Tag: Innovation


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.

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)


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.


Insider Trading and Innovation

Ross Levine is Professor of Finance at the University of California, Berkeley. This post is based on an article authored by Professor Levine; Chen Lin, Professor of Finance at the University of Hong Kong; and Lai Wei of the School of Economics and Finance at the University of Hong Kong.

In our paper, Insider Trading and Innovation, which was recently made publicly available on SSRN, we investigate the impact of restricting insider trading on the rate of technological innovation. Our research is motivated by two literatures: the finance and growth literature stresses that financial markets shape economic growth and the rate of technological innovation, and the law and finance literature emphasizes that legal systems that protect minority shareholders enhance financial markets. What these literatures have not yet addressed is whether legal systems that protect outside investors from corporate insiders influence a crucial source of economic growth—technological innovation. In our research, we bridge this gap. We examine whether restrictions on insider trading—trading by corporate officials, major shareholders, or others based on material non-public information—influences technological innovation.


13(d) Reporting Inadequacies in an Era of Speed and Innovation

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on a Wachtell Lipton publication by Mr. Katz and Laura A. McIntosh. The complete publication, including footnotes, is available here. Related research from the Program on Corporate Governance includes 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.

The Securities and Exchange Commission and other market regulators confront a challenging issue: How to effectively monitor and regulate activity in an environment that is both fast-moving and highly complex? The principles and architecture of the Securities Exchange Act of 1934 were created for a much simpler financial world—an analog world—and they struggle to describe and contain the digital world of today. The lightning speed of information flow and trading, the constant innovations in financial products, and the increasing sophistication of active market participants each pose enormous challenges for the SEC; together, even more so. The ongoing controversy over Section 13(d) reporting exemplifies the many challenges facing the SEC in this regard.


Development of Corporate Governance in Toulouse from 1372 to 1946

Sébastien Pouget is Professor of Finance at Toulouse School of Economics. This post is based on an article authored by Professor Pouget; David Le Bris, Assistant Professor of Finance at KEDGE Business School; and William Goetzmann, Professor of Finance at Yale University.

In our recent NBER working paper, The Development of Corporate Governance in Toulouse 1372-1946, we study the birth and evolution of the oldest shareholding companies in the world: the grain-milling companies of Toulouse. Shareholding companies that began in the 11th century formally incorporated themselves into two large-scale, widely held firms: the Bazacle Company (1372) and the Castel Company (1373). In the years that followed, they experienced the economic challenges and conflicts we now recognize as inherent in the separation of ownership and control.

The historian of law, Germain Sicard, in his 1953 landmark study of the Toulouse companies in the Middle Ages that has recently been translated in English by the Yale University Press, shows that they resembled modern corporations in many respects. We build upon the archival research by Sicard and extend the analysis of the archives of these early firms from the 16th through the 19th centuries in order to trace the evolution of corporate governance mechanisms over the “longue durée.”


Corporate Venture Capital, Value Creation, and Innovation

The following post comes to us from Thomas Chemmanur, Professor of Finance at Boston College; Elena Loutskina of the Finance Area at the University of Virginia; and Xuan Tian of the Finance Department at Indiana University.

There is no doubt that innovation is a critical driver of a nation’s long-term economic growth and competitive advantage. The question lies, however, in identifying the optimal organizational form for nurturing innovation. While corporate research laboratories account for two-thirds of all U.S. research, it is not obvious that these innovation incubators are more efficient than independent investors such as venture capitalists. In our paper, Corporate Venture Capital, Value Creation, and Innovation, forthcoming in the Review of Financial Studies, we explore this question by comparing the innovation productivity of entrepreneurial firms backed by corporate venture capitalists (CVCs) and independent venture capitalists (IVCs).


Financial Dependence and Innovation

The following post comes to us from Viral Acharya, Professor of Finance at NYU, and Zhaoxia Xu of the Department of Finance and Risk Engineering at NYU.

While innovation is crucial for businesses to gain strategic advantage over competitors, financing innovation tends to be difficult because of uncertainty and information asymmetry associated with innovative activities (Hall and Lerner (2010)). Firms with innovative opportunities often lack capital. Stock markets can provide various benefits as a source of external capital by reducing asymmetric information, lowering the cost of capital, as well as enabling innovation in firms (Rajan (2012)). Given the increasing dependence of young firms on public equity to finance their R&D (Brown et al. (2009)), understanding the relation between innovation and a firm’s financial dependence is a vital but under-explored research question. In our paper, Financial Dependence and Innovation: The Case of Public versus Private Firms, which was recently made publicly available on SSRN, we fill this gap in the literature by investigating how innovation depends on the access to stock market financing and the need for external capital.


Corporate Takeovers and Economic Efficiency

The following post comes to us from B. Espen Eckbo, Professor of Finance at the Tuck School of Business at Dartmouth College.

In the paper, Corporate Takeovers and Economic Efficiency, written for the Annual Review of Financial Economics, I review recent takeover research which advances our understanding of the role of M&A in the drive for productive efficiency. Much of this research places takeovers in the context of industrial organization, tracing with unprecedented level of detail “who buys who” up and down the supply chain and within industrial networks. I also review recent research testing the rationality of the bidding process, including whether the sales mechanism promotes a transfer of control of the target resources to the most efficient buyer. This literature draws on auction theory to describe optimal bidding strategies and it uses sophisticated econometric techniques to generate counterfactuals, exogenous variation, and causality. The review is necessarily selective, with an emphasis on the most recent contributions: half of the referenced articles were drafted or published within the past five years.


The New Financial Industry

The following post comes to us from Tom C.W. Lin of Temple Law School.

The recent discussions surrounding Michael Lewis’s new book, Flash Boys, revealed a profound and uncomfortable truth about modern finance to the public and policymakers: Machines are taking over Wall Street. Artificial intelligence, mathematical models, and supercomputers have replaced human intelligence, human deliberation, and human execution in many aspects of finance. The modern financial industry is becoming faster, larger, more complex, more global, more interconnected, and less human. An industry once dominated by humans has evolved into one where humans and machines share dominion.


Motivating Innovation in Newly Public Firms

The following post comes to us from Nina Baranchuk and Robert Kieschnick, both of the Finance and Managerial Economics Area at the University of Texas at Dallas, and Rabih Moussawi of the Wharton School at the University of Pennsylvania.

How do shareholders motivate managers to pursue innovations that result in patents when substantial potential costs exist to managers who do so? This question has taken on special importance as promoting these kinds of innovations has become a critical element of not only the competition between companies, but also the competition between nations. In our paper, Motivating Innovation in Newly Public Firms, forthcoming in the Journal of Financial Economics, we address this question by providing empirical tests of predictions arising from recent theoretical studies of this issue.