When activist hedge funds intervene at portfolio companies,
company managers often take defensive action.
Managers at these firms are likely to strategically change
voluntary disclosure practices and earnings management
strategies in order to protect against heightened career and
reputation risks, according to forthcoming research in academic journal Management
The findings, from authors Inder Khurana of the University
of Missouri-Columbia, Yinghua Li of Arizona State University,
and Wei Wang of Temple University, emerge as a handful of big
companies find themselves in the crosshairs of high-profile
activists. Pershing Square CEO Bill Ackman is already saying
his firms latest target, ADP, will likely need a new CEO, while
industrial parts company Arconic has only recently settled with
activist Elliot Management after a lengthy proxy fight.
The studys authors said companies embroiled in these
types of battles become more likely to withhold bad news and
use earnings management techniques to inflate their reported
financial performance. The research was based on a study of 510
companies targeted by 191 activist hedge funds, using data from
U.S. regulatory filings and management earnings forecasts.
Bad news disclosures send an adverse signal of firm
performance to the market, which gives hedge funds an upper
hand in corporate control contests and puts target firm
managers in a more vulnerable position, they wrote.
In an effort to maintain control and job security, target
firm managers are more likely to refrain from releasing bad
news prematurely during hedge fund interventions.
Khurana, Li, and Wang found that disclosure of bad news had
real adverse consequences for company executives and increased
the chances of CEO and CFO turnover.
[II Deep Dive: What Makes a Firm a Target for
While the authors noticed no increase in the disclosure of
good news, they suggested this was because good news
disclosures create an optimistic expectation that is difficult
to achieve, adding, Failure to meet their own
forecasts reflects poorly on managers ability, tarnishing
managers reputation in the labor market and, in the
context of our study, provides activist hedge funds with more
firepower to push their activism agenda.
As for earnings management, the trio said firms targeted by
activists were more likely to adopt strategies like cutting
discretionary expenses and temporarily boosting sales.
By resorting to bad news withholding and real earnings
management as substitutive strategies, the authors
concluded, target firm managers attempt to maintain
corporate control and alleviate reputational and career
concerns evoked by hedge fund activism.