It is shaping up to be another banner year for activist hedge funds, investors who acquire big stakes in underperforming companies to pressure for changes in direction, strategy or management. But while activist funds are no longer derided as "corporate raiders" looking for a quick payday, there is plenty of argument about whether their campaigns improve target companies' profitability and stock performance in the long term.
Much of that debate takes place in academia -- often via competing blog posts on the Harvard Law School Forum on Corporate Governance and Financial Regulation. But it is hardly academic. According to various estimates, activist hedge funds managed more than $90 billion in assets at the end of 2013, a growing portion of that money coming from pension funds and other institutional investors.
The growth of activist funds' assets could accelerate if policy makers become convinced that activist investing promotes the long-term value of public companies and enact rules that make it easier for future activists to win board seats and otherwise agitate for change.
This would please some investor rights advocates a great deal. In a February 15 editorial, the Economist lobbied for British-style policies that would allow easier votes on ousting board members and the elimination of "poison pills" and other anti-takeover measures.
"Rather than making life harder for activists, America's regulators should make it easier," the Economist wrote, saying that activists as a rule generated "much-needed debate about strategy and leadership" that can benefit companies.
To back up its view, the Economist cited a study that has become a focal point of the debate over the merits of activist investing. First published last July by Harvard Law Professor (and corporate governance guru) Lucian Bebchuk and two colleagues, the paper claims to be the first to look at the long-term effects of hedge fund activism on U.S. companies.
The researchers studied all 2,000 interventions by activist hedge funds from 1994 through 2007, finding no evidence that target companies' operating performance or stock prices suffered in the five years following the announcement of an activist fund campaign. On the contrary, the companies tended to do better after an activist fund's intervention than during the three years beforehand.
In addition, Bebchuk and his colleagues said the same positive effects occurred for companies subject to the "most resisted and criticized" types of activist interventions: those that "lower or constrain long-term investments by enhancing leverage, beefing up shareholder payouts, or reducing investments;" and hostile interventions. Finally, the study found no evidence of "pump-and-dump" patterns where stock prices collapsed after activists left the scene.
In short, Bebchuk and his fellow researchers found that activist interventions increased both the performance and stock value of target companies over a five-year period, even accounting for the familiar spike in share prices after a hedge fund's intentions are announced.
"The Long-Term Effects of Hedge Fund Activism" responded directly to a challenge issued by opponents of activist funds, chief among them Martin Lipton of Wachtell Lipton, a vocal critic of efforts to expand shareholder rights.
Basing his argument on anecdotal evidence gleaned from 30 years of advising corporations, Lipton argues that activist funds significantly harm companies: diverting important resources to governance initiatives, promoting short-term results and their own interests over those of shareholders in general.
"Activist hedge funds typically focus on immediate steps, such as leveraged recapitalization, a split-up of the company or sales or spinoffs of assets or businesses that may created an increase in the company's near term stock price, allowing the activist to sell out at a profit, but leave the company to cope with the increased risk and decreased flexibility that these steps may produce," Lipton wrote in a blog post.
The facts say otherwise, according to Bebchuk. "Our findings indicate that policy makers and institutional investors should not accept assertions that activist interventions are detrimental in the long run," he wrote in an op-ed about the study published in The Wall Street Journal. "Such claims should be rejected as a basis for limiting the rights and powers of public-company shareholders."