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Hedge Fund Activism and Internal Control Weaknesses
China Accounting and Finance Review,
Purpose: The aim of the paper is to investigate the associations between hedge fund activism and corporate internal control weaknesses.
Design/methodology/approach: In this paper, the authors identify hedge fund activism events using 13D filings and news search. After matching with internal control related information from Audit Analytics, the authors utilize ordinary least square (OLS) and propensity score matching (PSM) to analyze the data.
Findings: The authors find that after hedge fund activism, target firms report additional internal control weaknesses, and these identified internal control weaknesses are remediated in subsequent years, leading to better financial-reporting quality.
Originality/value: The findings indicate that both managers and activists have incentives to develop a stronger internal control environment after targeting.
Trading away Incentives
IWH Discussion Papers,
Equity pay has been the primary component of managerial compensation packages at US public firms since the early 1990s. Using a comprehensive sample of top executives from 1992-2020, we estimate to what extent they trade firm equity held in their portfolios to neutralize increments in ownership due to annual equity pay. Executives accommodate ownership increases linked to options awards. Conversely, increases in stock holdings linked to option exercises and restricted stock grants are largely neutralized through comparable sales of unrestricted shares. Variation in stock trading responses across executives hardly appears to respond to diversification motives. From a theoretical standpoint, these results challenge (i) the common, generally implicit assumption that managers cannot undo their incentive packages, (ii) the standard modeling practice of treating different equity pay items homogeneously, and (iii) the often taken for granted crucial role of diversification motives in managers’ portfolio choices.
29.07.2021 • 20/2021
Communication instead of conflict – why are female CEOs so interesting for hedge funds
The value of female-led firms is enhanced more by the intervention of activist investors than that of firms with male CEOs. This is the result of a recent paper by Iftekhar Hasan (Fordham University and IWH) and Qiang Wu (Rensselaer Polytechnic Institute, RPI) at the Halle Institute for Economic Research (IWH). "The results show that female CEOs particularly benefit from the intervention of hedge fund activists due to their strong communication and interpersonal skills," explains Iftekhar Hasan. This is because, on average, the intervention of an activist hedge fund increases the value of the firm ex post. To achieve this, activist hedge funds such as Carl Icahn, Trian Fundmanagement or Elliott prefer to rely on communication and cooperation with the management.
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Do Activist Hedge Funds Target Female CEOs? The Role of CEO Gender in Hedge Fund Activism
Journal of Financial Economics,
Using a comprehensive US hedge fund activism dataset from 2003 to 2018, we find that activist hedge funds are about 52% more likely to target firms with female CEOs compared to firms with male CEOs. We find that firm fundamentals, the existence of a “glass cliff,” gender discrimination bias, and hedge fund activists’ inherent characteristics do not explain the observed gender effect. We also find that the transformational leadership style of female CEOs is a plausible explanation for this gender effect: instead of being self-defensive, female CEOs are more likely to communicate and cooperate with hedge fund activists to achieve intervention goals. Finally, we find that female-led targets experience greater increases in market and operational performance subsequent to hedge fund targeting.
Activism and Empire Building
Journal of Financial Economics,
Hedge fund activists target firms engaging in empire building and improve their future acquisition and divestiture strategy. Following intervention, activist targets make fewer acquisitions but obtain substantially higher returns by avoiding large and diversifying deals and refraining from acquisitions during merger waves. Activist targets also increase the pace of divestitures and achieve higher divestiture returns than matched non-targets. Activists curtail empire building through the removal of empire building chief executive officers (CEOs), compensation based incentives, and appointment of new board members. Our findings highlight an important channel through which activists improve efficiency and create shareholder value.
The Value of Firm Networks: A Natural Experiment on Board Connections
CEPR Discussion Papers,
This paper presents causal evidence of the effects of boardroom networks on firm value and compensation policies. We exploit exogenous variation in network centrality arising from a ban on interlocking directorates of Italian financial and insurance companies. We leverage this shock to show that firms whose centrality in the network rises after the reform experience positive abnormal returns around the announcement date and are better hedged against shocks. Information dissemination plays a central role: results are driven by firms that have higher idiosyncratic volatility, low analyst coverage, and more uncertainty surrounding their earnings forecasts. Firms benefit more from boardroom centrality when they are more central in the input-output network, hence more susceptible to upstream shocks, when they are less central in the cross-ownership network, or when they have low profitability or low growth opportunities. Network centrality also results in higher directors' compensation, due to rent sharing and improved executives' outside option, and more similar compensation policies between connected firms.
A Factor-model Approach for Correlation Scenarios and Correlation Stress Testing
Journal of Banking and Finance,
In 2012, JPMorgan accumulated a USD 6.2 billion loss on a credit derivatives portfolio, the so-called “London Whale”, partly as a consequence of de-correlations of non-perfectly correlated positions that were supposed to hedge each other. Motivated by this case, we devise a factor model for correlations that allows for scenario-based stress testing of correlations. We derive a number of analytical results related to a portfolio of homogeneous assets. Using the concept of Mahalanobis distance, we show how to identify adverse scenarios of correlation risk. In addition, we demonstrate how correlation and volatility stress tests can be combined. As an example, we apply the factor-model approach to the “London Whale” portfolio and determine the value-at-risk impact from correlation changes. Since our findings are particularly relevant for large portfolios, where even small correlation changes can have a large impact, a further application would be to stress test portfolios of central counterparties, which are of systemically relevant size.
Spillover Effects among Financial Institutions: A State-dependent Sensitivity Value-at-Risk Approach
Journal of Financial and Quantitative Analysis,
In this paper, we develop a state-dependent sensitivity value-at-risk (SDSVaR) approach that enables us to quantify the direction, size, and duration of risk spillovers among financial institutions as a function of the state of financial markets (tranquil, normal, and volatile). For four sets of major financial institutions (commercial banks, investment banks, hedge funds, and insurance companies) we show that while small during normal times, equivalent shocks lead to considerable spillover effects in volatile market periods. Commercial banks and, especially, hedge funds appear to play a major role in the transmission of shocks to other financial institutions.