Before COVID-19 halted the global economy, European regulators watched closely as activist hedge funds increased the number of campaigns against public companies in the region. Activists have been a prominent feature of U.S. capital markets, but are relatively new to Europe.
Rodolphe Durand, a professor at business school HEC Paris, told Institutional Investor that the increase in activity prompted him and Mark DesJardine, a professor at Pennsylvania State University’s Smeal College of Business, to undertake research to assess the long-term impact of financial and non-financial campaigns on public companies.
The two professors found that hedge fund activism leads to a decline in the market value of targeted companies and a decrease in the performance of social responsibility goals four and five years after the third parties intervened in these companies compared to similar firms that weren’t on the radar of activists.
Durand, professor of strategy at HEC Paris and academic director of the school’s Society and Organizations Center, and Penn State’s DesJardine, professor of strategy and sustainability, studied 1,324 publicly-owned U.S. firms that have been the target of at least one activist between 2000 and 2016.
According to the research, the value of activist-targeted companies increases 7.7 percent within the first 12 months of being the subject of a campaign. Four years later, however, the value of these companies drops by 4.9 percent.
Within five years of being targeted, the average company sheds 7 percent of its employees and cuts operating expenses and research and development by 6.6 percent and 9 percent, respectively.
“The bump comes early and then after that the market value is lower,” said Professor Durand, in an interview. “And we see that restructuring [prompted by activists] leads to employee losses,” he added.
The study supports anecdotal evidence that activists are “hollowing out” companies in myriad ways beyond just negative impacts on stock prices and market capitalization.
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In their study, the researchers compared the 1,324 targeted companies’ financial results with a control group of more than 7,600 firms that were operating during the same time period. They also compared the companies to 1,300 similar businesses that were not the target of activists.
“With hedge fund activism on the rise, determining the consequences of equity ownership by activist hedge funds on target companies’ short‐term and long‐term financial and social performance takes on central importance,” wrote the professors.
As for why firms do worse than peers in the longer term, Durand can only guess at the reasons, at least at this point. “Maybe there is some disengagement by employees, who suffer in a new environment,” he said.
Regulators may ultimately enact new rules to rein in activists. “Some people from market regulators have been interested in this research. Activists here are fairly new and regulatory agencies are asking how to tackle hedge fund activists,” said Durand.
Activists, however, may go away, given the chaos in global markets. These hedge funds are looking for companies to change their management, restructure or sell off underperforming divisions in order to get a stock price pop. Many companies right now are fighting to stay alive.