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Hedge Fund Investor Activism and Takeovers Associate Professor, Harvard Business School Robin Greenwood December 6, 2007 New York 7,000+ experts help clients analyze financial statements, dissect complex accounting, finance or tax situations, and identify accounting irregularities

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Hedge Fund Investor Activism and Takeovers

Associate Professor, Harvard Business School

Robin Greenwood

December 6, 2007

New York


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7,000+ experts help clients analyze financial statements, dissect complex accounting, finance or tax situations, and identify accounting irregularities


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Council Member Biography

Robin Greenwood is currently an Associate Professor at Harvard Business School. His research investigates the effects of market conditions on corporate financing and investment policies, and on the effects of investor demand on stock prices. His recent research on investor activism has been profiled in the Wall Street Journal, CNBC, and the Harvard Business Review. His work on stock price manipulation in Japan forecast the downfall of Livedoor, Japan’s “Enron,” and was profiled in the Wall Street Journal. Professor Greenwood received a Ph.D. from Harvard in Economics in 2002, and holds B.S. degrees in Economics and Mathematics from MIT. He teaches in the first year MBA finance curriculum, as well as developing a new MBA course on value investing.


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Topics

  • The impact of activism strategies on shareholder value

  • The operating policy or governance changes vs. acquisition efforts

  • Indications that activism is most successful when there is a high probability of a takeover

  • The future of activism as an investment strategy


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Investor Activism and Takeovers

Robin Greenwood

Harvard Business School

Michael Schor

Morgan Stanley

GLGi Seminar

December 6, 2007


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Investor Activism

  • In widely held firm, no individual investor has incentive to monitor management. Easier for investors to “move with their feet” than to engage in costly monitoring.

  • The presence of large shareholder may alleviate this problem. Large shareholder does not have to share all benefits of his/her work.

  • In practice, large shareholders like mutual funds and pension funds communicate frequently with management.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Investor Activism in Historical Perspective

  • Ineffective (Karpoff 2001; Romano 2001).

  • Shareholder proposals have done little to affect firms’ performance (Karpoff et al 1996; Wahal 1996; Gillan and Starks 2000).

  • Mutual funds are averse to engaging in activism.

  • A few institutions, like Calpers, have had successful activist campaigns.

  • Why not effective? Davis and Kim (2005) hypothesize conflicts of interest.

  • Hedge funds, in contrast, do not face these conflicts.

  • Growth of hedge fund capital → increase in activist strategies.

  • Brav et al (2007), Klein and Zur (2007), Becht et al (2007), Clifford (2007) analyze returns to hedge fund activism.

  • These papers document (1) abnormal returns; (2) operational changes, in target firms. Maybe hedge funds are the answer?


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Activist Filings 1994-2006

Hedge Funds

Others

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Activist Filings 1994-2006

  • Similar growth of activism in Europe

  • Expect to see more activism when value stocks are cheap.

Hedge Funds

Others

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

This Paper

  • We question idea that activist investors create value by instituting corporate governance changes, or strategic change.

  • Our premise: Activist investors want to exit position as quickly as possible, at a premium to the price they paid, without facing the price pressure of selling. (Takeover)

  • Our findings:

    • Returns accrue to shareholders only when targets are taken over.

    • Activists increase conditional probability of takeover.

  • Consistent with hedge funds own characterizations of their work.

  • Findings verified in a series of interviews / casework with activist investors in the US and UK.

  • Provides for a consistent account of changes in value of activist portfolios in August 2007.

  • More pessimistic view of role of hedge funds in corp. governance.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Takeaways

  • Investor activism, and hedge fund investor activism in particular, is a form of arbitrage.

    • Take an undervalued asset, and transform it into an asset that investors are willing to pay more for.

    • Easiest way to do this: buy a minority stake (<10%) and get another investor to takeover the company and pay a majority stake price for your shares.

  • Different view of activism than perpetuated in popular press, or recent academic work.

  • Back of the envelope: Activists increase probability of takeover by roughly 12 %.

    12% x 40% takeover premium = 5% event return

  • Prediction 1: Success of activism will depend, in large part, on overall takeover interest in market.

  • Prediction 2: Announcement returns to activism will fall.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Approach

  • Assemble comprehensive database of hedge fund filings between 1994 and 2006. 800-990 incidents.

  • Classify events on both an ex-ante (demands), and ex-post basis (outcomes).

  • Analyze returns conditional on both types of classifications.

  • Analyze operating performance conditional on outcome.

  • Other papers: Analyze average returns, and average operating performance. Miss point that most significant outcome is for firms that drop out of the sample!

    • Our results differ most significantly from other papers when we look at returns separated based on ex-post classification.

    • Suggests that ex-ante classification (based on what the activist asks for) does not do a terrific job.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Our Data

  • On attaining a 5% stake, SEC requires a 13D to be filed within 10 days.

  • We study 1994-2006

  • 13D versus 13G

  • All 13D Filings available electronically +

    All DFAN materials by non management: 173,078

  • Portfolio Investors Only (13F):20,771

  • Parse to find activist events (manual): 990

  • Search process yields approximately twice as many events as other papers.

  • Classify filers into hedge funds, and non hedge funds.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Our Data in Greater Detail…

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Hedge funds are smaller and take more concentrated positions

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Both hedge funds and non hedge funds target smaller firms

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Activism targets are “value” stocks that have performed poorly relative to industry

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Stock Returns around Activism

  • Goal: Measure abnormal performance, controlling for performance of “market” during event.

  • Pre-estimate factor loadings:

    R(i,t) = a + b(Rm-Rf) + cSMB+dHML+u(i,t)

    Where Rm-Rf = Market Factor

    SMB = Small stock returns minus large stock returns

    HML = Value minus Growth stock returns

  • Use estimated factor loadings to calculate benchmark returns during event window.

  • Activism targets tend to load on “Value” characteristic.

  • Calculate abnormal returns around event.

    R(abnormal) = R(Activist stock) – R(Benchmark)

  • Aggregate abnormal returns in event time.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

(Abnormal) Stock Returns around Activism

Daily

Monthly

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

(Abnormal) Stock Returns around Activism

Daily

Monthly

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Daily

Monthly

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Daily

Monthly

Post-activism drift!

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Classifying Events

  • First set of classifications based on what the activists ask for in the 13D filing, purely from “Purpose of Transaction” Section.

  • Exclude filing amendments with essentially similar content.

  • Exclude several hundred Gabelli “events”.

  • Include follow-on filings as separate events, if nature of activism has changed.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Classifying Events

  • First set of classifications based on what the activists ask for:

1160 =

990 Events + Overlap

811 Distinct target-fund matches

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Classifying Events

  • First set of classifications based on what the activists ask for:

  • Most common complaints are “undervalued,” “corporate governance,” and “asset sale.”

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Table IV: Daily Returns

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Table V: Monthly Returns

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Ex-post classifications

  • Based on ex-ante measures, difficult to discern what activists actually do, and, more importantly, how what they do creates value for shareholders.

  • Our main analysis is focused on what activists get done, and what the relationship is between what gets done and the returns experienced by shareholders.

    • Classify activism targets based on outcomes

    • Study returns based on outcomes

    • Study accounting performance based on outcomes

    • Link accounting performance with returns

    • Try to detect whether activists increase the probability of a takeover outcome occurring.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Ex-post classifications:

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Daily Stock Returns and Ex-post Classifications

Acquired

All Others

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Monthly Stock Returns and Ex-Post Classifications: The smoking gun

Acquired

All Others

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Accounting Performance: Non-acquired targets

  • Leverage rises, Capital Expenditures fall, Asset Growth is modest.

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Accounting Performance and Stock Returns

  • Bottom line: Some evidence of changes in operating performance, but no match for takeover in creating stock returns for shareholders!

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Do activists increase probability of takeover?

  • Two approaches:

    • Anecdotal approach: Read about all events in which a takeover was completed, and try to understand why, and what role the activist played.

    • Statistical approach: Based on identifying a matched sample (firms that could have been targeted by activists, but weren’t), and identifying incidence of takeover in matched sample.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Do activists increase probability of takeover?

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Matched Sample Approach

  • Identify firms based on size, industry, and past return.

  • E.g., Hills Department Stores targeted by Dickstein Partners in 1995, matched with Federated Department Stores.

  • Track outcome of target, as well as matched firm.

  • Question: Within 12 or 18 months, what is the incidence by which the target has been taken over, compared with the matched firm?


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Matched Sample Approach

Table 11: Delisting Outcomes

Back of the envelope: Activists increase probability of takeover by roughly 12 %.

12% x 40% takeover premium = 5% event return

Source: Greenwood/Schor (2007)


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Supporting Evidence from Press

  • “I’d like to thank my friend Carl Icahn, Nelson Peltz, Jana Partners, Third Point for teeing up deals […], because many times [activism targets] are driven into some form of auction.”

    -- Thomas H. Lee, Private Equity fund manager

  • Activists, when pressed to talk about their favorite incidents, will invariably mention targets where a takeover was consummated.

  • Activist Robert Chapman seeks targets that are “digestible.”

  • In the UK, activists call this “buying a minority price” and selling it at a “majority price.”


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Conclusions

  • Activism creates value for shareholders primarily in instances where the activist can increase the probability of a takeover event.

  • Supports view of activists as arbitrageurs: Identifying assets that are mispriced by their current owners.

  • On average, activists have a good record at increasing the probability of a takeover event.


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Overview | Data | Ex-ante classifications | Ex-post classifications | Takeover Probability | Conclusions

Looking Ahead

  • Activism needs to be viewed for what it is: a form of arbitrage that “transforms” the target into an asset with a higher price.

  • Activism tends to be successful when there is sustained takeover interest in the target.

  • Prediction: as private equity demand for targets tails off, activism as an investment strategy will decline in popularity.

  • Prediction: Returns on announcement of a 13D will continue to rise, but eventually fall. Two forces: Competition, and decline in takeover interest.

  • U.S. is ahead in some measures, behind in many others.

  • Future work: understanding mechanism employed by hedge funds when opposing takeover bids that are “too cheap.”

  • How much do investor chase activist targets? What is the role of disclosure?


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