THE IMPACT OF HEDGE FUND ACTIVISM ON TARGET FIRM PERFORMANCE, EXECUTIVE COMPENSATION AND EXECUTIVE WEALTH

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Abstract

This paper examines the relationship between hedge fund activism and target firm performance, executive compensation, and executive wealth. It introduces a theoretical framework that describes the activism process as a sequence of discrete decisions. The methodology uses regression analysis on a matched sample based on firm size, industry, and market-to-book ratio. All regressions control for industry and year fixed effects. Schedule 13D Securities and Exchange Commission (SEC) filings are the source for the statistical sample of hedge fund target firms. I supplement that data with target firm financial, operating, and share price information from the CRSP-COMPUSTAT merged database. Activist hedge funds target undervalued or underperforming firms with high profitability and cash flows. They do not avoid firms with powerful CEOs. Leverage, executive compensation, pay for performance and CEO turnover increase at target firms after the arrival of the activist hedge fund. Target firm executives’ wealth is more sensitive to changes in share price after hedge fund activism events suggesting that the executive team experiences changes to their compensation structure that provides incentive to take action to improve returns to shareholders. The top executives reap rewards for increasing firm value but not for increased risk taking.

Keywords: Hedge Funds, Investor Activism, Institutional Investors, Executive Compensation, Corporate Governance

Received: 03.08.2017

Accepted: 19.09.2017

How to cite this paper: Carrothers, A. (2017). The impact of hedge fund activism on target firm performance, executive compensation and executive wealth. Journal of Governance & Regulation, 6(3), 14-28. https://doi.org/10.22495/jgr_v6_i3_p2