Hedge Fund Activists: Do They Take Cues from Institutional Exit?
This paper investigates the role of institutional trading in the emergence of hedge fund activism – an important governance device associated with large improvements in the performance and governance of target firms. We find that institutional selling volume raises a firm’s probability of becoming an activist target. Institutional selling appears to accelerate the timing of a campaign at firms whose potential benefits from monitoring have already been recognized by activists rather than bring attention to firms that are not ex-ante viable targets. Further, we study the hedge funds’ accumulation of target shares at the daily frequency and find that: (i) institutional selling volume increases hedge fund buying volume, and (ii) this relationship is significantly stronger for firms with lower expected benefits from activism or lower initial activist toeholds. We use each institution’s funding circumstances as an exogenous determinant of institutional trading to identify causal effects. Taken together, our results provide empirical support to theoretical predictions that expected gains from trading with uninformed investors supplement expected returns from monitoring in determining the activist’s targeting decision.