1. Aims and objectives
Hedge funds are becoming more popular in last few decades. Investors in hedge fund seek to achieve absolute return above the benchmark of risk-free rate (Goetzmann and Ross, 2000).
Hedge fund activism, as a positive strategy, has attracted the attention of fund managers. It is a new form of corporate governance, which can trigger reforms in corporate operations and financial regulation. Klein and Zur (2006) defined hedge fund activism as a strategy in which a hedge fund purchases 5% or more stake of a publicly listed company with an intention to influence the company's policies.
Until now some researches have done about the effects of hedge fund activism on operating performance of target firms, but results are inconclusive. Whether hedge fund activism is a hero or a villain to companies from different industries remains controversial. The present research study has been aimed at reviewing the operating performance of firms post-intervention by hedge funds activist. This research has further attempted to investigate and test if there are any significant deviations in the impact of activists on financial performance of target firms from different industries in the US."
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Stakeholders, investors, fund managers are supposed to be interested in this investigation result. The firms’ performance is directly affected stakeholders’ benefits, while for investors and fund managers, this will help them well hedged their funds.
2. Literature review
2.1 The purpose of hedge fund activism
According to Schedule 13D, the purposes of hedge fund transaction include: change board of directors’ composition, firm should pursue strategic alternatives, oppose a merger, sell the firm or merge with another company, buy more stock with intention of buying the firm, firm should buyback its own stock, get list of shareholders, support management, become an active investor, expresses concerns with corporate governance, replace the CEO, cut CEO’s salary, firm should pay a cash dividend and other reasons.
2.2 The impact of hedge fund activism on target companies
1. Negative effect of hedge fund activism
Klein and Zur (2006) found EPS and ROA decline in the fiscal year after the activism and conclude that hedge funds do not improve the accounting performances of firms in the year after the initial activism event. In 2011, they further examined that hedge fund activism significantly reduces bondholders’ wealth.
In addition, Chen and Jung (2016) examined whether activist hedge funds affect firms' disclosure decisions. The result is that firms are more likely to cease providing financial guidance or reduce the information in the guidance in the quarter after new investment by activist hedge funds.
2. Positive effect of hedge fund activism
Based on the researches did by Brav et al. in 2008, 2010, and 2017, activist hedge funds have lots of positive effect on target firms. They found that there was abnormal return around the announcement of activism with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. Additionally, firms targeted by activists improve their innovation efficiency over the five-year period following hedge fund intervention.
Klein and Zur (2009) found after hedge fund activism, there are significantly positive returns of target firms over the subsequent year, and the activist has high success rate in achieving its original objective.
Aslan and Kumar (2014) found that activist funds have significant wealth effects on product markets.
Bebchuk et al. (2014) found that activism target firms underperform their peers at the time of intervention, but that performance increases steadily in the following five years. In 2015, they tested whether hedge funds activism has a long-term positive effect on companies and their shareholders. The conclusion is that no evidence that activist interventions, followed by short-term gains in performance, come at the expense of long-term benefits.
The methodology is aimed at examining the impact of hedge fund activism on target firm’s financial performance from different industries. The hypothesis is as follows:
H1: Financial performance of target company post-involvement by hedge fund activists is not affected by industry type
1. Data and Ratio Analysis
Pre-intervention and post-intervention financial performance ratios will be extracted from Compustat database and the average ratios for each industry will also be computed. Average ratios prior and after activists’ intervention will be compared to see if there is any statistically significant change in financial performance due to hedge fund activism, using “paired sample t-test” at confidence level of 0.05.
This research will make use of three types of financial ratios:
- First, profitability ratios measure a company’s ability to generate profit. Profit margin (net income divided by revenue), return on assets (net income divided by average total assets), return on equity (net income divided by average shareholders’ equity) and dividend payout ratio (dividend paid divided by net income) will be examined in this research.
- Second, activity ratios measure how efficient the assets are utilized to generate revenue. Fixed asset turnover ratio (revenue divided by average fixed assets) will be examined in this research.
- Third, liquidity ratios measure the ability of a company to meet its short-term financial obligations. Current ratio (current assets divided by current liabilities) and quick ratio (sum of receivables, cash, and marketable securities divided by current liabilities) will be examined in this research.
2. Regression Analysis
Dummy variables regression will be used to help draw a further conclusion on which industry is mostly impacted by hedge fund activism. The regression model is in the following form:
Where Y is the average industry-adjusted level of financial ratios (industry-adjusted PM, ROE, ROA, DP, AT, CR), which is the difference between the firm’s level and the industry’s mean or median level (Gompers et al.,2003). Dj,t is dummy variables which equals to one if j is the same as t in one industry, otherwise, it equals to zero. If one industry is largely affected, the parameter βj should be significantly different from zero.
4. Data description
SEC Regelation 13-D requires every investor who acquires a beneficial ownership of more than 5 percent of a publicly traded security to file a holding report with the SEC. Brav et al. (2008a) rely on the information from both SEC filings and Factiva's news search for the coding of the key aspects of events, such as announcement date, ownership stake, goals, managerial responses, and results. This paper will use the same procedure, hand collecting data for events from 2015 to 2016.
In addition, each target firm will be matched by industry, using the Fama and French (1997) classifications, size, as measured by revenues and market-to-book ratio.
Data on the financial performance ratios from 2013 to 2018, up to two years prior and two years after the intervention event, for each targeting firm will be extracted from Compustat database.
5. Proposed structure
The dissertation is presented in six sections as follows:
- Literature review
- Methodology and hypotheses
- a) sample
- b) analysis
- Limitations and conclusions
- Aslan, H., Kumar, P. (2014). The Product Market Effects of Hedge Fund Activism.
- Bebchuk, L. A., Brav, A., & Jiang, W. (2015). The long-term effects of hedge fund activism (No. w21227). National Bureau of Economic Research.
- Brav, A., Jiang, W., & Kim, H. (2010). Hedge fund activism: A review. Foundations and Trends in Finance, 4(3), 185-246.
- Brav, A., Jiang, W., Ma, S., & Tian X. (2017). How does hedge fund activism reshape corporate innovation? Journal of Financial Economics.
- Brav, A., Jiang, W., Partnoy, F., & Thomas, R. (2008). Hedge fund activism, corporate governance, and firm performance. The Journal of Finance, 63(4), 1729-1775.
- Chen, J., & Jung, M. J. (2016). Activist hedge funds and firm disclosure. Review of Financial Economics, 29, 52-63.
- Goetzmann W. N., Ross S. A. (2000). Hedge Funds: Theory and Performance.
- Gompers, P. A., lshii, J. L., & Metrick, A. (2003). Corporate Governance and Equity Prices. Financial Institutions Center.
- Hoffmann, C. P., Brønn, P. S., & Fieseler, C. (2016). A Good Reputation: Protection against Shareholder Activism. Corporate Reputation Review, 19(1), 35-46.
- Kahan, M., & Rock, E. B. (2009). Hedge funds in corporate governance and corporate control (Vol. 389, No. 461, pp. 389-461). ROUTLEDGE in association with GSE Research.
- Klein, A., & Zur, E. (2006). Hedge Fund Activism. Working Paper. European Corporate Governance Institute and New York University.
- Klein, A., & Zur, E. (2009). Entrepreneurial shareholder activism: Hedge funds and other private investors. The Journal of Finance, 64(1), 187-229.
- Klein, A., & Zur, E. (2011). The impact of hedge fund activism on the target firm's existing bondholders. Review of Financial Studies, 24 (5): 1735-1771.