Activist Hedge Funds Can Smell Greenwashing, Study Finds

Hedge funds are going after firms that announce environmental, social, or governance plans — but not the ones that take them seriously.

Bloomberg Creative Photos

Bloomberg Creative Photos

Companies implementing social responsibility plans are twice as likely to enter activist hedge funds crosshairs as firms that are not addressing these issues. But management teams that are truly serious, not just greenwashing, about environmental, governance and other impact goals, may be able to avoid luring activists, according to new academic research.

Investors are increasingly deploying money via ESG and impact frameworks. Even Jeff Ubben, founder of $16 billion ValueAct Capital, is quitting to start an impact fund. Skeptics have long believed that a financial crisis would reduce the amount of attention paid to what are often considered soft issues like board diversity or the environmental impact of manufacturing plants. But investors have actually doubled down on ESG strategies since the pandemic shut down economies in March.

For companies wanting to get in on those capital flows (or do the right thing), the new study sheds light on how activists may react to ESG initiatives.

“We asked, ‘Is corporate social responsibility (CSR) a signal, according to hedge fund activists, that a firm is over-investing in long-term projects?’” said Rodolphe Durand, professor of strategy at HEC Paris and a co-author of the research, in an interview. “It could be for the simple reason that CSR is about long-term projects. If I’m an activist, and if I want a return over the next 18 months, I can think this firm is thinking too far down the road. I can get them to make changes that are profitable to me because they are not necessarily maximizing short-term shareholder value.”

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The study, evaluating data on U.S.-based activist campaigns from 2000 to 2016, found that hedge funds are significantly more likely to target companies that have a strong performance record in corporate social responsibility. In fact, the likelihood of a company being targeted increased from 3 percent to 5 percent if their CSR scores rose by two standard deviations above the average. If companies are trying to do the right thing in industries that have historically not addressed environmental, social, or governance issues, they’re even more likely to be in the sight lines of activists, according to the study.

Durand said it comes down to activists believing that these initiatives are a waste of money and that management is distracted from their core duty of maximizing profits. But he said there is good news for companies that want to pursue ESG without luring activists: be serious about it.

Although social responsibility can put an target on a company’s back, management teams that clearly articulate their operational and financial strategies for impact and ESG initiatives have a better chance of escaping an activist campaign than those who are vague about their plans.

“Vague financial communication strengthens the relationship between a firm’s CSR activities and the likelihood that this firm will be targeted by an activist hedge fund,“ wrote the authors in the study.

To assess a company’s seriousness and clarity of its plans, the authors used natural language processing to analyze the words that managers used to describe their ESG plans during conference calls. If managers frequently used vague words (measured as a percentage of overall language used) like would, should, and could as well as future tenses — signaling that ESG work may be years off — then they were more likely to be attacked by activists.

Durand said the lessons of the study are important in light of his previous research, showing that market value of companies targeted by activists increases in the first two years after a campaign. But after that, they underperform peers that have been left alone. “There’s a 25 percent differential,“ Durand pointed out. He added that management should do whatever it can to prevent activists from gaining a foothold.

“Firms are more likely to be attacked if they showcase CSR strategies, but especially if they greenwash. Take note.”