Tag: Hedge funds


2015 Year-End Activism Update

Barbara L. Becker is partner and co-chair of the Mergers and Acquisitions Practice Group at Gibson, Dunn & Crutcher LLP, and Eduardo Gallardo is a partner focusing on mergers and acquisitions, also at Gibson Dunn. The following post is based on a Gibson Dunn M&A Client Alert. The full publication, including charts and survey of settlement agreements, is available here.

This post provides an update on shareholder activism activity involving domestically traded public companies with market capitalizations above $1 billion during the second half of 2015, together with a look back at shareholder activism throughout 2015. While many pundits have suggested shareholder activism peaked in 2015, shareholder activism continues to be a major factor in the marketplace, involving companies of all sizes and activists new and old. Activist funds managed approximately $122 billion as of September 30, 2015 (vs. approximately $32 billion as at December 31, 2008). [1] In 2015 as compared to 2014, we saw a significant uptick in the total number of public activist actions (94 vs. 64), involving both a higher number of companies targeted (80 vs. 59) and a higher number of activist investors (56 vs. 34). [2]

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The New Paradigm for Corporate Governance

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum. 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 The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here). Critiques of the Bebchuk-Brav-Jiang study by Wachtell Lipton, and responses to these critiques by the authors, are available on the Forum here.

Since I first identified a nascent new paradigm for corporate governance with leading major institutional investors supporting long-term investment and value creation and reducing or eliminating outsourcing to ISS and activist hedge funds, there has been a steady stream of statements by major investors outlining the new paradigm. In addition, a number of these investors are significantly expanding their governance departments so that they have in-house capability to evaluate governance and strategy and there is no need to outsource to ISS and activist hedge funds. The following is a summary consolidation of what these investors are saying in various forums.

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Activist Hedge Funds, Golden Leashes, and Advance Notice Bylaws

Matteo Tonello is managing director of corporate leadership at The Conference Board. This post relates to an issue of The Conference Board’s Director Notes series authored by Jason D. Schloetzer of Georgetown University. The complete publication, including footnotes, is available here. For details regarding how to obtain a copy of the report, contact matteo.tonello@conference-board.org. 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 The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

The tactics used by activist hedge funds to target companies continue to command the attention of corporate executives and board members. This post discusses recent cases highlighting activist efforts to replace directors at target companies. It also examines the use of controversial special compensation arrangements sometimes referred to as “golden leashes,” the arguments for and against such payments, their prevalence, and the parallel evolution of advance notification bylaws (ANBs) to require disclosure of third party payments to directors.

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Reply

Martijn Cremers is Professor of Finance at the University of Notre Dame; Erasmo Giambona is Associate Professor of Finance and Real Estate at the University of Amsterdam; Simone M. Sepe is Professor of Law and Finance at the College of Law at the University of Arizona; and Ye Wang is a PhD Candidate in the Department of Finance at Bocconi University. This post responds to a post, titled The Long-term Effects of Hedge Fund Activism: A Reply to Cremers, Giambona, Sepe, and Wang, by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (available on the Forum here). The post by Professors Bebchuk, Brav, Jiang and Keusch replied to the criticism of the study on The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here) that was put forward in a paper by Cremers, Giambona, Sepe and Wang discussed in this post.

In a December 10, 2015 post to the Harvard Corporate Governance Blog, Professors Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (“BBJK”) suggest that a study the four of us have recently coauthored, Hedge Fund Activism and Long-Term Firm Value (the “CGSW study”), “overlooks prior opposing evidence on the subject, offers a flawed empirical analysis, and makes [contradictory] claims.” For these reasons—BBJK unequivocally conclude—the CGSW study’s claims “should be given no weight in the ongoing examination of hedge fund activism.” We are thankful to BBJK for the time spent analyzing our work and the occasion they have provided us to offer a few clarifications. Hopefully, those clarifications will add clarity to our attempt at better understanding the effects of hedge fund activism, which is what, ultimately, we should all care about.
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The Long-term Effects of Hedge Fund Activism: A Reply to Cremers, Giambona, Sepe, and Wang

Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School; Alon Brav is Professor of Finance at Duke University; Wei Jiang is Professor of Finance at Columbia Business School; and Thomas Keusch is Assistant Professor at the Erasmus University School of Economics. This post relates to a recent article, Hedge Find Activism and Long-Term Firm Value, by Cremers, Giambona, Sepe, and Wang, which was recently made publicly available on SSRN. This post is related to the study on The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here).

This post replies to a study by Cremers, Giambona, Sepe, and Wang (“the CGSW Study”), Hedge Find Activism and Long-Term Firm Value. The CGSW study, which has recently been publicly released on SSRN and simultaneously announced in a Wachtell Lipton memorandum, aims at contesting existing evidence on the long-term effects of hedge fund activism. As we explain below, the paper overlooks prior opposing evidence on the subject, offers a flawed empirical analysis, and makes claims that are contradicted by its own reported evidence. Furthermore, the paper’s conclusions are inconsistent not just with our work, but with a large body of empirical studies by numerous researchers. CGSW’s claims, we show, should be given no weight in the ongoing examination of hedge fund activism.

In a paper titled The Long-Term Effects of Hedge Fund Activism, (“the LT Effects Study”), three of us tested empirically the “myopic activism claim” that has long been invoked by opponents of shareholder activism. According to this claim, hedge fund activism produces short-term benefits at the expense of long-term value. The LT Effects Study shows that the myopic activist claim is not supported by the data on targets’ Tobin’s Q, ROA, or long-term stock returns during the five years following the activist intervention.

CGSW focus on one part of the results of the LT Effects Study—those concerning Q (financial economists’ standard metric of firm valuation). Accepting that industry-adjusted Tobin’s Q improves in the years following activist interventions, CGSW assert that what has been missing is a comparison of how activist targets perform relative to a matched sample of similarly underperforming firms. CGSW claim that their matched sample analysis shows that the Q of activist targets improves less in the years following the intervention than the Q of matched control firms and that activism therefore decreases, rather than increases long-term value. Although CGSW do not look at stock returns, their conclusions imply that the announcement of an activist intervention represents “bad news” for investors that should be expected to be accompanied immediately or ultimately by negative stock returns for the shareholders of target companies.

Below we in turn comment on:

(i) Our obtaining different results than those reported by CGSW when applying CGSW’s empirical methodology to the same data;

(ii) The inconsistency of CGSW’s claims with some of their own reported results;

(iii) CGSW’s puzzling “discovery” of a well-known selection effect;

(iv) CGSW’s failure to engage with prior work conducting matched sample analysis and reaching opposite conclusions;

(v) CGSW’s flawed empirical methodology;

(vi) The inconsistency of CGSW’s conclusions with the large body of evidence on stock returns accompanying activist interventions; and

(vii) CGSW’s implausible claim that activist interventions have destroyed over 50% of the value of “innovative” target firms.

Although CGSW direct their fire at the Long-Term Effects Study, the discussion below explains that their conclusions are inconsistent not just with this study but with a large number of empirical studies by numerous researchers, including the many studies cited below.

CGSW’s Data and Results

The CGSW paper is based on a dataset of activist interventions that two of us collected and that the LT Effects Study used. Although we are still working with the data to produce additional papers, we agreed to provide the authors with our data to facilitate research in this area. To our surprise, the authors did not provide us an opportunity to comment on their paper before making their paper public, and we first learnt about the paper from Wachtell Lipton’s memorandum announcing it.

Although we view the empirical procedure used by CGSW as flawed, we have attempted to replicate their results using our data (which CGSW used), following the procedure described in their paper and making standard choices for elements of the procedure that the paper does not fully specify. Doing so, we have obtained results that are very different from those of CGSW.

We asked the authors to provide us with the list of the matched sample companies used in their tests. Even though their paper is based on data we shared with them, CGSW declined to provide us with the requested list and stated that they would not do so prior to the publication of their paper in a journal (which might be many months away).

Claims Inconsistent with CGSW’s Own Results

CGSW claim that their matched sample analysis shows that “firms targeted by activist hedge funds improve less in value … than similarly poorly performing firms that are not subject to hedge fund activism.” However, the patterns displayed in the authors’ key Figure 1 do not support this central claim.

This Figure 1, which we reproduce below, reports industry-adjusted Tobin’s Q for firms targeted by hedge funds (blue graph) and industry-adjusted Tobin’s Q for the matched control firms (paired with the target firms by CGSW) during the years before and after the year at which target firms became a target.

Although the authors state that the Figure “confirms” their conclusions, it does not appear to do so. The Figure vividly shows that targets’ valuation increases more sharply than that of matched control firms that are not subject to hedge fund activism during the years following time t (denoting the end of the intervention year).

CGSW might argue that, although target valuation increases more sharply relative to matched control firms from time t (the end of the intervention year) forward, the activist intervention is responsible for the short-term decrease in value relative to control firms that targets experience from time t-1 (the beginning of the year of the intervention) to time t (the end of the year of the intervention). However, this short-term decrease is likely to at least partly precede the intervention and thus be a potential cause rather than a product of it. Furthermore, while opponents of hedge fund activism have been seeking to ground their opposition in claims regarding long-term effects, we are unaware of any claims by such opponents that such activism decreases value in the short term, and the well-documented stock market gains accompanying announcements of activist interventions would make such a claim implausible.

Indeed, CGSW themselves explain that the view that is empirically supported by their paper is that hedge fund interventions pressure management to produce short-term gains that come “at the potential expense of long-term performance.” This view implies a short-term increase in valuation followed by a decline in valuation during the years following the intervention year. The clear improvement in target valuation (relative to control firms) from time t forward displayed in Figure 1 thus contradicts CGSW’s claims and conclusions.

Tobin’s Q around the start of activist hedge fund campaigns (sample of all hedge funds campaigns)

cremers1

Source: Cremers et al., November 2015, page 44.

Although the inconsistency of CGSW’s claims with their own Figure 1 is worth noting in assessing CGSW’s paper, we should stress that, due to the methodological problems noted below, we otherwise do not attach weight to the authors’ results, including those in Figure 1.

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Some Thoughts for Boards of Directors in 2016

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Steven A. Rosenblum, and Karessa L. Cain. 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 The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

 

Over the last two decades, the corporate governance landscape has become increasingly dominated by the view that maximizing the power and influence of shareholders will lead to stronger and better-governed companies. The widespread dismantling of staggered boards and change-of-control defenses, the promulgation of say-on-pay and other governance mandates, and the proliferation of best practices are largely premised on this shareholder rights manifesto. In the aggregate, the changes have been transformative and have precipitated a sea change in the gestalt of Wall Street. Hedge fund activism has exploded as an asset class in its own right, and even the largest and most successful companies are vulnerable to proxy fights and other activist campaigns. In response to short-termist pressures brought by hedge funds and activist shareholders, companies have been fundamentally altering their business strategies to forego long-term investments in favor of stock buybacks, dividends and other near-term capital returns. At this point, theoretical debates about the pros and cons of a shareholder-centric governance model have been superseded by observable, quantifiable trends and behaviors. For example, according to Standard & Poor’s, dividends and stock buybacks in the U.S. totaled more than $900 billion in 2014—the highest level on record, and last December, a Conference Board presentation compiled data demonstrating that capital investment by U.S. public companies has decreased and is less than that of private companies.

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Is 2015, Like 1985, an Inflection Year?

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton. 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 The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

In an October 2015 post, I posed the question: Will a New Paradigm for Corporate Governance Bring Peace to the Thirty Years’ War? As we approach the end of 2015, I thought it would be useful to note some of the most cogent recent developments on which the need, and hope, for a new paradigm is based. These developments include, among other things, the accumulation of a critical mass of academic research that discredits the notion that short-termism, activist attacks and shareholder-centric corporate governance tend to create rather than destroy long-term value.
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Insider Trading and Tender Offers

Christopher E. Austin and Victor Lewkow are partners focusing on public and private merger and acquisition transactions at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum.

Valeant’s hostile bid for Allergan was one of 2014’s most discussed takeover battles. The situation, which ultimately resulted in the acquisition of Allergan by Actavis plc, included a novel structure that involved a “partnership” between Valeant and the investment fund Pershing Square. In particular, a Pershing Square-controlled entity having a small minority interest owned by Valeant, acquired shares and options to acquire shares constituting more than nine percent of Allergan’s common stock. Such purchases were made by Pershing Square with Valeant’s consent and with full knowledge of Valeant’s intentions to announce a proposal to acquire Allergan. Pershing Square and Valeant then filed a Schedule 13D and Pershing Square then supported Valeant’s proposed acquisition. Ultimately Pershing Square made a very substantial profit on its investment when Allergan was sold to Actavis.

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The Product Market Effects of Hedge Fund Activism

Praveen Kumar is Professor of Finance at the University of Houston. This post is based on an article authored by Professor Kumar and Hadiye Aslan, Assistant Professor of Finance at Georgia State University, available here. 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.

Whether intervention by activist investors, such as hedge funds, is beneficial or detrimental to the shareholders of target firms remains controversial. Proponents marshal considerable empirical evidence that hedge fund activism (HFA) is associated with significant medium-to-long-run improvements in targets’ cost and investment efficiency, profitability, productivity, and shareholder returns. Opponents, however, insist that HFA forces management to take myopic decisions that weaken firms in the longer run. The debate rages in academia, media, and has already featured in the 2016 presidential campaign.

Despite this intense interest, however, the research on the effects HFA has typically focused only on its impact on the performance of target firms. But targets of HFA do not exist in vacuum; they have industry competitors, suppliers, and customers. It is by now well known that HFA has a broad scope that often—simultaneously or sequentially—touches on virtually every major aspect of company management, including changes in product market strategy, negotiation tactics with suppliers and customers, and knowledge-based technical advice of production organization. In particular, HFA that improves target’s cost efficiency and product differentiation, and generally redesigns its competitive strategy, should have a significant impact on the target’s competitors (or rival firms). This prediction follows from basic principles of strategic interaction among firms in oligopolistic interaction. Indeed, the received theory of industrial organization provides the effects of cost improvements and product differentiation on rivals’ equilibrium profits and market shares.

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Deal Activism

Adam O. Emmerich is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz focusing primarily on mergers and acquisitions and securities law matters. This post is based on a Wachtell Lipton publication authored by Mr. Emmerich, William SavittRonald C. ChenEdward J. LeeSabastian V. Niles, and Remi KorenblitRelated research from the Program on Corporate Governance about hedge fund activism includes: The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

In today’s robust M&A environment, parties to a potential merger or acquisition must anticipate and manage “deal activism.” Just as all companies and boards should prepare for shareholder activism generally, deal participants should plan for the possibility that, after a deal is announced, activists may seek a higher price, encourage a topping bid for all or part of the company, dissent and seek appraisal, try to influence the combined company and its integration, or even try to scuttle a deal entirely, leveraging traditional disruptive activist campaign tactics in their efforts.

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