The Agency Costs of Activism: Information Leakage, Thwarted Majorities, and the Public Morality
Series number :
- Activism •
- agency costs •
- Bid/Ask Spread •
- Corporate governance •
- hedge fund •
- Hedge Fund Activism •
- Information Leakage •
- Informed Trading •
- insider trading •
- Principal Costs •
- private benefits •
- Private Settlements
Few doubt that hedge fund activism has radically changed corporate governance in the United States -- for better or for worse. Proponents see activists as desirable agents of change who intentionally invest in underperforming
companies to organize more passive shareholders to support their proposals to change the target’s business model and/or management.
1. Private Benefits. Activists do receive private benefits (most notably in the form of expense reimbursement), but to date these benefits have been fairly modest (probably for a variety of reasons).
2. Information Leakage. The appointment of hedge fund nominees to a corporate board is followed by a shortterm increase in information leakage in the target firm’s stock price. That is, the target firm’s stock price regularly moves in the direction of a subsequent public disclosure -- and does so significantly more often and more emphatically than in the case of a control group of firms. This can most plausibly be explained as a consequence of informed trading by persons apprised of the material information that is to be released in the subsequent public disclosure. Moreover, this phenomenon of information leakage is significantly greater when the hedge fund’s nominees include a hedge fund employee (as opposed to nominees who are simply independent directors).
Further, once hedge fund nominees are appointed to the board, bid/ask spreads widen in comparison to the spreads on stocks in a control group.
3. Thwarted Majorities. Activists often have a short-term agenda, to which indexed investors object. Given these disagreements, it is undemocratic (even if predictable) that an organized minority can dominate a larger, more dispersed “silent majority.” This is a “horizontal” agency cost in contrast to more traditional “vertical” agency costs.
4. Public Morality. Although most institutional investors favor public goals, such as greater gender diversity on the board and a shift from “dirty” to “clean” energy, activists have opposed both and are constraining the ability of public companies to behave in a manner consistent with the public morality.
Finally, this article will discuss proposed reforms intended to minimize these agency costs, without materially chilling shareholder activism.