Competition for Flow and Short-Termism in Activism

We develop a dual-layered agency model to study blockholder monitoring by activist funds that compete for investor flow. Competition for flow affects the manner in which activist funds govern as blockholders. In particular, funds inflate short- term performance by increasing payouts financed by higher (net) leverage, which subsequently discourages value-creating interventions in economic downturns due to debt overhang. Our theory suggests a new channel via which asset manager incentives may foster economic fragility and links together the observed procyclicality of activist investments with the documented effect of such funds on the leverage of their target companies.