Do Activists Turn Bad Bidders into Good Acquirers?

Nickolay Gantchev is Associate Professor of Finance at Southern Methodist University Cox School of Business; Merih Sevilir is Associate Professor of Finance at Indiana University Kelley School of Business; and Anil Shivdasani is Wells Fargo Distinguished Professor of Finance at University of North Carolina Kenan-Flagler Business School. This post is based on their recent paper. 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 Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

The growing influence of activists in global capital markets has prompted financial economists to investigate the drivers of shareholder activism as well as the role of activists in shaping corporate financial strategy. Although several recent studies show that shareholder activism improves the performance of targeted firms, our understanding of the mechanisms through which activists enhance shareholder value remains limited.

In our new working paper, Do Activists Turn Bad Bidders into Good Acquirers?, available on SSRN, we uncover a new role of activists in the market for corporate control. We present evidence that activists curb incentives to engage in empire building acquisitions, limiting the scope of one of the most destructive forces in public companies. Hence, activists not only play an important role in facilitating the acquisition of targeted firms (see related post Activism Mergers by Boyson, Gantchev, and Shivdasani), they also constrain inefficient M&A strategies.

Activist investors target firms overinvesting in unproductive acquisitions. We show that acquirers with poor announcement returns and those with a high number of recent acquisitions are substantially more likely to be targeted. For example, having returns in the bottom tercile of bidder returns increases the probability of being targeted by about one third of the unconditional probability in the sample. The importance of a firm’s acquisition strategy as a determinant of activist targeting suggests that mitigating empire building incentives is a potential source of value creation in activism.

While some of the targeted firms become merger targets themselves, those remaining independent exhibit a more disciplined M&A strategy following activism. Relative to firms with no activist involvement, an activism target is about 15% less likely (based on the unconditional probability in the sample) to engage in a takeover in the three-to-four years after activism. This lower takeover intensity is driven by cash bids rather than stock bids, consistent with prior findings that activists frequently demand a reduction in excess cash and an increase in leverage at their targets, thus limiting capital availability to pursue acquisitions.

Importantly, activists influence not only the amount of M&A activity but also the quality of the deals undertaken subsequent to their intervention at a target firm. Compared to acquirers without activist involvement, recent targets of activism obtain higher announcement returns from the fewer acquisition bids they make after activism. Specifically, acquirers with activist involvement obtain 1.3-1.4% higher three-day announcement cumulative abnormal returns (CARs) than non-targets. Acquisitions by activism targets also outperform acquisitions by non-targets by 9-11% over the two years after the announcement. It does not appear that acquirers with activist involvement pay lower premiums than those without activism; thus, activism appears to promote higher quality acquisitions rather than simply limit the extent of overpayment.

Finally, we test for the mechanisms through which activists influence the acquisition behavior of their targets. We find that recent activism targets implement larger reductions in cash holdings, and increases in dividends and leverage, relative to other firms without activism campaigns. These recent activism targets are substantially less likely to make acquisition bids in the three-to-four years following the campaigns. This suggests that the primary channel through which activists affect the acquisition propensity of their targets is the more disciplined capital policies resulting from their campaigns.

Taken together, our results suggest that activists perform an important governance role in the market for corporate control by disciplining inefficient acquirers. Hence, one of the sources of value creation in hedge fund activism is lower value destruction associated with empire building.

The complete paper is available for download here.

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