in activism targets relative to firms in which the same hedge fund is a passive equity holder. In addition, we show that when an activist hedge fund switches from a passive to an activist posture in the same firm, there is a three-fold increase in takeover probability relative to firms in which no switch in posture occurs.

One reason why hedge fund activism makes an acquisition more likely is that activists face strong incentives to maximize the value of their equity positions. In the context of a takeover, activist hedge funds can help other shareholders better evaluate outside takeover bids. Specifically, the endorsement of a third-party bid by an activist hedge fund can constitute a credible signal that the bid is fair, thereby garnering broad shareholder support for the offer. We show that an activist’s ability to credibly certify offer fairness is an important factor during the M&A process.

While most M&A offers for companies embroiled in activist campaigns are from third-party buyers, in roughly 15% of campaigns the acquisition bids are launched by the hedge fund activists themselves. Since the activist is both a target shareholder and the bidder in these cases, activist bidders cannot credibly certify the fairness of the takeover proposal. Consistent with this view, we document sharp differences in merger terms and outcomes in activism mergers involving third-party bidders and activist bidders. Activism mergers with third-party bidders experience cumulative abnormal returns (CARs) that are 8% higher than those obtained in non-activism mergers, while offers by activist hedge funds result in 18% lower CARs relative to those in non-activism mergers. Activist bidders offer lower acquisition premiums and experience far higher rejection rates than third-party bidders. Although activist bidders frequently attract follow-on bidders, overall merger completion rates are still significantly lower relative to targets not involving activist bidders. These results illustrate that the separation of the activist and bidder functions is critical for activists to enhance value during corporate takeovers.

Why do activists sometimes become bidders even though their takeover attempts are often unsuccessful? It is possible that activists launch low-ball offers in an attempt to put firms in play without the intention to acquire control, but we find that this is not the predominant explanation. We also find that activists do not merely launch takeover bids for firms that are seen as undervalued in the market with the hope of profiting from a takeover-induced revaluation of the firm. Rather, activists appear to launch bids because these bids, even when unsuccessful, are associated with value-enhancing operational and financial policy changes at activist targets and help generate long-term share price appreciation at the target firms.

The complete article is available here.

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