Activism pressure and the market for corporate assets

The rise of shareholder activism, and its recent international expansion, have led researchers to look at many aspects of hedge fund activism. Academic papers have almost exclusively focused on the effects on firms targeted in activist campaigns. But the intense and sustained presence of hedge fund activists in many industries and markets makes it likely that activism produces effects beyond those on activism target firms. The real effects of activism on other firms, stakeholders, institutions, and markets remain largely unexplored.

Our paper attempts to make headway in this direction by exploring the impact of hedge fund activism on markets for corporate transactions, in particular in markets with heavy exposure to activists. We try to answer the following questions: Does activism affect the acquisition and asset sale decisions of firms that are only indirectly affected by activists? Has activism grown sufficiently in importance that it influences the equilibrium in corporate asset markets, and what is its impact on the liquidity and efficiency of these markets? Our paper is the first to consider the impact of activism threats (rather than actual campaigns) on corporate acquisitions and sales, and the first to explore the effect of activism on the equilibrium outcome in asset markets.

We take into account a wide range of corporate transactions: takeovers and mergers, divestitures, and acquisitions, including acquisitions of private targets. In line with earlier studies[1], we find that firms directly targeted in activist campaigns are more likely to receive merger bids, make more divestitures, and make fewer acquisitions. We show that the reduction in the number of acquisitions is due to larger firms doing fewer deals, while  smaller firms show no significant change.

We then consider that activism should also affect the acquisition and divestiture behavior of firms under threat of future activist campaigns. The idea that managers adjust their behavior in anticipation of increased activism is related to the disciplining effect in the market for corporate control. There is some evidence that activism threats can exert disciplining effects,[2] but no earlier study has tried to estimate such effects on the acquisition and divestiture behavior of firms. We consider the impact of these threats on individual firms, by estimating the probability of their becoming an activist target in the near future, as well as on industries  (3-digit SIC codes), using as our measures the frequency of recent activist campaigns in an industry and the increase in the stakes of activist hedge funds in that industry.

We show that firms facing the threat of activism behave in the same way that activist targets do: They sell more assets, are more likely to be acquired, and on average also tend to acquire less. The latter effect, however, is nuanced: Only large firms make fewer acquisitions, whereas small firms maintain or increase their acquisition activity.

Taken together, our results show that there are two channels through which activism pressure operates: through target firms and through firms under activism threat. In a typical industry, only a few  activist targets  change their behavior dramatically, whereas many firms are exposed to activism threats, with moderate impact on behavior. In our next step, we try to find out which of these two channels has a larger effect on corporate transaction markets. We find that the overall impact that we attribute to firms under activism threats is about the same as that attributed to activist targets, with a larger relative effect on the demand side (acquisitions), and a smaller effect on the supply side (mergers and divestitures).

We estimate that firms in industries in the top quintile of activism pressure sell on average about 23 percent more assets and make close to 12 percent fewer acquisitions, leading to a roughly 35 percent combined shift in the relation between demand and supply for corporate assets. We expect this squeeze in real asset liquidity to have an effect both on transaction volume and prices.

Hence, we consider the impact on liquidity in highly affected industries. When firms in an industry under activism pressure simultaneously aspire to sell more, and buy fewer, assets, then real asset liquidity dries up, creating a role for outside liquidity providers. Indeed, we find that outside acquirers –  private equity funds, private firms, and listed firms in other industries – provide liquidity and that their acquisition volume increases in affected industries. We show that this difference is due to private equity providing asset liquidity only in industries whose assets can be readily redeployed and that outside asset liquidity provision is stronger in these industries.

We then explore whether the squeeze in asset liquidity also affects transaction prices. We find that the returns on a seller’s shares after the announcement of a transaction are smaller in industries under activist pressure (merger bids and divestiture bids), and the returns on buyer shares are slightly larger. We do not find a similar price effect for activist target firms – thus, unlike other firms in industries under heavy activist pressure, activist target firms themselves are not affected.

Finally, we consider whether activism pressure improves the efficiency of corporate transactions, in the sense of transactions creating more long-term value. We find positive long-term performance effects when activist targets engage in transactions. We do not find similar effects for transactions involving companies under activist threat. The direct involvement of activists appears to be a necessary ingredient for activism pressure to produce additional efficiency gains.

Endogeneity is a concern in any study on the impact of activism. Activism targets might be selected because of unobserved characteristics that drive the observed changes in firm behavior, or because activists anticipate value-enhancing developments in those firms. We address these concerns in various ways. First, for target firms we look at the effect when a hedge fund switches from a sizable passive stake in a given firm (Schedule 13G filing) to an activist stance (Schedule 13D filing). We show that such switches produce a significant change in firms’ corporate transactions in the same direction we found earlier. Second, for firms under activism threat, we eliminate any effect of unobserved firm-level characteristics beyond those common to all firms in the industry by our use of industry-level measures of hedge fund pressure that are based on the premise that all firms in an industry face the same threat level.  Third, we deploy an instrumental variable that aims at eliminating any possible selection bias resulting from hedge funds picking specific industries (because, for example, industries might experience an unrelated change in deal activity). The instrumental variable is built on episodes when a hedge fund experiences a large fund inflow, and neutralizes the fund’s decision how to allocate the inflow across industries. Our findings are unchanged when we use this instrument.

ENDNOTES

[1]  See Gantchev, Gredil, and Jotikasthira (2017) and Feng, Xu, Zhu (2017).

[2]  See Boyson, Gantchev, and Shivdasani (2017), Becht, Franks, Grant, and Wagner (2017), and Gantchev, Sevilir, and Shivdasani (2018).

REFERENCES

Becht, Marco, Julian Franks, Jeremy Grant, and Hannes F Wagner, 2017, Returns to hedge fund activism: An international study, The Review of Financial Studies 30, 2933{2971.

Boyson, Nicole M, Nickolay Gantchev, and Anil Shivdasani, 2017, Activism mergers, Journal of Financial Economics 126, 54{73.

Feng, Felix Zhiyu, Qiping Xu, and Heqing Zhu, 2017, Caught in the cross-fire: How the threat of hedge fund activism affects creditors, Working Paper.

Gantchev, Nickolay, Oleg Gredil, and Chotibhak Jotikasthira, 2017, Governance under the gun: Spillover effects of hedge fund activism, SSRN Working Paper.

Gantchev, Nickolay, Merih Sevilir, and Anil Shivdasani, 2018, Activism and empire building, ECGI Finance Working Paper 575/2018.

This article first appeared on the CLS Blue Sky Blog
http://clsbluesky.law.columbia.edu/2019/01/23/activism-pressure-and-the-market-for-corporate-assets/