Governance under the Gun: Spillover Effects of Hedge Fund Activism

Tuesday November 19, 2013
  • Working Paper

Hedge fund activism is an important monitoring mechanism associated with substantial improvements in the governance and performance of targets. In this paper, we investigate whether the managers of peer firms view activism in their industry as a threat, and undertake real policy changes to mitigate that threat. We find that they do – industry peers with fundamentals similar to those of previous targets reduce agency costs and improve operating performance along the same dimensions as the targets. These effects are distinct from those of product market competition or time-varying industry conditions, and are anticipated by the market as evidenced by increased valuations. Finally, we show that these policy and valuation improvements lower the peers’ ex-post probability of being targeted, suggesting that this “do-it-yourself” activism is indeed effective. Taken together, our results imply that shareholder activism, as an external governance device, reaches beyond the target firms.