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ANNUAL MEETING AND CENTENNIAL CELEBRATION
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Activist investors are a plus for firms they target not just for days but for years, new research finds.

Activist hedge funds, take heart. With the debate about activist investing still raging, a new study that can fairly lay claim to being the largest and broadest investigation of activism yet undertaken yields evidence that amounts to a solid endorsement of it.

The new research, to be presented at the forthcoming annual meeting of the American Accounting Association (New York City, August 5-10), analyzes the largest sample of activist events yet examined – some 5,000 initiatives over the course of 21 years – and finds that above and beyond the short-term boost in share prices that they occasion, they generally result in superior stock performance and strengthened company fundamentals over the long term.

Comments Edward P. Swanson, a professor of accounting at Texas A&M's Mays Business School, who carried out the research with doctoral student Glenn M. Young, "Activism is widely seen as a way to make a quick buck – so much so that the Brokaw Act was recently introduced in Congress to keep activist hedge funds from capitalizing on short-term profits at the expense of companies' basic finances. What we set out to do in this study, in contrast, is to assess activism's long-term effects – and to do so not just in one or two ways but in a variety of respects.

"We found that, on average, these initiatives turn out to be a plus for the  firms they target. Activists are not just good pickers of underpriced stocks; their interventions improve companies' long-term financial health."

Besides analyzing companies' stock performance during the two years following the announcement of activist initiatives, Swanson and Young investigated the response over that span of three types of informed investors – analysts, short-sellers, and institutional investors – and gauged  firms' financial fundamentals over the same period. By each measure, activist interventions emerged as having positive effects.

The researchers obtained information on activist events (that is, initiatives by investors who take a large position in a firm's stock for the purpose of increasing share price through changes in company operations) over the 21 years 1994 through 2014. Events were identified through two large databases, SharkRepellent.net and ThomsonOne, that specialize in investor-activism campaigns and defenses against them. In all, the study embraces 4,870 activist campaigns involving 2,652 unique firms.

Findings include the following:

Stock performance. Unsurprisingly, stocks of targeted firms enjoyed a cumulative market-adjusted return of about 3.4% in the week following announcement of an activist initiative. The largest boost, of about 13%, occurs in campaigns advocating sale of part or all of the business, with campaigns having other goals (for example, changing company strategy or board composition or corporate governance) averaging 2.5%. In the two years following initiative announcements, cumulative market-adjusted returns averaged about 10.6% overall – 21.6% for campaigns aimed at sales and 9.6% for other initiatives.

Analysts. Buy endorsements by stock analysts fell from 54% of recommendations two years before campaign announcements to about 42% at the time of announcements, then rose slightly to about 44% a year later, then more quickly to about 49% a year after that. In contrast, a group of untargeted firms similar to the targeted companies in other ways (in other words, matched controls) experienced no such striking rises and falls, with percentage of buys declining slowly from about 53% to about 51% over the entire four-year period.  In the words of the study, "The pattern of recommendation changes shows that analysts respond favorably to activist interventions and provides further support [to the belief] that, on average, shareholder activism is beneficial for target firms."

Short-sellers. Short interest in targeted firms, reflecting doubts about their viability, was about 4.7% for targeted firms at the time campaigns were announced, which was not significantly different from the 5.0% for the controls. Two years later short interest in the targeted firms had fallen to less than 4.1%, compared to a significantly different 4.6% for the controls. Referring to the sharp drop seen in the targeted firms, the authors comment that "over at least a two-year period short-sellers behave consistent with the perception that activist targets are better off in the post-announcement period."

Firm fundamentals. Swanson and Young assessed company fundamentals with F-scores, developed by previous researchers as a way to identify underpriced and overpriced firms based on nine accounting measures that capture profitability, changes in leverage and liquidity, and changes in operating efficiency. Each of the nine scores firms receive is classified as good, for which it receives one point, or bad, for which it receives zero. In the two years before activist events the F-scores of targeted firms dropped from a mean of 4.36 to 4.13 from which they proceeded to rise in the succeeding two years to 4.48, falls and rises alike being significantly greater than those of controls. The results lead the authors to observe that "the pre-intervention deterioration at target firms is opposite to what would be expected if activists were simply superior stock-pickers who identify firms with strong, but underpriced fundamentals...Furthermore, the increase in F-score in the post-intervention period...is inconsistent with the assertion that shareholder activism has a negative effect on target firms' financial health."

Institutional Investors. Targeted companies experience a sharp decline in ownership by transient institutional investors (those with high portfolio turnover and highly diversified holdings) from a mean of about 16.7% at the time of campaign announcements to about 14.8% two years later while the comparable percentages for controls hover at about 15.5% over the entire four years. Meanwhile, ownership by dedicated investors (those with long investment horizons) rises slightly at targeted firms in the two post-announcement years from about 10% to about 10.6%, while comparable percentages for controls hover steadily at about 9.5%. In the words of the study, "these results are inconsistent with activism inducing short-termism at target firms."

The authors see their findings as having timely public-policy implications, given that "Congress is considering legislation, the Brokaw Act, which includes regulations favored by activist critics." Further, "presidential hopeful Hillary Clinton has taken aim at 'hit-and-run activists whose goal is to force an immediate payout.' Even billionaire investor Warren Buffett has criticized activists whose 'short-term objectives have eroded faith in corporations' continuing to be the foundation of the American free enterprise system.' "

To which Swanson and Young add, in conclusion: "As the activist landscape continues to evolve, [our] results should be of interest to boards and managers as they engage with activist shareholders pushing for change, and to regulators who are considering actions that may increase or reduce incentives for activists to intervene at poorly performing companies."

The paper, entitled “Are Activist Investors Good or Bad for Business? Evidence from Capital Market Prices, Informed Traders, and Firm Fundamentals," will be among hundreds of scholarly presentations at the American Accounting Association annual meeting and centennial celebration, expected to attract some 3,500 scholars and practitioners to New York City from August 5th to 10th. The AAA is a worldwide organization devoted to excellence in accounting education, research, and practice. Journals published by the AAA and its specialty sections include The Accounting Review, Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Auditing: A Journal of Practice & Theory, and The Journal of the American Taxation Association.

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