April 20, 2015

The DuPont Proxy Battle: New Myths, Old Realities—and Even Newer Data About Hedge Fund Activism

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

A watershed moment is coming for shareholder activism and corporate governance generally, as the proxy contest brought by Trian Management Fund, seeking effectively to break up DuPont, enters its final stages (with the vote being less than a month away). Technically, the contest is to elect four Trian Fund nominees to the DuPont board, but, as a column in the New York Time’s Dealbook put it more bluntly, the real fight is over whether to break DuPont into three parts and “shut down DuPont’s central research labs.”[1] Much about this contest is unusual: unlike other targets of activism, DuPont has regularly outperformed the S&P 500 Index and virtually all other metrics for corporate profitability. Its stock price has risen over 185% since its CEO, Ellen Kullman, took office six years ago (while the S&P 500 Index rose only 122% over the same period).[2] The Trian Fund owns only a small stake (less than 3%), but still the contest is close. This column will use this episode as a stalking horse by which to approach a key issue in corporate governance today and also as a case study that illustrates both what we know and still do not know about hedge fund activism.

Let’s start with what we know. Hedge fund activism dates back for at least a decade to the appearance of proactive hedge funds that bought stocks specifically to challenge the management.[3] With that development, institutional activism moved to the offense, departing from a prior history of largely being defensive in nature (i.e., opposing managerial initiatives). What caused this development? Some of the answer lies in deregulatory SEC rules, but probably more of the answer stems from the inability of a hedge fund to consistently beat the market. If the market is efficient (or even approximately so), a hedge fund cannot outperform it for long as a stock picker—unless it buys stocks intending to change existing management policies and thus enhance firm value. Intense competition and thin returns probably drove some hedge funds into becoming pro-active. Relatively quickly, a consistent pattern emerged to characterize this new activism: on the filing of a Schedule 13D by an activist investor, the stock price of the target shows an immediate abnormal return of around 6 to 7%.[4] Whether this short-run price improvement later dissipates has long been debated,[5] but now there is newer data. The latest study, just released in March, shows that long-run returns to shareholders depend on the outcome of the activists’ engagement with the target.[6] If the activists fail to achieve their desired outcome, the long-term return is modestly negative.[7] If, however, the activists succeed, everything depends on what outcome they were seeking. The market largely ignores changes in corporate governance and “liquidity events” (such as special dividends or stock buybacks),[8] but jumps with alacrity in response to takeovers and restructurings.[9] This suggests that the real source of the gains to pro-active hedge funds is not superior corporate strategy, but increases in the expected takeover premium for the target. Apparently, the market perceives most corporate governance issues as important only as a signal of an impending takeover battle. Still, if nothing more materializes, the target’s stock price will stabilize or decline. Even if activists present themselves as superior business strategists or marketing gurus, their success comes largely from jump-starting a takeover or a bust-up.

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