Lecture 4 Shareholders II and Market for Corporate Control. Prof. Daniel Sungyeon Kim

Transcription

1 Lecture 4 Shareholders II and Market for Corporate Control Prof. Daniel Sungyeon Kim

2 Hedge Fund Activism Who are Hedge Funds? Why are Hedge Funds different? Activist Hedge Funds Academic research The Market for Corporate Control The Threat of Takeover Governance Index (G-Index) 2

3 14 different possible definitions.. Pooled, privately organized investment vehicle Professional investment managers Available only to sophisticated or accredited investors Cannot be offered/sold to the general public Limited partnership, limited liability company The name refers to the traditional hedging techniques Today do not necessarily hedge 3

4 As of 2009, hedge funds represented 1.1% of the total funds and assets held by financial institutions. As of June 2013, the estimated size of the global hedge fund industry was US $2.4 trillion. 4

5 Most often open-ended and allow additions or withdrawals generally on a monthly or quarterly basis Hedge fund managers often invest their own money Fee structure Annual management fee (2% of the assets of the fund) Performance fee (20% of the increase in fund s net asset value) 5

6 Mysterious on the surface However, SEC mandates a certain level of transparency Particularly when activist hedge funds are involved The most important form filed by activist hedge funds is the Schedule 13D, which is a statement of beneficial ownership (5% or above). 6

7 13D contains hedge fund's motivations and possible future actions Security and Issuer Identity and Background Source, Amount of Funds and Other Considerations Purpose of Transaction Interest in Securities of the Issuer Material to be Filed as Exhibits 7

8 Regulatory and structural barriers of other institutional investors Conflicts of interest Political constraints Diversification requirements Insider trading regulations Weak personal financial incentives for fund manager 8

9 Conflicts of interest HFs suffer fewer conflicts of interest HFs do not sell products Not subject to extensive state or local influence, or political control 9

10 Flexible investments HFs can take larger relative positions Not required to maintain diversified portfolio HFs can require investors to lock-up their funds for 2 years or longer Margin and derivative tradings are allowed 10

11 Fund manager s incentive alignment High fee structure (2-20) Other managers capture a smaller % of return Investment Company Act of 1940 limits performance fees EU bonus cap in 2014 and risk-taking 11

12 Avoid direct regulatory oversight Private offerings that are not subject to extensive disclosure requirement Bypass licensing requirement 12

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14 Distinct from private equity funds PE and VC focus on private capital markets Majority of hedge funds invest in relatively more liquid assets 14

15 Most hedge funds invest using unconventional strategies, but others take a more active role in realizing the value in their investments - these are known as activist hedge funds. Activist funds are likely to be long-term oriented Less diversified portfolio 15

16 Types of Activism Investments: Engage Management Activist will engage with management and try to increase shareholder value. Capital Structure Activist will target capital structure issues such as recapitalization, dividends, or stock buybacks Corporate Governance Activist will target corporate governance issues such as poison pills, electing directors, removing company management, or removing board members 16

17 Types of Activism Investments: Business Strategy Activist will generally try to spin-off unprofitable or non-core assets, push for particular merger or sale, or reject other takeover bid Asset Sale Activist will push for the company to sell itself or sell parts of the business Block/Support Merger Activist will block/support a proposed merger Financing/Bankruptcy Activist provides financing for a distressed company 17

18 Long-term turnarounds vs. Short-term exit strategies Short-Term Activities: -Sale of the company -Liquidation of assets -Special dividends Medium-Term Activities: -Replacing board members -Firing management Long-Term Activities: -Share buyback programs -Increase dividends -Capital structure changes 18

19 Activist HFs List: Atlantic Investment Management (Active in OSK, SWK, LZ) Blue Harbor Group (Active in CACI, SWS, FCN) Blum Capital (Active in ESI, SBAC, JDAS) Breeden (Active in BYI, FLS, SWK) Cevian Capital (Active in SWEDA SS) ESL Investments (Active in CSCO, GPS, STX) Icahn (Active in AMLN, MOTR, CLX) MSD Capital (Active in APL, EXXI, TAT) New Mountain Vantage (Active in (NFG, LINTA, NCR) Pershing Square Capital (Active in GGP, FO, GM) Sageview Capital (Active in LIFE, SD) SPO Advisory (Active in CPN, V) TCI (Active in KO, UNP, WLP) Trian Partners (Active in FDO, K, KAR) ValueAct Capital (Active in BCR, VRSN, SNA) *Investments as of

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21 Brav, Jiang, Partnoy and Thomas, Hedge Fund Activism, Corporate Governance and Firm Performance (2008, JF) Which firms do activists target and how do those targets respond? How does the market react to the announcement of activism? Do activists succeed in implementing their objectives? Are Activists short term in focus? How does activism impact firm performance? They find Hedge fund activism can reduce agency cost at target firms Hedge fund activism generate value on average The presence of hedge funds disciplines the management of public firms to make shareholder value a priority Disappearing abnormal profits around Schedule 13D filings 21

22 Gantchev, Gredil and Jotikasthira, Governance under the Gun: Spillover Effects of Hedge Fund Activism, 2014, working paper Activism often drives positive changes at the expense of managers Threat of activism is difficult to defend Managers and directors are taking a more hands-on approach 22

23 Gantchev, Gredil and Jotikasthira, Governance under the Gun: Spillover Effects of Hedge Fund Activism, 2014, working paper Abnormally high rate of activism in the same industry Reduce agency costs and improve operating performance increase leverage, payout and CEO turnover reduction in capital expenditures improve asset utilization and productivity Lower ex-post probability of becoming a target Activism, as a monitoring mechanism, reaches beyond the target firms (Externality) 23

24 Klein and Zur (2009), Entrepreneurial shareholder activism: Hedge funds and other private investors, JF Compares activist hedge funds and other, mostly individual, activists. Around Schedule 13D filing, targets of activist hedge funds experience significantly higher positive abnormal return than targets of other activists In contrasts, targets of activist hedge funds experience lower significant positive abnormal return than targets of other activists Both hedge fund and other activists are successful in getting their voice heard and also getting board represenatation Hedge fund activists target firms with higher profitability and more cash at hand Hedge fund activists pursue corporate financial reform, e.g. higher payout or increase in debt ratio Oher activists focus more on operational reform, e.g. reducing R&D and capital expenditures 24

25 Brav et al. (2014), Shareholder Power and Corporate Innovation: Evidence from Hedge Fund Activism, WP R&D expenditure at the target firms of activist hedge funds However, the targets innovation output improves after hedge fund intervention Patents post-hedge fund are cited significantly more than the patents before the hedge funds Human capital are optimally restructured such that the remaining inventors becomes more productive and leaving inventors becomes more productive with their new employer 25

26 When management fails to create shareholder value, stock price declines, and the firm becomes a target for Takeover bids: An opportunity to but the firm at a low price, restructure the firm, restore the lost value, and realize gains Challenges from activist shareholders via proxy fights Threats from the market for corporate control discipline managers. 26

27 Large investors have become increasingly interested in measuring the balance of power between shareholders and managers in a firm. The Investor Responsibility Research Center (IRRC) has collected information on 24 different characteristics that can entrench managers. 27

28 Many of the provisions listed in the IRRC index concern protection from takeovers One motivation for a takeover can be to replace poorly performing management. An active takeover market is part of the system through which the threat of dismissal is maintained. 28

29 Gompers, Ishii and Metrick (2003) Proxy for the strength of shareholder rights A composite of the twenty-four variables Adding one point if any of the provisions is present, where a higher score indicates more restrictions on shareholder rights or a greater number of anti-takeover measures 29

30 Delay Tactics for delaying hostile bidders Blank Check, Classified Board, Special Meeting, Written Consent Voting rights Shareholders rights in elections or charter/bylaw amendments Bylaws, Charter, Cumulative Voting, Secret Ballot, Supermajority, Unequal Voting 30

31 Director/Officer protection Provisions designed to insure officers and directors against job-related liability or to compensate them following a termination Compensation Plans, Contracts, Golden Parachutes, Indemnification, Liability, Severance Other takeover defenses Antigreenmail, Directors Duties, Fair Price, Pension Parachutes, Poison Pill, Silver Parachutes State laws Antigreenmail Law, Business Combination Law, Cash-Out Law, Directors Duties Law, Fair Price Law, Control Share Acquisition Law 31

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33 Selected Takeover Defenses Classified (Staggered) Boards Supermajority Golden Parachutes Antigreenmail Poison Pills Business Combination laws 33

34 Selected Takeover Defenses Classified (Staggered) Boards In many public companies, a board of directors whose three-year terms are staggered so that only one-third of the directors are up for election each time. Supermajority rules Two-third or even 90 percent, of shareholders have to approve a hand-over in control 34

35 Selected Takeover Defenses Golden Parachutes An extremely lucrative severance package that is guaranteed to a firm s senior management in the event that the firm is taken over and the managers are let go Antigreenmail Greenmail is a targeted repurchase of shares from a specific shareholder, at a substantial premium Antigreenmail provision discourages accumulation of large blocks of stock because one source of exit for the stake is closed The net effect on shareholder wealth is unclear (Shleifer and Vishny 1986, Eckbo 1990). 35

36 Selected Takeover Defenses Poison Pills It is a rights offering that gives the target shareholders the right to buy shares of either the target or an acquirer at a deeply discounted price. Business Combination laws It imposes a moratorium on certain kinds of transactions (e.g., asset sales, mergers) between a large shareholder and the firm, unless the transaction is approved by the Board of Directors 36

37 Firms in the highest deciles of the index The weakest shareholder rights Dictatorship governance Firms in the lowest deciles of the index The strongest shareholder rights Democracy governance 37

38 The authors find Firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and made fewer corporate acquisitions 38