In 2015, Larry Fink, chairman and CEO of the investment firm BlackRock, warned chief executives at top American companies about activist shareholders. These investors’ focus on “immediate returns,” he wrote in a letter, contributed to the “acute pressure, growing with every quarter, for companies to meet short-term financial goals at the expense of building long-term value.” Fink’s statement echoed long-standing arguments by some corporate leaders, researchers, and politicians that hedge fund activists—shareholders who seek to reshape a company’s operations but often sell their stock after a few years or less—temporarily increase earnings while disregarding the effect on future returns.
Song Ma, an assistant professor of finance at Yale SOM, wanted to know if the data supported this dire view. “We aim to provide empirical evidence to inform this debate,” he says.
In a new study, Song and his co-authors found evidence that hedge fund activists have a positive effect on firms, at least during the five years after intervention. Companies targeted by activists performed better on measures of innovation during that period than similar firms that weren’t targeted.
The idea that hedge fund activists destroy long-term investment “does not seem to be consistent with what the data tell us,” Ma says. Instead, the results suggest that “they’re actually particularly useful in driving up innovation productivity.” Earlier research has shown that the arrival of activists is greeted by a positive market reaction upon announcement, and this evidence is consistent with the market anticipating the benefits of target firms becoming more innovative.
To investigate, Ma collaborated with Alon Brav of Duke University’s Fuqua School of Business, Wei Jiang of Columbia Business School, and Xuan Tian of Tsinghua University’s PBC School of Finance. The researchers examined SEC filings to identify 1,770 cases from 1994 to 2007 where hedge fund activists intervened in firms’ operations, in industries such as technology, healthcare, and manufacturing. The team also obtained information on patent filings from NBER and and on the movements of inventors between companies from a Harvard Business School database.
For each firm targeted by activist investors, the researchers compared its performance to that of a similar company that had not been targeted. In doing so, they attempted to isolate the effects of hedge fund activism.
At targeted firms, R&D spending dropped by about $11 million per year, relative to control firms. But targeted companies also sold some assets, so the percentage spent on R&D didn’t change. “They’re becoming smaller but leaner,” Ma says.
Targeted firms’ patent filings were 15% higher than those of control firms. And their patents were cited 15% more times, suggesting they were higher quality. “Overall productivity of R&D increases dramatically,” he says.
How did activist shareholders jumpstart innovation? The researchers offer four explanations.
First, the targeted firms appeared to re-focus on core areas of expertise. For instance, they increased their fraction of explorative patents—those that heavily cite new knowledge—in core areas by 4% more than control companies did.
Similarly, targeted firms shed more peripheral patents. Those companies had previously sold 0.8% of their patents per year; that figure rose by 0.64 percentage points. And they were more likely to sell patents unrelated to areas of deep expertise.
Another factor is staff turnover. After intervention, the percentage of inventors leaving or arriving at targeted companies rose by 6-9%. New hires filed more patents than those at control firms, and the average productivity of existing staff members increased. Inventors who left had higher patent citation rates, suggesting they had “land[ed] on ‘greener pastures,’” the authors write.
Finally, the team analyzed changes in leadership. At targeted firms, the likelihood that the CEO would be replaced was 12-13% higher. But new CEOs stayed an average of 1.5 years longer than those at control companies. Executives also owned more shares in the firm. Activist investors are “creating incentive plans for them to work hard,” Ma says.
It’s still possible that some hedge fund activists are indeed greedy investors who only want to turn a quick profit. “But on average, we shouldn’t paint a dark picture of those people,” Ma says. If policymakers are going to change the regulation of such activities, “we need to have well-grounded, empirical evidence to blame certain types of investors.”
And employees of companies targeted by activist investors should keep an open mind, he says: “They might actually be helpful to your firm.”