January 26, 2016

Hedge Fund Activism: A Guide for the Perplexed

John C. Coffee, Jr. | The CLS Blue Sky Blog - Columbia Law School

The message of the Dow/DuPont merger and split up is simple: No firm is today “too big to target.” Activists can see the transaction as evidence that, even in the rare case where they lose a proxy fight (as they did at DuPont last year in a squeaker), the handwriting is still on the wall, and their game plan, if appealing, will ultimately prevail. Even though Trian could not win a majority vote to seat its candidates on the DuPont board, it held onto its stake, and the DuPont board quickly ditched their CEO in the wake of that fight and then approved the offer from Dow. Dow also was under pressure (from Third Point, an even more aggressive and short-tempered activist fund). The result was a marriage made somewhere other than in heaven.

Nor does this case stand alone. Lion Point Capital has now engaged Ally Financial (the former GMAC, which did fail in the wake of the 2008 crash), notwithstanding that Ally has been classified as a “systemically important financial institution” (or “SIFI”) by the FSOC. As soon as it became clear that even a SIFI could be stalked, AIG’s stock price began to soar, as market watchers predicted that it also would be targeted by activists seeking to downsize it. Lastly, MetLife downsized itself, beating activists to the punch in its effort to avoid being also classified as a SIFI […]

Some data about the impact of hedge fund activism is clear: namely, its impact on research and development (“R&D”).  One study by Allaire and Dauphin used the FactSet database to track the impact of a hedge fund “engagement” on R&D expenditures and found that over the four-year period following a hedge fund engagement, R&D expenditures at “surviving” target firms declined by more than 50% (expressed as a percentage of sales).  This statistic likely understates the full impact, as not all target firms “survive” (i.e., they are acquired in a merger or they are broken-up in a restructuring), and in these cases the decline in R&D expenditures (although not measurable from financial reports) is almost certainly greater.  This study did use a control, and in the control group R&D expenditures actually rose (modestly) over the same period, thus suggesting that causation is clear.

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