How Firms Fight Back Against Activists

Companies targeted by activist hedge funds are more likely to hide bad news and use earnings management techniques to make their quarterly numbers look better, according to new research.


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 Science.

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 firm’s 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 study’s 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 Activists]

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.”