Activist hedge fund success: The role of reputation

• Author: Albert Ahn,Yu Zhang,Margarethe Wiersema
• Date: 01 December 2020
• Published date: 01 December 2020
• DOI: http://doi.org/10.1002/smj.3210

RESEARCH ARTICLE

Activist hedge fund success:

The role of reputation

Margarethe Wiersema

1

| Albert Ahn

2

| Yu Zhang

3

1

Merage School of Business, University of

California, Irvine, California

2

School of Business, Hong Kong Baptist

University, Kowloon Tong, Hong Kong

3

China Europe International Business

School (CEIBS), Shanghai, China

Correspondence

Margarethe Wiersema, Merage School of

Business, University of California, Irvine,

CA.

Email: mfwierse@uci.edu

Abstract

Research Summary: Activist hedge funds are the new

breed of corporate raiders, yet we know little about

how the management and board of target firms

respond to activist investors. Using a behavioral per-

spective, we propose that an activist's reputation for

being confrontational conveys information to the target

company as to what they are likely to encounter in an

activist campaign. To avoid the potential adverse conse-

quences of engaging in such a contest, we propose and

find that target companies are more likely to settle with

an activist known for being confrontational. Our study

contributes to corporate governance research by pro-

viding insight into the importance of the social context

surrounding activist campaigns and the role of reputa-

tion in influencing how companies respond to activist

investors.

Managerial Summary: Given that hedge fund activ-

ism is having a major impact on firm's strategic and

financial decision-making, it is important to under-

stand how these activist investors influence companies.

An activist campaign is a highly disruptive event lead-

ing to considerable ambiguity and uncertainty as to

what is likely to transpire. Given this information void,

our study finds that the board and management

respond based on the reputation of the activist investor

that has taken a stake in the company. That activist

investors with a reputation for being hostile are more

successful may be a defensive response on the part of

management in order to avoid the potential adverse

Received: 7 June 2018 Revised: 5 May 2020 Accepted: 25 May 2020 Published on: 28 July 2020

DOI: 10.1002/smj.3210

Strat Mgmt J. 2020;41:2493–2517. wileyonlinelibrary.com/journal/smj © 2020 John Wiley & Sons, Ltd. 2493

consequences of a hostile campaign. This has implica-

tions for corporate governance and the fiduciary duty

of the board.

KEYWORDS

activist hedge funds, corporate governance, executive decision-

making, market signaling, reputation

1|INTRODUCTION

The surge in activism by hedge funds

1

over the past 10 years has shaken up corporate board-

rooms and the executive suite. From less than $12 billion in assets under management in 2003,

activist hedge funds have grown in number and now manage more than $127.5 billion in assets

(Morgan, 2018). In 2019, they deployed $42.2 billion in capital globally and engaged in 839 cam-

paigns,

2

targeting 470 US companies, 135 European companies, and 107 Asian companies

(Activist Insight, 2020; Lazard, 2019).

3

Activist hedge funds have been identified as the new

breed of corporate raiders and according to Morgan (2015, p.1), “no recent development has

influenced firms' strategic and financial decision-making as profoundly.”Due to regulatory

reforms that have made shareholder engagement easier, as well as weakened corporate defenses

(Briggs, 2007), these activists are more able than financial activists of the past to challenge man-

agement to improve shareholder value. Finance scholars have provided much insight into the

antecedents and performance outcomes of hedge fund activism (e.g., Bebchuk, Brav, &

Jiang, 2015; Brav, Jiang, & Kim, 2015). Yet despite the wealth of research on hedge fund activ-

ism (see Brav, Jiang, & Kim, 2009 for a review), how target firms respond to activist investors

largely remains a “black box.”The demands issued by activists range from putting the company

up for sale to requesting that the company buy back its shares. Whether management and the

board agree to an activist's demands represents a strategic decision that has consequences for

the firm's strategy and governance as well as how external constituents are likely to perceive

the firm.

While finance research has examined the outcome of activist campaigns from an agency

perspective, we propose that a behavioral perspective that takes into account the social context

surrounding these decisions may provide insight into how target firms respond to activist inves-

tors. We argue that incomplete information represents an important aspect of the social sur-

roundings of activist campaigns that may help us understand how target firms are likely to

respond. While activists conduct extensive research prior to engaging in their campaigns, the

management and board of target firms lack information about activists due to minimal disclo-

sure requirements on the part of hedge funds, limited media attention, and the general unfamil-

iarity that most companies have with activist investors (Ahn & Wiersema, in press). The

1

Hedge funds are private investment vehicles that are only available to qualified investors such as institutional investors

and wealthy individuals. They operate largely outside of Securities Exchange Commission (SEC) requirements.

2

An activist campaign occurs when an activist hedge fund takes a stake in a company and states its activist intention in

its SEC 13D filing.

3

Canadian and Australian firms made up 48 and 72 of the campaigns, respectively, in 2019.

2494 WIERSEMA ET AL.