Activist Arbitrage in M&A Acquirers

Wei Jiang is the Arthur F. Burns Professor of Free and Competitive Enterprise at Columbia Business School; Tao Li is Assistant Professor of Finance at University of Florida Warrington College of Business; and Danqing Mei is a Ph.D. candidate in Finance at Columbia 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 Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

In our paper, Activist Arbitrage in M&A Acquirers, we study a relatively new activist investor strategy in which investors adopt a non-conventional risk arbitrage strategy in the acquirer firms of announced M&A deals. Recall that, in a conventional risk arbitrage, an investor takes a long position in the target after an M&A deal is announced, sometimes accompanied by a short position in the acquirer. The investor bets on the completion of the deal (and will vote her shares for the deal) and profits from the price spread convergence. In contrast, in an “activist M&A arbitrage,” an investor takes a long position in the announced acquirer, aiming at upsetting an announced deal that is expected to be value destroying by using her shareholder rights.

While M&As usually benefit target shareholders thanks to a takeover premium, the effect on acquirer shareholders is far more ambiguous. A large body of research demonstrates that managers’ desire for private gains, e.g., empire building desire, may lead to acquisitions that are value-destroying for the shareholders in public corporations due to a lack of synergy and/or overpayment for the targets. Acquisitions often do not require a shareholder vote, or when they do, the voting outcome is usually confirmatory in the absence of a public dissenting voice. Therefore, without an activist leading the opposition, even deals that may not be in the acquiring shareholders’ interests usually complete under the management-proposed terms. A new form of “activist arbitrage” in acquirers arises when shareholder activism spreads to M&A activities and blends with traditional risk arbitrage. Between 2000 and 2017, we find that 76 activists challenged 58 public acquirers by exercising their shareholder rights; they advocated for modifications to the announced deals (i.e., lowering the bids), or even for terminating deals for which the price was perceived as too high or the promised benefits doubtful.

The average (median) percentage stake that activist arbitrageurs take in an acquiring firm is 7.2% (6.7%), and the average (median) dollar investment amounts to $259.7 ($81.0) million. This level of ownership is sizable but represents minority stakes, consistent with that in the general activism space. The median duration between deal announcement and initial disclosure of activist ownership is 52 days, and the median duration between initial disclosure of activist holdings and deal resolution is 80 days. In 62% of the targeted deals, shareholder approval is required, because the transactions result in new stock issuances that are 20% or more of the number of shares outstanding.

The most common tactics employed by the activists include: (1) public criticism of the transaction through letters addressed to the acquirer’s board and/or shareholders, usually accompanied by press releases or attachments to Schedule 13D filings (47 deals); (2) proxy solicitation intended to veto the deal (17 deals, 14 of which involved proxy contests); (3) proposing alternative acquisitions (4 deals); and (4) lobbying proxy advisory firms like ISS and Glass Lewis in order to influence their institutional shareholder clients.

Our analysis shows that targeted mergers are significantly more likely to be stock deals, reflecting the fact that only stock deals may require a shareholder vote, and so activists could threaten to block a deal more effectively. The acquirers are more likely to encounter takeover defenses and compete with concurrent bidders. Most importantly, these acquirers have a track record of poor returns on their invested capital. All these characteristics are associated with a heightened risk of overpaying, inefficiency, and, consequently, lower returns for acquirers, as shown in prior studies. In 36% of all targeted deals, activist arbitrageurs manage to block the deals; in comparison, the matched sample without activist intervention has a 91% completion rate. In an additional 17% of the cases, activists are successful in pushing to make the terms more favorable to the acquirers, including lowering the bids. On average, activist arbitrageurs earn a risk-adjusted return that is 6.0 percentage points higher than the matched sample in the post-deal announcement time period. Presumably, the superior returns also accrue to the long-term shareholders of the acquirers. In fact, the market reacts positively to the disclosure of activist involvement: the average abnormal return measured over the 20-day window around the disclosure date amounts to 5.7%.

Because the issuance of over 20% of outstanding stock necessitates voting approval by a majority (or supermajority) of acquirer shareholders, activists’ relationships with leading proxy advisory firms, notably ISS and Glass Lewis, is of particular interest in this setting. We find that ISS and Glass Lewis rarely recommend against a deal in the absence of any public dissent by acquirer shareholders. For example, for the non-event control sample, ISS (Glass Lewis) issues “Against” recommendations only 2.3% (7.5%) of the time; while for the event sample, ISS (Glass Lewis) gives negative recommendations in 44% (31%) of the time. When ISS (Glass Lewis) issues a “Against” recommendation, the shareholder approval rate is 52.0% (64.7%), as compared to 86.0% (78.1%) upon a positive recommendation.

The complete paper is available for download here.

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