Subject 5: Hedge Fund Activism

Question 1

What is the primary goal of hedge fund activism?

Answer 1

The goal is to increase shareholder value by pushing for changes in management, policies, or structures that activists believe will improve company performance.

Question 2

How do activist hedge funds typically acquire influence in a company?

Answer 2

They acquire a stake (often around 6.5% on average) and gain support from other shareholders rather than seeking full control.

Question 3

How long do hedge fund interventions typically last?

Answer 3

The median intervention duration is about 253 days, indicating they are not purely short-term investors.

Question 4

Who is Dan Loeb, and what is his approach in hedge fund activism?

Answer 4

Dan Loeb is the CEO of Third Point and is known for publicly criticizing executives through letters, calling for management changes.

Question 5

What is a well-known example of Dan Loeb’s activism?

Answer 5

Loeb’s intervention with Yahoo, where he called for resignations of directors and challenged the CEO’s credentials, ultimately leading to a leadership change.

Question 6

What are the two main hypotheses about the impact of activism on innovation?

Answer 6

1) Management entrenchment hypothesis, where activism can prevent management complacency.
2) Failure tolerance hypothesis, where long-term projects suffer under activist pressure.

Question 7

How does hedge fund activism potentially harm innovation?

Answer 7

By creating pressure for short-term results, it may cause managers to cut R&D spending and focus on quick returns over long-term projects.

Question 8

How can hedge fund activism benefit innovation?

Answer 8

Activists can bring a more efficient reallocation of resources, including the sale or better use of patents and hiring of productive innovators.

Question 9

What innovation measures are typically used in studies on hedge fund activism?

Answer 9

R&D spending, number of patents, patent citations, originality, and generality of patents.

Question 10

What does the term “patent originality” mean in innovation studies?

Answer 10

It refers to patents that cite a wide range of technology classes, indicating broad innovative effort.

Question 11

What is meant by “patent generality”?

Answer 11

Generality is the extent to which a patent is cited by patents in a wide range of technology fields, suggesting broad applicability.

Question 12

How does hedge fund activism affect R&D spending in the targeted firms?

Answer 12

Studies indicate a reduction in absolute R&D spending but not necessarily in R&D relative to assets.

Question 13

How does hedge fund activism influence the number of patents filed by a firm?

Answer 13

The number of new patents can increase after intervention, showing that activism can stimulate innovation outputs in specific cases.

Question 14

What role does the sale of patents pay in hedge fund activism’s impact on innovation?

Answer 14

Targeted firms often sell underutilized patents, improving resource allocation and focusing on core innovative areas.

Question 15

What does a higher market response to a patent grant indicate?

Answer 15

It shows a positive market valuation, suggesting that the patent is expected to add significant value to the firm.

Question 16

What is the “failure tolerance” hypothesis in relation to corporate innovation?

Answer 16

It suggests that tolerance for short-term failures is essential for long-term innovative success, often lacking in activist-targeted firms due to pressure for immediate results.

Question 17

How does the “management entrenchment” hypothesis view activism’s impact?

Answer 17

It suggests that activism deters management complacency, encouraging innovative investments.

Question 18

What kind of firms are often targeted by hedge fund activism concerning innovation?

Answer 18

Activists often target life science and technology firms, sectors heavily reliant on R&D and patent development.

Question 19

Why are activist hedge funds considered different from corporate raiders?

Answer 19

Unlike corporate raiders of the 1980s, activists focus on influencing company strategy without aiming for complete control.

Question 20

What impact does activist pressure have on managerial attention?

Answer 20

It may divert attention away from long-term innovative projects to short-term operational improvements.

Question 21

How does hedge fund activism impact employee morale in targeted firms?

Answer 21

Activism can create instability, impacting morale negatively as employees may fear job cuts or strategic shifts.

Question 22

What is the “value transfer” concern in hedge fund activism?

Answer 22

It questions if the immediate positive market response represents actual value creation or merely a transfer of value to shareholders.

Question 23

In the context of corporate governance, what is “agency conflict”?

Answer 23

It refers to conflicts between management and shareholders, where management might prioritize personal gain over shareholder value.

Question 24

How does activist hedge fund pressure potentially cause underinvestment in innovation?

Answer 24

Managers may focus on routine tasks with assured returns, reducing investment in uncertain, long-term innovative projects.

Question 25

What is the role of “market-to-book ratio” in selecting activist targets?

Answer 25

A low market-to-book ratio can indicate undervalued assets, making the firm attractive to activists seeking potential for restructuring and value increase.

Question 26

How does hedge fund activism affect the productivity of inventors?

Answer 26

Retained investors tend to be more productive, while newly hired inventors show similar productivity, contributing to improved innovation outcomes.

Question 27

What is meant by “reallocation of investors and patents” in activist-targeted firms?

Answer 27

It refers to the strategic reassignment of patents and inventor talent to optimize resources and strengthen innovation.

Question 28

What does research by Brav et al. (2018) suggest about the quality of patents after activism?

Answer 28

Both patent originality and generality tend to improve, indicating enhanced quality in innovation output.

Question 29

What is a “propensity score” in the context of hedge fund activism studies?

Answer 29

It is a statistical method used to match target firms with control firms based on similar characteristics, such as industry and size, for accurate comparisons.

Question 30

Why is innovation considered a risky but essential corporate strategy?

Answer 30

Innovation requires exploring untested approaches with high failure risks but is key for long-term competitive advantage.

Question 31

How does hedge fund activism impact patent citation rates?

Answer 31

Citation rates may increase, reflecting the higher economic and technical impact of patents post-intervention.

Question 32

How do hedge funds ensure patents are utilized effectively post-intervention?

Answer 32

They often reassign patents to entities that can better leverage them, maximizing their social and economic value.

Question 33

What are “matched control firms”, and why are they used in studies?

Answer 33

Matched control firms are non-target firms similar to target firms, used as benchmarks to assess the impact of activism accurately.

Question 34

How does hedge fund activism align with long-term value creation?

Answer 34

While it may enhance operational efficiency, the pressure for short-term gains can conflict with long-term innovative investments.

Question 35

What is the main finding of the Brav et al. (2018) study on hedge fund activism and innovation?

Answer 35

Hedge fund activism often leads to improved allocation and efficiency in innovation without significantly reducing innovation output.