“Management Lost Its Halo”
Menacing as the new activism may seem to management, however, a more complex picture of the phenomenon has begun to emerge. Contrary to the common portrayal of activists as short-term plunderers out for a quick buck, new research shows that they tend to hold on to their shares for a relatively long time. While some activists do harbor takeover dreams, the majority prefer to stay on as independent directors with an advisory role. Most activist hedge funds don’t seek to remove management, and many fund managers become activists only after stints as passive stockholders.
By some estimates, of the approximately 8,800 hedge funds (with combined assets of $1.2 trillion), fewer than 10 percent are activist funds, but the activist subsector is one of the fastest growing. Why the current surge? The rise has been fueled by a convergence of factors, says Goldstein, who is known for successfully suing to strike down the rule requiring hedge-fund advisers to register with the SEC. He says that increased investor skepticism is one reason for the rise of activism. “After Enron and WorldCom,” he says, “management lost its halo.” Activist hedge funds, which have been wildly successful at raising funds, are also less encumbered by the rules that make it harder for mutual funds and pension funds to influence companies. And the Internet has dramatically cut the cost of shareholder campaigns.
Most of all, the number of activist funds is burgeoning because they have been remarkably effective at making money for investors. “I think it’s simply that activists have been successful,” says Goldstein. “Success breeds imitators.” When news of potential activism breaks, the return on the investment jumps 5 to 7 percent above the norm as a result of stock-price appreciation, according to a study authored by Duke University’s Alon Brav, Columbia University’s Wei Jiang, the University of San Diego’s Frank Partnoy, and Vanderbilt University’s Randall Thomas. The gains are long-lasting. The research shows no apparent reversal of the trend for a year after the fund reveals its intentions. “The activism clearly generates a kick [in the stock price] once it’s announced, and we don’t see the price going back down,” says Brav, an associate professor of finance at Duke University’s Fuqua School of Business.
Another study shows that activist investors are remarkably successful at forcing changes at companies in which they invest. On average, the target company’s dividend per share doubles within one year of an activist hedge fund’s acquisition of at least a 5 percent stake, according to a study of 155 activist fund campaigns conducted between 2003 and 2005 by April Klein and Emanuel Zur of New York University’s Stern School of Business.
“When a hedge fund comes in,” explains Klein, “it reduces cash, increases debt, and pays out the dividend.” According to Brav and his colleagues, funds that set out to remove a CEO succeed almost 58 percent of the time. Their study found that funds that target specific goals spawn higher returns than activism stated in general terms. Hostile actions generate higher returns than friendlier measures. The biggest bang comes from dramatic strategic events like a spin-off or a company sale. But the market response to proposed capital-structure changes (debt restructuring, recapitalization, dividends, share repurchases) is “statistically insignificant,” according to the study.