Shareholder Activism by Hedge Funds: Motivations and Market’s Perceptions of Hedge Fund Interventions by Mihaela Butu

Shareholder Activism by Hedge Funds: Motivations and Market’s Perceptions of Hedge Fund Interventions by Mihaela Butu

1 Introduction 
For more than two decades shareholder activism has been part of the United States’ corporate 
governance landscape, affecting legal and financial decisions. This phenomenon generated a 
prompt academic response resulting in a series of empirical research contributions trying to 
assess the real impact of shareholder interventions. Yet, the views on whether shareholder 
activism enhances the value of target firms are mixed. The positive assessment of investor 
activism is based on the belief that it can provide an effective monitoring of the management 
of publicly listed companies, reducing agency costs. The logic of this conviction is based on 
the fact that institutional shareholders, owning large blocks, have an incentive to develop 
specialized expertise in assessing and monitoring investments (Bainbridge, 2005) and they are 
able “to absorb the costs of watching the management” (Shleifer & Vishny, 1986, p. 462). 
These features, coupled with their voting power, enable them to intervene and to initiate 
changes in the companies when they perform poorly or when the maximization of shareholder 
value is not pursued. On the other hand, there is increasingly more evidence suggesting that 
“shareholder activism, in general, has little effect on the target firm’s values, earnings, or 
operations” (Song & Szewczyk, 2003, p. 318) and that it “will not solve the principal-agent 
problem […] but rather will shift the focus on that problem” (Bainbridge, 2005, p. 1). 
Furthermore Romano claims that the empirical literature “presents an apparent paradox: 
Notwithstanding commentators' generally positive assessment of the development of such 
shareholder activism, the empirical studies suggest that it has an insignificant effect on 
targeted firms’ performance” and some studies find “a significant negative stock price effect 
from activism” (Romano, 2001, p. 4). 
However, it seems that the “playing field” of activism has changed and actors other than the 
pension and mutual funds are increasingly involved in activism, namely hedge funds. Hedge 
funds are considered to have better incentives to monitor a company’s management and board 
than other financial intermediaries, due to their unique organizational structure (Clifford, 
2008). The critical role played by hedge funds in corporate governance is reflected by their 
involvement in some large companies that have captured public attention. Thus, in 2005 
McDonald’s became a target of activist hedge funds who pressured the management to spin-

off 65% of company-owned restaurants and borrow USD 14.7 billion against its real estate 
(CFO, 2005). In the same year, the prominent hedge fund manager Carl Icahn asked Time 
Warner to split the company’s component businesses, to initiate a USD 20 billion share 
buyback and then started a proxy fight against the management (SEC, 2005; CNN Money, 
2006). And finally, hedge funds opposed the acquisition of the remaining 58% stake in Chiron 
Corporation by Novartis, in 2006 (SEC, 2006; CNN Money, 2006). 
Although shareholder activism in general and hedge fund activism in particular were not an 
issue on the German corporate market, no later than 2005 hedge fund activism became a 
subject of public attention. It was in the case of the German Stock Exchange’s attempt to 
acquire the London Stock Exchange, which failed (for the second time) because of the 

opposition of the London-based hedge fund, The Children’s Investment Fund Management 
(TCI). The fund argued that the transaction would not enhance shareholder value and instead 
the Exchange should buy shares back (Kahan & Rock, 2006). TCI was then supported by 
Atticus Capital who “accused the exchange of "empire building" at the expense of its share-

holders” (Financial Times, 2005). This marks the moment when German public opinion 
became aware of the potential influence of hedge fund activists and they received the epithet 
“locust” (The Economist, 2009). 
Even though the hedge fund industry was weakened by losses and cash outflows as a result of 
the late-2000s financial crisis, since 2009 hedge funds seem to have developed new interest 
for German companies and made investments in Rheinmetall (Greenlight Capital), Heidel-

bergCement (Paulson & Co.) and Gerresheimer (Sageview Capital, Pennant Capital, Eton 
Park, Brett Barakett) without revealing the purposes of their investments (Böhm & Grote, 
2009). Yet, there are few empirical studies which focus on effects of hedge fund activism on 
the German market in particular.
Since hedge funds are able to influence decision making in publicly listed companies, the 
public opinion of hedge fund activism is controversial. The main criticism is based on the 
accusation of short-termism and value destruction by distracting managers from long-term 
projects (Kahan & Rock, 2006). However, recent empirical studies (e.g., Brav, Jiang, Thomas, 
& Partnoy, 2008; Clifford, 2008; Klein and Zur, 2009) show the opposite, arguing that hedge 
funds may be able to perform better monitoring of management, leading to a reduction in 
agency costs and thus creating value at the target firms. 
While this paper is not able to clarify this dispute, it analyses the proposals made by hedge 
funds when acquiring large shares of voting rights in listed companies, for a better under-

standing of the motivations behind hedge funds’ activism and the market’s perception of 
interventions. More precisely, this study addresses some of the main questions regarding 
shareholder activism performed by hedge funds: How does the market react to the announce-

ment of activism? Does hedge fund activism create value in target firms? What type of 
activism are hedge funds performing, or, in other words, what types of demand do hedge 
funds bring forward and how does the market assess them? 
In addressing these questions the announcements of activism by hedge funds in the United 
States are analysed in a time period between 1994 and 1996. As soon as a hedge fund surpas-

ses the 5% ownership threshold in a publicly traded company, it must file a regulatory 
disclosure with the U.S. Securities and Exchange Commission (SEC). Investors who intend to 
influence the firm or who have future plans to do so file a Schedule 13D, thus signalling their 
activist intentions. Consequently, the first indication of the impact of hedge fund activism is 
derived from the market’s reaction to these filings. The findings show that the market res-

ponds positively to activism, resulting in average abnormal stock returns of 2.18% within a 
short 20-day interval around the announcement. These results are in line with evidence 
provided by Greenwood and Schor (2009) and Clifford (2008), who observed 3.61% and

Shareholder Activism by Hedge Funds: Motivations and Market’s Perceptions of Hedge Fund Interventions by Mihaela Butu