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Does hedge fund activism improve investment efficiency?

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Abstract

We examine the impact of hedge fund activism (HFA) on the investment efficiency of target firms. We find that target firms’ investment efficiency improves after the active involvement of hedge funds. This improvement is mainly evident for HFA campaigns with investment strategy-related reforms as one of the main stated objectives. Among investment strategy-related HFA campaigns, the changes in investment efficiency are more pronounced when hedge funds obtain board representation or privately settle with target firms. HFA improves the investment efficiency of target firms by mitigating overinvestment rather than underinvestment problems. Additional tests reveal that target firms with no resistance to HFA and higher free cash flow accommodate this improvement in investment efficiency following HFA. Overall, our findings highlight the role of HFA as a governance mechanism in improving investment efficiency and influencing managers to reduce overinvestment.

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Notes

  1. Source: https://corpgov.law.harvard.edu/2020/10/15/does-shareholder-activism-split-the-pie-or-grow-the-pie/.

  2. As per our sample estimates in the year before HFA.

  3. Our main findings remain consistent even after using Tobin’s Q as our measure of a firm’s growth opportunities.

  4. The results for the Richardson (2006) investment efficiency model are reported in the appendix (Table 10).

  5. We also compute the Z values, as in Clogg et al. (1995) and Caskey et al. (2023), to test for the difference between the coefficients of Post for investment strategy-related versus noninvestment strategy-related HFA objectives. Since we do not find a significant difference in the coefficients of Post across investment strategy-related HFA objectives and noninvestment strategy-related HFA objectives, we urge readers to be cautious when drawing inferences from these findings.

  6. In untabulated results, we also examine the role of activism from the perspective of noninvestment strategy-related HFA objectives and further categorize these campaigns into privately settled versus nonsettled hedge fund campaigns and campaigns resulting in board seats for activist hedge funds versus all others. We do not find a statistically significant impact of HFA on abnormal investments across all subsamples. These results are consistent with our previous findings, in Table 4, that investment efficiency improves for only those campaigns where hedge funds mention investment strategy-related reforms as one of their main objectives, requiring a closer, long-run involvement of activist hedge funds.

  7. We also find that overinvestment decreases significantly for target firms that had higher levels of free cash flow in the year before HFA.

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Acknowledgements

We thank Scott Richardson (editor), an anonymous reviewer, Anup Agrawal, Tarun Chordia, Ed deHaan, Vidhan Goyal, Roy Kouwenberg, Chandra Krishnamurti, Rik Sen, Pascale Valery, and participants at the Financial Management Association’s Annual Meeting (2020), Asian Finance Association’s Annual Conference (2021), and King’s University College at Western University for their helpful feedback. We also thank Cuong Phan for his excellent research assistance.

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Authors and Affiliations

  1. Deakin Business School, Deakin University, Geelong, Australia

    Saikat Sovan Deb & Harminder Singh

  2. Department of Banking and Finance, Monash University, Wellington Road, Clayton, Victoria, 3800, Australia

    Huu Nhan Duong

  3. School of Management, Economics, and Mathematics, King’s University College at Western University, 266 Epworth Avenue, London, ON, N6A 2M3, Canada

    Amanjot Singh

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Appendix

Appendix

Table 9 Variable definitions
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Table 10 Richardson model
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Deb, S.S., Duong, H.N., Singh, A. et al. Does hedge fund activism improve investment efficiency?. Rev Account Stud (2023). https://doi.org/10.1007/s11142-023-09776-7

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