It looks as if hedge fund activists engineer not just a short-term pop in target firms' stock prices but also long-term improvements in innovation.
While studies have shown that news of an activist position in a stock leads to a 5 to 7 percent pop, some have argued that hedge funds are simply creating a short-term share price gain at the expense of long-term competitiveness and productivity.
That's partly gainsaid by data showing no decline in share or operating performance in the five years after an initial intervention by an activist investor. It's also true that activist campaigns often, if not always, lead to cutbacks in the size of firms and of their research and development efforts.
A new working paper finds benefits to innovation at firms which get picked on by hedge fund activists, benefits which may extend to other firms not directly involved.
"The output from innovation, patent quality and quantity, tend to improve. These improvements are concentrated in areas that are central to the firms' business and technological expertise," Alon Brav and Song Ma of Duke University, Wei Jiang of Columbia University and Xuan Tian of Indiana University write in the working paper.
"Thus, our evidence suggests that firms become 'leaner' but not 'weaker' subsequent to hedge fund interventions. Moreover, the efficiency gains also emanate from the extensive margin through the redeployment of innovative assets (patents or innovators)."
The study looked at innovation at firms taken on by activists, both before and after the interventions. Not only the inputs, the money spent on research and development, but also the output, the number of patents registered and how often they were cited by others, all tended to improve. Spending on R&D drops significantly in the five years after an activist event but most of the measures of quality and quantity of output improve "significantly," implying that firms which activists are targeting get better and more focused at allocating assets to their core competencies.
This undermines the argument that activists are swashbuckling raiders who leave smoking and disabled ruins in their wake, but does it imply that this is actually the doing of the hedge funds involved?
How Do They Do It?
It looks as if better husbanding of resources is central to the improvements. The patents taken out by the firms increase in number and are cited more often, and much of the improvement is found in areas of technology which are central to the firms' core capabilities. In other words, it looks as if firms were prospecting in new areas, and not always successfully, before the arrival of an activist investor.