Hostile takeovers have long been considered the quintessential disciplinary governance mechanism, but a similarly confrontational strategy has lately come to prominence by way of activist hedge funds that buy into poorly run firms and use the threat of hostile tactics to pressure management into accepting specific proposals to improve shareholder value. This paper compares these two governance mechanisms within a unified framework where any outside investor—bidder or activist—faces a dual free-rider problem since target shareholders neither contribute to the cost of intervention nor sell their shares unless the price fully reflects the anticipated value improvement.

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The board is commonly described as a monitor of management on behalf of dispersed shareholders, but fundamental aspects of exactly how and when it adds value, are still open questions (Adams, Hermalin and Weisbach (2010)). While boards help to solve managerial agency problems, they also entail costs by introducing an additional agency layer to the organizational structure. The trade-offs between costs and benefits are, however, obscured because the statutory law, in any jurisdiction, does not only mandate the board but also prescribes its powers and duties.

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