Yes, activist hedge funds are good at pushing companies to sell themselves — but that’s about it, according to a researcher of financial economics.
Managers of activist hedge funds are “more or less impotent to effect meaningful change” at companies, J.B. Heaton, an attorney and former professor at the business and law schools of University of Chicago and Duke University, wrote in a paper this month. Many had expected this group to create “economically-meaningful improvements” at companies, succeeding where activist shareholders such as pension funds failed based on research through the mid-2000s, according to his paper.
“Yet a decade’s worth of research now shows hedge fund activism to be a mostly ankle-biting affair,” Heaton said in the paper. “Hedge fund activists are neither the threat to corporate strength that opponents decry nor the power for positive change that activists and their supporters claim.”
They have failed to become a “meaningful force” for improving the operations and share prices of companies they target partly because they have “no comparative advantage in generating ideas” for meaningful change beyond a sale, according to the paper. “Of course, selling the firm – especially for more than it is worth – is good for target shareholders,” Heaton wrote.
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There are other reasons for hedge funds’ mostly disappointing performance in shareholder activism, including excessive pessimism, according to Heaton’s paper.
They “likely suffer from a form of winner’s curse” in being too pessimistic about the companies they aim to shake up with their activist campaigns, he wrote. The hedge fund with the most pessimistic view of a target is the one likely to emerge as an activist at the company. But the most pessimistic hedge fund activist is unlikely to be a good match for “realistic and good ideas” for change at the business it's targeting, according to Heaton.
Then there are the high hopes for a company that’s targeted too late.
“Hedge fund activists often target declining firms, the equity in which is often unsalvageable by the time the activist has taken notice,” Heaton said in the paper. “These distressed corporations are frequently beyond salvage without a bankruptcy reorganization, so the efforts of activists at these corporations are often unsuccessful.”
The unfulfilled promise of hedge funds as successful activist shareholders hasn’t kept investors from believing in them, though, according to Heaton.
“The most prominent activists appear able to keep substantial assets under management despite mediocre returns relative to much cheaper index investing,” Heaton said. “But while fools and their money will always find a path away from each other, hedge fund activism mostly has turned out to be economically unimportant, neither particularly harmful, nor particularly useful.”