Research Papers - Hedge Funds

Governance under the Gun: Spillover Effects of Hedge Fund Activism

by Nick Gantchev, Pab Jotikasthira, and Oleg Gredil
Working Paper 2015

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.

Short Selling Risk

by Adam Reed, Joseph Engelberg, and Matthew Ringgenberg
Working Paper 2014

Short sellers face unique risks, such as the risk that stock loans become expensive and the risk that stock loans are recalled. We show that these short selling risks affect prices among the cross-section of stocks. Stocks with more short selling risk have lower returns, less price efficiency, and less short selling.

Hedge Fund Activists: Do They Take Cues from Institutional Exit?

by Nick Gantchev and Pab Jotikasthira
R&R at JF 2014

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.

How are Shorts Informed? Short Sellers, News and Information Processing

by Adam Reed, Joseph Engelberg, and Matthew Ringgenberg
Journal of Financial Economics Issue 105 No.2 2012

We find that a substantial portion of short sellers' trading advantage comes from their ability to analyze publicly available information. Using a database of short sales combined with a database of news releases, we show that the well-documented negative relation between short sales and future returns is twice as large on news days and four times as large on days with negative news. Further, we find that the most informed short sales are not from market makers but rather from clients, and we find only weak evidence that short sellers anticipate news events. Overall, the evidence suggests that public news provides valuable trading opportunities for short sellers who are skilled information processors.

Are Hedge Funds Systemically Important?

by Prof. Gregory Brown, John Hand, and Jeremiah Green
Journal of Derivatives Issue 20 No.2 2012

Using a proprietary and unusually comprehensive database of hedge fund returns, we seek to identify abnormal performance consistent with opportunistic trading (e.g., bear raids) or synchronized actions (e.g., widespread forced liquidations) that could generate systemic risk. We find no evidence that hedge funds systematically benefit from opportunistic trading. In contrast, some funds operating with strategies that commonly utilize leverage (e.g., fixed income arbitrage and event-driven strategies) perform significantly worse than would be expected given ex ante risk-factor loadings. This suggests that forced liquidations probably caused some funds to sell into a falling market at fire sale prices. However, underperformance is not concentrated in specific funds that use leverage or during the height of the systemic risks in September 2008 indicating that selling pressure likely derives from meeting redemptions versus forced selling during the crisis. These results suggest new policies regulating hedge funds should focus on certain fund-level risks instead of strategy or industry risks.

Hedge Funds as Investors of Last Resort?

by Paige Ouimet, David J. Brophy, and Clemens Sialm
Review of Financial Studies Issue 22 No.2 2009

Hedge funds have become important investors in public companies raising equity privately. Hedge funds tend to finance companies that have poor fundamentals and pronounced information asymmetries. To compensate for these shortcomings, hedge funds protect themselves by requiring substantial discounts, negotiating repricing rights, and entering into short positions of the underlying stocks. We find that companies that obtain financing from hedge funds significantly underperform companies that obtain financing from other investors during the following two years. We argue that hedge funds are investors of last resort and provide funding for companies that are otherwise constrained from raising equity capital.

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