Chap 16 - Event-Driven Hedge Funds Flashcards
What is Corporate event risk ?
Corporate event risk is dispersion in economic outcomes due to uncertainty regarding corporate events.
When a shareholder fears corporate event risk, he sell his shares and reinvest their sales proceeds in firms that are not subject to substantial event risk, this is said to be purchasing insurance against the failure of the firms to complete the anticipated merger.
What is the selling insurance side ?
Event-driven hedge funds may be viewed as seeking to earn risk premiums for selling insurance against failed deals. Selling insurance in this context refers to the economic process of earning relatively small returns for providing protection against
risks, not the literal process of offering traditional insurance policies.
Long positions in call options in equities tend to have higher betas than their underlying stocks and in theory should offer even higher expected risk premiums. Thus, using this long binary call option view, it may be argued that typical eventdriven strategies contain substantial systematic risk and that higher returns for this strategy may reflect bearing systematic risk, or beta, rather than alpha.
What is corporate governance ?
Corporate governance describes the processes and people that control the decisions of a corporation.
What is activist investing ?
Activist investing is involvement in corporate governance as an
alpha-driven investment strategy. The activist investment strategy involves efforts by shareholders to use their rights, such as voting power or the threat of such power, to influence corporate governance to their financial benefit as shareholders.
What does an activist investing strategy involve ?
An activist investment strategy often involves (1) identification of corporations whose management is not maximizing shareholder wealth; (2) establishment of investment positions that can benefit from particular changes in corporate governance, such as replacement of existing management; and (3) execution of the corporate governance changes that are perceived to benefit the investment positions that have been established.
What is shareholder activism ?
The divergence between the preferences of shareholders and managers is the foundation for most shareholder activism. Shareholder activism refers to efforts by one or more shareholders to influence the decisions of a firm in a direction contrary to the initial recommendations of the firm’s senior management. These efforts can include casting votes, introducing shareholder resolutions, and taking legal action.
Activist investment strategy as any investment strategy with the objective of generating superior rates of return through shareholder activism.
What is a proxy battle ?
Shareholders attend meetings to cast their votes, cast direct votes prior to
meetings using ballots provided to them by the firm, or complete proxies that allow others to vote on their behalf. The outcome of the shareholder votes typically depends on the results of a proxy battle. A proxy battle is a fight between the firm’s current management and one or more shareholder activists to obtain proxies (i.e., favorable votes) from shareholders. These proxies permit them to vote the shares of the other shareholders in support of their activism.
What are the 5 dimensions of shareholder activism ?
The players in the arena of shareholder activism differ on several dimensions:
- Financial versus social activists: Efforts by shareholder activists can have social objectives or financial objectives. Social objectives include attempts to steer
a firm toward behavior deemed by some as more beneficial to society as a whole. - Activists versus pacifists: Activists oppose current management and seek
major changes in a firm’s leadership or decision-making. Pacifists oppose the
proposed activism. Instead, pacifists support current management, the status quo, and any proposed changes outlined by the current management. - Initiators versus followers: Some shareholders initiate activism, whereas
others actively follow the activists. Importantly, initiators pay for the direct expenses of activism. Active followers support the plans of the initiators and establish positions in the firms being targeted by activists. - Friendly versus hostile activists: Activism is executed with different degrees of confrontation with management. Hostile activists tend to threaten managers with adverse consequences, whereas friendly activists tend to work with managers to develop mutually beneficial outcomes.
- Active activists versus passive activists: This dimension refers to the motive for investing. Active activists establish positions for the purpose of activism. Passive activists participate in activism when they happen to hold positions in firms that become targets of activism.
What is a free rider ?
Passive activists, those who have positions in firms where an activist is leading
the efforts, may be viewed as free riders. A free rider is a person or entity that allows
others to pay initial costs and then benefits from those expenditures.
Active followers have a symbiotic relationship with active initiators.
Although they act as free riders to the active initiators who pay the direct costs of
activism, active followers typically help the initiators by voting in support of the activism.
What is agency theory ?
Agency theory studies the relationship between principals and agents. A
principal-agent relationship is any relationship in which one person or group, the
principal(s), hires another person or group, the agent(s), to perform decision-making
tasks. The principals enter this relationship with the objective of having their utility maximized, while the agents seek to maximize their own utility. Preferences and
goals generally differ among all people and all groups of people. Therefore, conflicts
of interest typically exist within all organizations and among all groups within those
organizations.
(Shareholders are the principals and the executive management team members are
their agents).
What is an agency costs ?
Agency costs are any costs, explicit (e.g., monitoring and
auditing costs) or implicit (e.g., excessive corporate perks), resulting from inherent
conflicts of interest between shareholders as principals and managers as agents.
What are the sources of agency costs ?
These agency costs have two sources:
(1) the costs of aligning the interests of shareholders and managers when those interests can be cost-effectively aligned
(2) the costs to the shareholders of unresolved conflicts of interest between shareholders and managers.
Simply put, in some cases, it is cheaper for shareholders to accept managerial actions that conflict with their best interests than to try to bring managers’ interests into perfect alignment with their own interests.
What is a toehold ?
A toehold is a stake in a potential merger target that is accumulated by a potential acquirer prior to the news of the merger attempt becoming widely known.
Why some activist acquire 4.9% stake on the firm they target ?
This tactic helps them by avoiding to fill out Form 13D. This SEC form publicize the activist stake publicly. So by doing this tactic, they keep their
holdings secret and to allow time for conversations with the firm to progress.
What are Forms 13G and 13F ?
Form 13 G is required of passive shareholders who buy a 5% stake in a firm,
but this filing may be delayed until 45 days after year-end. Form 13F is a required
quarterly filing of all long positions by all U.S. asset managers with over $100 million in assets under management, including hedge funds and mutual funds, among
other investors. These forms must list all long positions; however, disclosure of short
positions is not required.
