The activists are taking on Washington.

Billionaire investors Paul Singer, Carl Icahn, Barry Rosenstein, William Ackman andDaniel Loeb are setting aside their political differences to launch a Washington-based lobbying group to fight mounting attacks on shareholder activism.

Dubbed the Council for Investor Rights and Corporate Accountability, or Circa, it is the first coordinated effort by activists to make their case to lawmakers and the American public that their investment strategy helps, rather than harms, companies and the U.S. economy.

The lobbying push comes as debate over the merits of activist investing spills over into the presidential campaign. Hillary Clinton last year proposed changing the tax code to crack down on “hit and run” activists. In March, Bernie Sanders, Mrs. Clinton’s rival for the Democratic presidential nomination, co-signed legislation aimed at their ability to buy stakes and influence companies.

Activist investors have targeted some of the biggest companies in the U.S., from Apple Inc. to Procter & Gamble Co. to Dow Chemical Co., agitating for an array of changes designed to boost shareholder value.
Circa’s five backers together manage about $90 billion. The group’s message to lawmakers: Activist investors, as owners of the companies they target, are spurring a debate about corporate decision making that has the potential to benefit all shareholders and, by extension, the broader economy.

“We’re telling a story about an ecosystem and how they help America and make it a competitive system,”

said Rob Collins, a political strategist who is advising Circa.

 

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Co-authors of “Top Hedge Funds: The Importance of Reputation in Shareholder Activism,” which found that

“The most reputed hedge funds have more assets under management, a longer track record of activism, a history of obtaining board seats, and invest in targets with the intent of making board changes.

Top activists’ reputations prove to have been deserved: their targets enjoy superior operating performance post intervention.”

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We test the empirical validity of a claim that has been playing a central role in debates on corporate governance — the claim that interventions by activist hedge funds have a detrimental effect on the long-term interests of companies and their shareholders. We subject this claim to a comprehensive empirical investigation, examining a long five-year window following activist interventions, and we find that the claim is not supported by the data.

We find no evidence that activist interventions, including the investment-limiting and adversarial interventions that are most resisted and criticized, are followed by short-term gains in performance that come at the expense of long-term performance. We also find no evidence that the initial positive stock-price spike accompanying activist interventions tends to be followed by negative abnormal returns in the long term; to the contrary, the evidence is consistent with the initial spike reflecting correctly the intervention’s long-term consequences. Similarly, we find no evidence for pump-and-dump patterns in which the exit of an activist is followed by abnormal long-term negative returns.

Our findings have significant implications for ongoing policy debates. Policymakers and institutional investors should not accept the validity of the assertions that activist interventions are costly to firms and their shareholders in the long term; such claims do not provide a valid basis for limiting the rights, powers, and involvement of shareholders.

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The Securities and Exchange Commission (SEC) is currently considering a rulemaking petition requesting that the Commission shorten the ten-day window, established by Section 13(d) of the Williams Act, within which investors must publicly disclose purchases of a five percent or greater stake in public companies. In this Article, we provide the first systematic empirical evidence on these disclosures and find that several of the petition’s factual premises are not consistent with the evidence.

Our analysis is based on about 2,000 filings by activist hedge funds during the period of 1994–2007. We find that the data are inconsistent with the petition’s key claim that changes in market practices and technologies have operated over time to increase the magnitude of pre-disclosure accumulations, making existing rules “obsolete” and therefore requiring the petition’s proposed “modernization.” The median stake that these investors disclose in their 13(d) filings has remained stable throughout the 17-year period that we study, and regression analysis does not identify changes over time in the stake disclosed by investors. We also find that:

A substantial majority of 13(d) filings are actually made by investors other than activist hedge funds, and these investors often use a substantial part of the ten-day window before disclosing their stake.

Even when activists wait the full ten days to disclose their stakes, their purchases seem to be disproportionately concentrated on the day they cross the threshold and the next day; thus, the practical difference in pre-disclosure accumulations between the existing regime and the rules in jurisdictions with shorter disclosure windows is likely much smaller than the petition assumes.

About ten percent of 13(d) filings seem to be made after the ten-day window has expired; the SEC may therefore want to consider tightening the enforcement of existing rules before examining the proposed acceleration of the deadline.

Our analysis provides new empirical evidence that should inform the SEC’s consideration of this subject — and a foundation on which subsequent empirical and policy analysis can build.

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The debate about whether U.S. public companies are afflicted by short-termism rather than more beneficial longer-term behavior and, if so, its effect on our economy is ubiquitous. It occupies increasing attention in corporate board rooms, executive suites and investment management businesses from the smallest to the largest. The debate is a commonplace topic in the legal and academic worlds as well as the financial press, and it is rapidly spreading to more general news outlets and the political scene—to the point where at least one Presidential candidate has made the debate a focal point of her tax reform platform.

A complicating factor in the debate is that there is no consensus about what short-term and long-term refer to. Is or should the debate be about:

• investor behavior (e.g., short-term traders versus long-term holders),
• investor objectives (e.g., increases in portfolio value in the short-term at the cost of foregoing better long-term fund performance),
• corporate behavior (e.g., focusing on short-term profitability to meet or better quarterly performance goals to the detriment of greater long-term profitability), or
• corporate objectives and strategy (e.g., engaging in financial engineering to generate short-term value creation, thereby precluding long-term investment in building the business through research and development, improved plants and production methods or product and market expansion)?

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This paper studies how hedge fund activism reshapes corporate innovation.

We find that firms targeted by hedge fund activists experience an improvement in innovation efficiency after intervention.

Despite reduction in R&D expenditures, target firms experience increases in innovation output (measured by both patent counts and citations), with stronger effects seen among firms starting with more diversified innovation portfolios. We further show that the reallocation of innovative resources and the redeployment of human capital contribute to the refocusing of the scope of innovation and lead to gains in efficiency. Finally, we establish that the link between hedge fund interventions and improvements in innovation efficiency is a by-product of asset reallocations triggered by activist interventions at the target firms.

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We summarize and synthesize the results from 67 studies that examine the consequences of shareholder activism for targeted firms, and draw two primary conclusions.

First, activism that adopts some characteristics of corporate takeovers, especially significant stockholdings, is associated with improvements in share values and firm operations.

Activism that is not associated with the formation of ownership blocks is associated with insignificant or very small changes in target firm value. Second, shareholder activism has become more value increasing over time.

Research based on shareholder activism from the 1980s and 1990s generally finds few consequential effects, while activism in more recent years is more frequently associated with increased share values and operating performance. These results are consistent with Alchian and Demsetz’ (1972) argument that managerial agency problems are controlled in part by dynamic changes in ownership, and with Alchian’s (1950) observation that business practices adapt over time to mimic successful strategies.

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Over the past two decades, hedge fund activism has emerged as new form of corporate governance mechanism that brings about operational, financial and governance reforms to a corporation. Many prominent business executives and legal scholars are convinced that the entire American economy will suffer unless hedge fund activism with its perceived short-termism agenda is significantly restricted. Shareholder activists and their proponents claim they function as a disciplinary mechanism to monitor management and are instrumental in mitigating the agency conflict between managers and shareholders.

We find statistically meaningful empirical evidence to reject the anecdotal conventional wisdom that hedge fund activism is detrimental to the long term interests of companies and their long term shareholders.

Moreover, our findings suggest that hedge funds generate substantial long term value for target firms and its long term shareholders when they function as a shareholder advocate to monitor management through active board engagement.

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The rise of shareholder activism has become a global phenomenon. Shareholder activists are not only present–as they started–in the US, but also in European and Asian Markets.[1] This situation has generated a vast literature about the desirability (or not) of shareholder activism. [2] In essence, there are two main positions: (i) those who argue that shareholder activists improve the corporate governance of the firm, and therefore they help increase the value of the firm;[3] and (ii) those who claim that shareholder activists only improve the value of the firm in the short-term, and they encourage managers to cut investment in research, development and other long-term projects with higher profitability (but less liquidity) that may best contribute to the promotion of social welfare.[4]

Unlike other topics in corporate law, the discussion about shareholder activism has gone beyond the academic debate. Politicians have started to discuss about the desirability of shareholder activists, and some legislations (particularly in Europe) have even taken steps to prevent the “short-terminism” that activists investors are supposed to generate.[5] Therefore, shareholder activism has become a hot topic even for the public opinion.

Despite the disagreements about the impact of shareholders activists, most corporate law scholars seem to accept that shareholder activists help improve the corporate governance of the firm,[6] at least, if we understand corporate governance as those mechanisms consisting of aligning incentives between managers and investors.[7] Therefore, shareholder activists help increase the value of the firm, at least in the short-run. The immediate questions to be asked, then, are: (1) Does shareholder activism harm the long-term value of the firm? (2) If so, should we be worried from a policy perspective? (3) If so, what should policy-makers do?

The first question is an empirical one. So far, it is not clear the impact of shareholder activism on the long-term value of the firm. Some studies have shown that hedge fund activism does not harm the long-term value of the firm,[8] while other studies have found the opposite result.[9] However, while this question will remain empirical, what would it happen if it were confirmed that shareholders activists harm the long-term value of the firm? Should we be worried from a policy perspective? Unlike the previous question, this is a theoretical question, and it depends on the concept, nature and role of the corporation. Is the corporation a private contract among a group of investors that just creates a nexus of contracts to efficiently operate in the market? Or is it something else that should benefit a variety of stakeholders? In the former case, it is clear that the managers should act in the interest of the investors –no matter what interest is, provided that, of course, it is within the limits of the law, and minority shareholders are properly protected.^[10] Therefore, if the group of investors collectively agrees to give an instruction to the managers, they should be able to do so. Nevertheless, if we argue that a corporation is “something else” that should maximize the interest of a variety of stakeholders, it becomes more unclear to whom the directors are accountable. According to this latter perspective, a director could make a decision even when it is unwanted by the shareholders, provided that, according to its own view, it can be beneficial for “society”^[11].

To solve this dilemma, let us use a simple example. Let´s suppose that a person is the sole proprietor of a business. This person decides to hire an employee. Let´s assume that the employee will help maximize, as nobody else can, the best interest of “society”, or even the long-term value of the firm. Even if this assumption were hypothetically met, should the sole entrepreneur of the business be prohibited from firing his employee? Would it change the answer in a corporation where, as it may happen in many countries, there is a single shareholder? And what about in a corporation where the shareholders as a whole or, with the due protection of minority shareholders, the majority of the shareholders decide to fire the employee? In our opinion, denying the right to fire the employee to any of these actors may threaten some of the most elemental foundations of a modern economy: private property, liberty of freedom, and liberty of enterprise. Therefore, unless the legislator clearly defines the primary role of a corporation, and parties can adjust ex ante their business decisions, denying to the shareholders the right to decide their own interest may be harmful for society.

Indeed, a corporation is, or at least it is created by, a (private) contract. Therefore, the parties that originally (or subsequently) enter into (or join) this contract (i.e., the shareholders), should be allowed to agree, among other aspects, the goal of this contract within the limits of the laws.^[12] If the parties’ will is not respected, they may be discouraged to enter into these contracts, and if so, one of the greatest inventions of modern times for the promotion of social welfare (i.e., the corporation) may be put at risk.^[13] In other words, the imposition of a goal potentially unwanted by the shareholders may discourage the formation and financing of corporations. Therefore, this solution may be harmful for society.

In our opinion, several reasons justify the imposition, as a default rule, of the maximization of the long-term value of the firm as the legitimate goal of the corporation.^[14] However, shareholders should be able to opt out this rule.^[15] Hence, by allowing investors to change the rule whenever their expectations may differ from the maximization of the long-term value of the firm, policy makers would incentivize, in a better way, the creation and financing of enterprises, and therefore the promotion of economic growth.^[16]

However, this theoretical argument based on the contractual nature of a corporation is not the only one to support the empowerment of shareholders, even if they were short-term investors. Many other arguments have been convincingly made to support this view. First, markets should be evaluated as a whole, and therefore including all type of firms and investors.^[17] Thus, whereas a potential short-term problem may be local, does not seem to be systemic.^[18]Indeed, markets are formed by many types of investors, with different preferences in terms or risks and returns. Therefore, some investors may indeed prefer short-term profits and therefore less risky (and less profitable) projects with more liquidity, while other investors may prefer highly profitable (and highly risky) investment projects with less liquidity. Hence, a regulatory intervention imposing one type of market participants (e.g., long-term investors) may reduce the firms’ ability to raise capital, and therefore the size of the market, since there could be many investors (e.g. short-term investors) who might be reluctant to provide funds.^[19]

Second, managers serving long-term shareholders may have incentives to destroy economic value in the short-term, especially in firms which heavily buy and sell their own shares.^[20] Therefore, by favoring long-term shareholders, value can be destroyed in the short-term, at the expense of the firm´s ability to generate cash flows, to repay debts (and salaries), and to reinvest benefits in new investments opportunities that may contribute to the promotion of social welfare. Third, while it is not clear that hedge fund activism harms the long-term-value of the firm, it is generally accepted that activist shareholders reduce managerial agency costs, and therefore lead to a better alignment of incentives between managers and investors.^[21] Therefore, as shown by several studies, shareholder activists increase the value of the firm –at least, in the short-term.^[22] Fourth, some managerial mechanisms inside the corporation, such as compensation schemes, may encourage short-term profits. Therefore, insulating boards from markets would actually exacerbate, rather than mitigate, short-term profits.^[23]

Thus, several conclusions can be made regarding the role of activist investors. First, they improve the corporate governance of the firm –at least, if, as it is generally accepted, corporate governance is understood as those mechanisms consisting of aligning incentives between managers and investors. Second, hedge fund activism help maximize the short-term value of the firm. Third, it is unclear that activist investors harm the long-term value of the firm.

Finally, and perhaps more importantly, even if it were hypothetically proved that hedge fund activists (on average) encourage short-terminism, should not they be allowed, as any other investor (sole proprietor, single shareholder or shareholders as a class) to pursue their own legitimate interest, no matter what interests is, provided that it is within the boundaries of law? In our opinion, a negative answer to this question would be the real threat for the global economy.