The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance

Hedge fund activism has increased almost hyperbolically. Although some view this trend optimistically as a means for bridging the separation of ownership and control, we review the evidence and find it far more mixed. In particular, engagements by activist hedge funds appear to be producing a significant externality: severe cut-backs in long-term investment (and particularly a reduction in investment in research and development) by both the targeted firms and other firms not targeted but still deterred from making such investments. We begin by surveying the regulatory and institutional developments that have reduced the costs and increased the expected payoff from activism for activist investors. We give particular attention to new tactics (including the formation of “wolf packs†—loose associations of activist funds that do not constitute a “group†under the Williams Act) and new institutional structures (such as the alliance between an activist hedge fund and a strategic bidder struck in the recent Allergan takeover battle). Then, we survey the empirical evidence on how the investment horizons of firms are changing. Next, we review prior studies on the impact of activism, looking successively at (1) who are the targets of activism?; (2) does hedge fund activism create real value?; (3) what are the sources of gains from activism?; and (4) do the targets of activism experience post-intervention changes in real variables? We find the evidence decidedly mixed on most questions. Finally, we examine the policy levers that could encourage or curb hedge fund activism and consider the feasibility of reforms (including with respect to the law on insider trading). In particular, we consider possible private ordering responses, including new defensive tactics. Our policy preference is to find the least restrictive alternative.