Hedge Funds activism and the impact on target Company share prices

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Hedge Funds activism and the impact on target

Company share prices

University of Groningen Faculty of Economics and Business

MSc International Business & Management – specialization in International Financial Management

Master Thesis

Rijksuniversiteit Groningen Piet Hein Conijn 1333984 Supervisor: Niels Hermes

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Abstract

In this paper the effect of hedge fund related initial share filing announcements on the target company’s share price in Europe has been studied. The sample is comprised of 99 share filing events which were announced in period between 1999-2007. This empirical research is conducted by making use of event study methodology. Results are based on the cumulative abnormal returns over a 21-day and 41-day event window.

This study has led to the conclusion that hedge fund related initial share filings lead to significant positive abnormal returns on the target company’s shares. And therefore indicating that hedge fund related share filings can be seen as value creating for the target firm’s share price. The studied event characteristics; Investor Protection, Hedge Fund Reputation, Percentage of share filing and Hedge fund strategy (single operating or Wolfpack) were foundsto have nossignificantsinfluence on abnormal returns. What did have a significant impact on the abnormal returns was the country of origin of the hedge fund whereby investors seem to have a preference towards home country related hedge funds investing in home country related target firms.

Keywords: Hedge Funds, Shareholder Activism, Initial Filings, Cumulative Abnormal

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After an absence of over a decade, shareholder activism is once again a hot topic, but this time with a difference1. Back in the end of the 20th century the focus of shareholder activism was on institutional investors and whether they could step in and help corporate management after speculations of hostile takeovers. However Thomson Financial’s Simon Tse (2008) describes how nowadays ‘hungry’ hedge funds are using these former corporate saviors to target company’s corporate management.

Hedge funds are not a new phenomenon in the corporate landscape. According to Stulz (2007) the first hedge fund was founded by Alfred W. Jones in 1949 and since its first establishment the number of hedge funds has been growing ever since. However last decade the number of hedge funds and the amount of assets under management has been growing at a fast pace. (Bundell-Wignall, OECD 2007). According to the OECD this enormous growth in hedge funds and its assets under management can be explained by several changes in the global financial landscape. Most important changes have been the internationalization of global capital markets which has led to lower costs of capital, (Bundell-Wignall, OECD 2007) Second of all and according to Briggs (2006) the strongest reason for the fast pace of hedge funds has to do with the changing corporate landscape due to corporate governance. LaPorta (2000) indicates the change of corporate landscape and describes how corporate power has shifted from corporate management towards the common shareholder. At the moment a complicated battle is taking place among academic commentators, governments, shareholders and the corporate community whether this shifts in power will lead to a more regulated, transparent and stable corporate environment.

Another interesting discussion, that has received an increasing amount of press coverage over the last 2 years, has to do with the so-called ‘objectives’ of these activist shareholders. Many question the integrity of these so-called ‘aggressive’ shareholders and their activism. Some state that hedge funds are only ‘in’ for the short run and destroy long term returns by stripping their targeted firms (Kahan & Rock, 2007).

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See, e.g. T.W. Briggs, Corporate Governance and the New Hedge Fund Activism; and Empirical

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1.2 Objective

Based on a recent stream of academic studies this paper strives to reveal the determining factors underneath the success of hedge fund related activism. Based on a paper of Brav, Jiang, Partnoy and Thomas (2008) on US hedge funds related share returns this paper focuses on its European equivalent. Several academic studies, Briggs (2006), Brav, Jiang, Partnoy and Thomas (2008) and Kahan & Rock (2007), all find empirical evidence for cumulative abnormal returns during initial share filings done by hedge funds in the US. For this study we will focus on the impact of hedge fund related initial share filings in Europe. This impact will be measured based on changes in share prices of the target company's shares.

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2. Theoretical Framework

In order to provide a decent research framework it is important to give a clear overview of the exact meaning of hedge funds, the different types of hedge funds and shareholder activism.

2.1 Hedge Funds

As stated earlier in this paper the existence of hedge funds is not a new phenomenon in corporate landscape. According to Caldwell (1995) the development of the first hedge fund is generally attributed to Alfred W. Jones. Herdeveloped theyconcepttof the first hedge fund by means of a market neutral strategy by which long positions in undervalued securities would be offset and partially funded by short positions in others. According to Brown (1999) this ‘hedged’ position leads to an effective leverage situation of the invested capital. And therefore providing possibilities to place large bets at limited resources. To provide a more accurate and modern definition of hedge funds t5his study uses the statement as used by Brav, Jiang, Partnoy and Thomas (2008). Brav, Jiang, Partnoy and Thomas (2008) define hedge funds by four common characteristics: “Hedge Funds are”;

(1) pooled, privately organized investment vehicles; (2) administered by professional investment managers; (3) not widely available to the public; (4) hedge funds operate outside of securities regulation and registration requirements.

The 4th characteristic makes hedge funds so unique. The fact that hedge funds operate outside the security regulation and do not need to register itself makes it extremely hard to detect its tactics and strategies. Furthermore due to this lack of regulation there is no exact central data source that lists all hedge funds and its activities.

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Figure 1, Assets managed by Hedge Fund Source: Credit Suisse Tremont

Like all investment vehicles hedge funds intend to generate a return on their investments and their approach of how they try to generate this above market returns vary widely.

Based on a paper by Goetzmann & Ross (2000) three different groups of hedge funds can be distinguished. These different categories of hedge funds are based on the differences in investment strategies which the organizations use. First and biggest category of hedge funds use the tactical strategy approach of long/short positions as mentioned earlier by Caldwell (1995) in the case of Jones’ first hedge fund.

Second category of hedge funds focuses on arbitrage strategies. Hedge Funds that operate on arbitragessituations and make use ofsobservable pricesinefficiencies and, as such, puresarbitrage is consideredsriskless. Consider assimple example. Say Shell’ssstock currentlystrades at $10 and assingle stock futuresscontract due inssixsmonths is priced at $14. The futuresscontract is aspromise tosbuy or sellsthe stock at aspredetermined price. So byspurchasing thesstocksand simultaneouslysselling thesfutures contract, you can, withoutstakingson any risk, locksin a $4 gainsbefore transactionsand borrowing costs.

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want to earn a piece of these arbitrage situation the arbitrage is perishable and self-defeating: if a strategy is too successful, it gets duplicated and gradually disappears. Third and last category of hedge funds focuses on so called event driven hedge funds. A clear definition of event driven hedge funds is given by Nicolas (2004) who states that event driven hedge funds ‘are hedge funds that base their investments on investment

opportunities created by significant upcoming transactional events, such as spin-offs, mergers and acquisitions, liquidations, recapitalizations, share buybacks and other extraordinary corporate transactions’.

According to Nicolas (2004) in the category of eventsdrivenshedgesfunds a newskind of hedge fund hassarisedsover the lastsdecade, namely, thesevent drivensactivist fund. Uniquesfor thesactivist hedgesfunds is thatstheir strategy is morespredatory insnature wherebysthe activist hedgesfundsproffers their ownsearlier mentionedstransactional events. Accordingsto Nicolas (2004) this activiststype of hedge fundsstypically takes sizeablespositionssin flawedscompanies and thensuses itssownership tosforce managementschanges or asrestructuring of thesbalance sheet.

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2.2 Hedge funds, Corporate Governance and Shareholder Activism

Hedge funds have been prominently featured in the news during the last decade, whether in stories about their historical high returns, high management fees, legal entity structures or different strategies of creating these high returns. And although all these different articles report on different hedge fund related trend all indicate the enormous growth of assets under management of these so called activist hedge funds. Due to several changes in corporate landscape new possibilities have aroused and hedge funds are stepping into new investment strategies that most large institutions did not actively pursue. According to Pearson & Altman (2006) and Bundell-Wignall (2007) the most profound argument for the upcoming of event driven activist hedge funds has to do with the upcoming of corporate governance regulations whereby corporate power shifted from corporate management towards corporate shareholders (LaPorta, 2000). Based on Nicolas (2004) event driven activist hedge are known for their more predatory approach on creating transactional events within their target companies. Whereas the practice of intervention by pension funds or mutual funds used to be limited to (1) buying/selling of stocks, (2) monitoring developments and (3) meeting with the management, nowadays ‘active’ shareholders such as event driven activist hedge funds and private equity firms openly criticize the corporate management of their target firms. Something that was thought impossible before the upcoming of corporate governance regulations.

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Some clear examples of these recent activist intentions of event driven activist hedge funds are Stork and ABN AMRO bank. Where in the case of ABN the event driven activist hedge fund, Children’s Investment Fund’s (TCI), had send an open letter to the management of former Dutch ABN AMRO bank. With its letter TCI started a campaign for splitting up the bank because of failing management and significant undervaluation (shareholder value) in comparison to its peer competitors. Another clear example of an open confrontation towards corporate management by an activist shareholder is Stork N.V. against a combination of two hedge funds, a so called wolf pack, of Centaurus Capital and Paulson & Co. In their initial letter to the management Centaurus and Paulson demanded a restructuring of the company by selling of specific divisions of Stork N.V. that were according to them not inline with the ‘core business’ of Stork. However when corporate management did not agree with the shareholders Centaurus and Paulson organized several extra of calendar shareholder meetings where they openly criticized Stork’s corporate management.

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3. Research Framework and Hypotheses

3.1 Initial Filing and the impact on the target company’s share price.

Based on the research of Brav, Jiang, Partnoy and Thomas (2008) we focus on the initial filing of a significant share purchase by activist hedge funds. In their study they indicate this as a situation that could lead to abnormal returns in share prices. Previous studies based on shareholder activism in the United States done by Klein & Zur (2006), Clifford (2007), Brav, Jiang, Partnoy and Thomas (2008) and Boyson & Mooradian (2007) all find empirical evidence for initial abnormal returns after compliance with the Schedule 13D. However no large scale studies have been conducted on the impact of these filings by Hedge funds on European firms. Several explanations are given for these sudden abnormal returns due to these initial filings. According to Clifford (2007) a filing of a substantial percentage of shares triggers investors interest in the target company. Clifford (2007) relates this investment related trigger to an article of Kyle & Villa (1991) on noise trading and takeovers. In their paper Kyle & Villa (1991) describe noise trading as a theory whereby investors do not make investment decisions based on fundamental analyses but invest as a reaction on good/bad news and possible rumors which as a reaction lead to share price fluctuations. Inline with Clifford (2007) we expect a possible situation of higher investor related interest in companies that are experiencing hedge fund interest. Based on the article of Kyle & Villa (1991) on noise trading and takeovers whereby company’s share price boosted due to rumors of a possible takeover we expect similar share price fluctuations during the initial filing process of a substantial percentage of shares filled by event driven activist hedge funds. Based on previous events and outcomes of shareholder filings earlier done by event driven activist hedge funds investors expect that future changes are upcoming and may lead to a possible situation of abnormal returns.

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Hypothesis 1

A Hedge Fund announcement concerning an Initial filing of a substantial2 percentage of shares will lead to abnormal returns on the target company’s share price.

Based on the outcome of Hypothesis 1 this study will focus on the specific event characteristics and whether these characteristics will lead to higher abnormal returns. In their research Brav, Jiang, Partnoy and Thomas (2008), Gillian & Starks (2006) and Boyson & Mooradian (2007) all indicate different returns during the announcement date of initial shareholder filings of event driven activist hedge funds. In their papers Brav, Jiang, Partnoy and Thomas (2008), Gillian & Starks (2006) and Boyson & Mooradian (2007) all calculated the share price fluctuations during the initial filing process by means of the cumulative abnormal returns (CAR) whereby the actual share price during the event period is compared to the expected share price based on historical share price fluctuations. However these earlier mentioned studies do not give any explanations for the differences in CAR during the similar initial filing process of these hedge funds. As previously stated this study will not solely focus on whether these activist hedge funds related share filings will lead to a situation of cumulative abnormal returns but also try to explain the differences in CAR of the different filing events. Based on specific event characteristics (hedge fund, country and target firm characteristics) this paper tries to project the possible outcomes in share price returns during the initial filing process of hedge funds.

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3.2 Investor protection

In comparison to previous studies on hedge fund activism this study will not only focus on events within the borders of one single country so in order to test the different returns on share prices we will have a closer look at different country characteristics that influence the investment climate. As mentioned earlier Pearson & Altman (2006) and Bundell-Wignall (2007) state that the rapid growth of event driven activist hedge funds can be linked to the introduction of corporate governance whereby the corporate power and decision mechanisms shifted from the corporate management to the corporate share,- and stakeholders. Based on a paper of Becht, Franks, Mayer, and Rossi (2006) on hedge fund operations in the UK we expect that a countries institutional environment can have a considerable influence on the abnormal returns during hedge fund related initial share filings. In their paper “Investor protection and corporate governance” La Porta & Lopez-de-Silanes (2000) describe how corporate governance is a set of mechanisms through which outside investors protect themselves against expropriation by the company’s managers and controlling shareholders. La Porta & Lopez-de-Silanes (2000) describes how ‘insiders’, corporate management and controlling shareholders, run their companies by means of their own best interests instead of the shareholders best interests. We have reason to believe that the degree of self defending mechanisms against expropriation influences the returns on share prices. One of the institutional mechanisms for investors to protect themselves against expropriation is the countries law system.

This is inline with a paper of La Porta & Lopez-de-Silanes (1997) in which they describe how both shareholder power and shareholder protection are influenced by countries law systems. Hereby La Porta & Lopez-de-Silanes (1997) indicate two different law systems within Europe on the one hand we see the UK orientated common law system whereas the continental Europe can be indicated as a civil law system. What distinguishes both law systems from one another is the degree of shareholder protection and voting power. According to La Porta & Lopez-de-Silanes (1997) a company which is located in a common law country protects its shareholders better than a company which is located in a civil law country.

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As explained Clifford (2007) states that shareholders and other investors will notice that future changes are upcoming within this company that is experiencing hedge fund’s interests due to this initial filing. However the possibilities to succeed in implementing their imposed strategies is determined by shareholder rights. So in other words the chances that the expected changes can be realized by the hedge funds are highly dependable on the power that is provided to the shareholders based on the local law system.

Due to the fact that common law countries serve their investor's rights better than civil law countries we expect better possibilities for hedge funds to impose their new strategies to their target firms and therefore strong company changes are more likely to occur within common law countries. These expected company changes will lead to a possible situation of higher cumulative abnormal returns. Based on this we formulated the first hypothesis

Hypothesis 2

Higher abnormal returns are to be expected during hedge fund filings in common law countries than in civil law countries.

3.3 Home investor bias and higher returns

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In this study we will test the impact of home country investments by hedge funds and its impact on share prices. Based on the argument on better knowledge of the ‘home investment market’ by Tesar & Werner (1995) we will test whether local share filings by hedge funds lead to higher returns.

Based on the fact that other institutional and common investors expect better local market knowledge of home investing hedge fund we expected higher return on share prices during initial filings by hedge funds targeting firms on their home market due to the fact that other institutional and common investors will follow this local preference of the hedge fund. This will be tested using the following hypothesis.

Hypothesis 3

Higher abnormal returns are to be expected during home country related hedge fund filings than in foreign country related hedge fund filings.

3.4 Wolf pack strategies

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So in other words based on this higher success rate in US related shareholder activism we expect higher abnormal returns during initial filings done by multiple hedge funds in Europe.

Hypothesis 4

Higher abnormal returns are to be expected during initial filings done by ‘wolf packs’

3.5 Percentage of initial filing

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Hypothesis 5

Higher abnormal returns are to be expected during hedge fund filings of a high percentage (>5 %) of shares.

3.6 Reputation

Last characteristic by which we want to further specify the abnormal returns is investor reputation. Several studies have been conducted on the effects of investor reputation. Kelly & Hay (2000) describe how reputation of financial investors during venture capital IPO’s have a positive impact on share prices.

In their paper Kelly & Hay (2000) explain how the reputations of leading ‘deal makers’ attract extra investors and outperform market returns on both short and long run. Based on the papers of Brav, Jiang, Partnoy and Thomas (2008), Briggs (2006) and Becht, Franks, Mayer, and Rossi (2006) on activist hedge funds performance we expect that hedge funds are seen as the ‘leading deal makers’ and their investments, both financial

and management related , in companies will lead to abnormal returns based on the fact

that other investors are attracted by the possible outcomes of expected future hedge fund related efforts. In other words due to the reputation of hedge funds and their historical returns on investment other common investors and institutional investors will invest in the target company in times of initial filings. Kahan & Rock (2007) describe this situation as ‘free riding’ whereby other investors share the benefits of the hedge fund’s activism however only one shareholder, the hedge fund, carries the costs. However we have reason to expect that the hedge fund’s reputation leads to a self-fulfiling prophecy in times of the initial filings whereby the normal investor haphazardly invests in the targeted companies during these filings. Based on the significant share filings of activist hedge funds (leading deal makers) investors expect upcoming future changes and therefore also invest in the target company's share which again causes a raise in demand for the target company's share (hence boost the share price).

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The Financial Times compiled a list of the ‘top 100 hedge funds to watch’. The Financial Times selection criteria we based on the following characteristics, (1) assets under management, (2) major deals, (3) performance. In order to test whether hedge fund’s reputation leads to a self-fulfiling prophecy we will compare the abnormal returns during these initial filings of both the hedge funds that are listed by the Financial Times and the ‘normal’ hedge funds.

Based on the papers of both Kelly & Hay (2000) and Kahan & Rock (2007) we expect higher abnormal returns for the hedge funds with favorable reputations due to their ranking and historical returns. Therefore the following hypothesis is created.

Hypothesis 6

Higher abnormal returns are to be expected during hedge fund filings by hedge fund with a proven track record.

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4. Methodology and Data collection

The main question in this paper is best addressed by examining the specific effects of shareholder activism and the impact on the target firm’s share price. According to Warner (1988) the best order to measure the precise impact of certain events is the event study model. According to MacKinlay (1997) an event study measures the impact of a specific event by using financial market data. An important feature of an event study is the efficient market hypothesis whereby it is stated that the effects of an event will immediately be reflected in the firm’s share price.

4.1 Structure of an event study

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4.2 Estimation and Event Window

The total data sample as used in this research consists of 99 events and in order to measure the exact effects of hedge fund related shareholder filings we need to measure both the (1) the estimation window and (2) the event window. In Figure 2, a timeline for an event study is given, on which this research is based. Unfortunately due to data constrains it is currently not possible to measure the post-event window.

Figure 2, Timeline for event study source: MacKinlay (1997)

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Based on Brav, Jiang, Partnoy and Thomas (2008) this paper uses a 20 day interval period before the initial filing and a 20 day interval period after the initial filing. So in total the event window for this study will be 41 days and will last from day -20 (τ = T1 + 1) to +20 day (τ = T1), and is denoted as Y2 (see Figure 3). However based on the paper of Boysen & Mooradian (2007) on shareholder activism in the US we will perform a second interval period. In their paper Boysen & Mooradian (2007) state that by conducting different time interval periods a more accurate measurement of the exact impact of the initial share filing is measured. They state that based on a 41-day time interval as used by Brav, Jiang, Partnoy and Thomas (2008) its hard to conclude the exact effect of the specific event. With a relative stretched time interval like this (41-days) the results can be disturbed by other events happening at the same time. Therefore in line with Boyson & Mooradian (2007) this paper also uses a 10 day interval period before the initial filing and a 10 day interval period after the initial filing. So in total the event window for this study will be 21 days and will last from day -10 (τ = T1 + 1) to +10 day (τ = T1) (see Figure 4).

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For this paper we will use an estimation period from -200 days (τ = T0 + 1) to -20 days (τ = T1), and is denoted as Y1 . For our second event window we will extend the estimation window with 10 days to 190 days however the period of 200 days prior to the events is still used. A period of 180 days is around the average for event studies using daily stock returns (Peterson, 1989). This period will be sufficient in order to make a proper prediction of the normal return on a given company’s share.

Figure 3: Specific event study time line (41-day time interval)

Figure 4: Specific event study time line (21-day time interval)

Y1: Estimation window Y2: Event window

Days -190 -10 0 +10 Y1: Estimation window Y2: Event window

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4.3 Abnormal returns

Important for evaluating the impact of an event is that abnormal returns have to be measured. Abnormal returns can be calculated as the actual return of a security over the period of the event window minus the normal return of the company over the same period (Warner & Brown,1985). According to MacKinlay (1997) the normal returns can be defined as the expected return without taking into account the event taking place (MacKinlay, 1997). For company i the abnormal return for a given event dateτ _is

calculated by; t it i i R E R X AR_τ = _τ − ( / ) [1]

Where AR is the abnormal return, _i_τ R is the actual return, and _i_τ E(R_it/X ) is the

normal return for time period τ without taking into account the event taking place.

According to MacKinlay (1997) there are multiple models to calculate the normal return of a given share, which will be discussed in the next paragraph.

4.4 Market Model

According to MacKinlay (1997) a number of approaches are available to calculate the normal returns of a given security. These different calculation methods can be grouped into two categories, namely economic and statistical. Models in the first category, economic, rely on assumptions concerning investors’ behavior whereas the statistical models follow from statistical assumptions concerning the behavior of an asset’s return and do not depend on any economic argument. Based on these assumptions MacKinlay (1997) identifies two models measuring normal performance, economic, the Constant Mean Return Model and statistical, the Market Model.

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Withythisyadvantage there isyan increased abilityyto findyany announcementyeffects. Based on this we will use the Market Model to measure normal performance.

As mentioned earlier the market model is a statistical model which measures the return of any given security (share) to the related market portfolio. In other words the statistical model measures the fluctuation differences of an individual share in comparison to the overall market fluctuation in the specific event window. The linear specificationnof the model followss from the assumption that asset returns are jointly normally distributed, (MacKinlay, 1997). In order to calculate the individual abnormal returns as accurate as possible all country specific stock exchanges will be used as market index for this research.

The securities underlying these indices are assumed to be mutually normally distributed, independently and identically distributed through time. In other words all target firm share conditions and market conditions remain unchanged through time, so no claim emissions, share mergers, etc. This is an important condition in order to calculate the exact impact of the events on the cumulative abnormal returns of the given security. The market model formula for any company i is

it mt i

i a R E

R_τ = +

β

_i + and t= -200,….-20 [2]

Where Rit is the period-t return on security i, and Rmt is the period-t return on the

market portfolio. εit is the zero mean disturbance term. αi and βi are the parameters of

the market model. The parameters αi and βi are estimated through line estimation from

the regression Rit on Rmt this regression is conducted by means of SPSS software. This

test is called the Ordinary Least Squares (OLS) and will be used to estimate αi and βi

over the 180 days (t= -200,….-20) estimation window. The market model assumes that if the event would not occur, the relationship between the returns of company i and the market index remains unchanged. Furthermore, the disturbance term’s (εit) expected

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4.5 Average and cumulative abnormal returns

Based on the earlier calculated normal returns by use of the market model it is now possible to calculate the abnormal returns of the time period Y2. Based on MacKinlay (1997) using the market model to calculate normal returns the sample’s abnormal return can be calculated using formula [3].

τ τ τ i αi βi m i R R AR ∧ ∧ − − = . [3] Hereby i ∧ α and _i ∧

β represent the estimates of αi and βi as calculated by means of the OLS regression. When all daily abnormal returns have been individually calculated for every specific target, they have to be aggregated to get overall conclusions. So first the cumulative abnormal returns (CAR) will be measured for each target company in the sample. The CAR is calculated as the sum of all abnormal returns of all the target companies during the event window period (Y2). Based on MacKinlay (1997) and Warner & Brown (1985) the cumulative abnormal return of the target companies i are formulated by the following formula [4].

∑

= = 2 1 ) 2 , 1 ( τ τ τ τ τ τ τ ARi CAR with [4]

Based on formula [4] all individual CAR’s over the total event window Y2 can be calculated. In order to come to an overall conclusion on the effects of activist hedge fund related share filings across the ‘entire’ European continent the average cumulative abnormal returns of all individual events have to be measured. Than based on these calculations the answer to our first hypothesis can be calculated based on statistical tests. However first the average cumulative abnormal return for all companies in the sample is formulated by the following formula

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Hereby CAR(τ1,τ2) represent the average cumulative abnormal return per individual share calculated over the event window. And

∑

represents to sum of all individual share CAR’s and N stands for the total number of events. In the case of this study

N =99.

4.6 Statistical tests

Based on the calculations of the average cumulative abnormal returns it is now necessaryyto test whether they significantly differ from zero. As stated earlier based on the concept of perfecttcapital markets no situations of arbitrage opportunities exist. Within the perfect capital market theory all investors receive and act on all relevanttinformation as soonaas it becomessavailable. The theory states that sinceeeveryone hassthe sameiinformation abouttasstock, theepricesshould reflecttthe knowledgeaanddexpectations ofaalliinvestors. The bottommline issthat anninvestorris not ableeto beattthe markettand alllshareepricessshould be positioneddon the security market line and no excess returns will occur. In other words based on the perfect capital market theory the cumulative abnormal returns during hedge fund related share filings should not differ from zero. The following hypotheses can be formulated in order to test if the average CARs differ significant from zero over both the 21-days and the 41-days event window. 0 ) 2 , 1 ( : 0 CAR

τ

= H 0 ) 2 , 1 ( : 1 CARτ τ ≠ H .

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Besides testing if the cumulative abnormal returns during share filings differ from zero this study will focus on specific event characteristics and whether these characteristics influence the CAR’s. In order to test if the different characteristics significantly differ from one another we will use two-sample T-tests to answer hypotheses two, three, four, five and six. Based on Brown & Warner (1985) the following formula will be used to conduct the two-sample T-test:

[7]

Where k is a characteristic used as a dummy variable (1 or 0) and _i n represents the _i

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4.7 Variables influencing the abnormal return

Based on the earlier mentioned hypotheses this paper will test the effects of the initial filings on the target firm’s share prices. Different abnormal returns are to be expected based on hedge fund reputation, percentage of shares during initial filings, home country bias, ‘wolf pack’ strategies and investor protection. However according to the academic literature several other variables possibly influences the abnormal returns during share filings. In order to test whether the abnormal returns during initial share filings are heavily influenced by other specific factors this study will use 3 control variables. Based on a paper by Boyson & Mooradian (2007) this study will use target firm related control variables, namely, firm size, growth and profitability. In their study Boyson & Mooradian (2007) perform a study on hedge fund related shareholder activism and the relation to the target company’s stock performance. In this paper, Boyson & Mooradian (2007) relate to firm size, growth and profitability as profound drives in share price fluctuations and should therefore be filtered.

4.7.1 Firm Size

First variable which will function as a control variable in this paper has to do with the size of the target company. The size of the targeted firms can widely diverge and along with it the impact of certain events. Based on Boyson & Mooradian (2007) a company’s size (firm size) is calculated as the log of the company’s assets.

4.7.2 Growth

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4.7.3 Profitability

Last control variable that will be tested in this paper concerns profitability.

Profitability

has proven to influence company share prices both positive and negative. Profit

figures could for example be negative however not as disappointing as the

previously projected losses. However this is not something that will be tested in

this study. Based on Berger & Ofek (1995) profitability is calculated by the

annual percentage change in revenue.

4.7.4 Testing the control variables:

As mentioned earlier the different hypotheses used in this study are tested in two different ways. The first test, one-sample T-test, focuses on one individual variable namely the CAR’s of the entire data sample in order to test if the hedge fund related share filings lead to abnormal returns. In other words do share filings have a significant impact on the target firm’s share price. The second test, independent-samples T-test, focuses on each variable (characteristic) individually and tests whether the means in CAR of these variables differ significantly from each other.

Finally a last test will find out whether the individual CAR’s and characteristics as used in hypotheses 2,3,4,5 and 6 have been affected by the control variables (growth, firm size and profitability). This will be done using the OrdinaryyLeasttSquares regression. The CAR’s as resulted due to the initial share filings and the individual event characteristics are regressed on the different independent control variables (Growth, Profitability and Firm Size) in order to analyze the influence of these independent control variables.

CAR =α + (β InvestorProtection) + β Growth + β Profitability + β Firm Size +ε [8]

Whereby(β InvestorProtection) will be individually changed per event characteristic to

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represented by means of 1 and 0. Indicating 1 as a positive number so for example representing growth, profitability or firm size big.

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5.1 Data collection

As stated earlier in this paper currently no large scale databases exist on hedge funds related shareholder activism and target firm performance. So in order to conduct this research on hedge fund related activism a new individual data set had to be created from scratch. According to Brav, Jiang, Partnoy and Thomas (2008) there are some publicly available hedge fund databases (TASS, CISDM) that report on hedge funds’ assets under management, historical performance and hedge fund strategies. However they do not report on specific cases of shareholder activism. Furthermore according to Brav, Jiang, Partnoy and Thomas (2008) there is a widespread criticism on the available data regarding hedge funds in general as data vendors rely mostly on voluntary reporting by the hedge funds. In order to create our own database on shareholder activism we conducted an extensive research by the use of both publicly available data as not publicly available data.

Several criteria were used to conduct our dataset:

1. The Hedge funds need to acquire a substantial stake in the target company. Whereby substantial is indicated as the minimum % of shares that needs to be filled to the authorities. All European countries, as used in the data sample, require a filing at a minimum of 5% except for Italy’s 2%.

2. The case of the actual share filing must have taken place in the time span of 1999-2007. Based on Briggs (2006) most recent hedge funds filings have occurred in this last decade and therefore our time span of 1999-2007 covers a majority of the European hedge funds related activism.

3. Since we focus on European related shareholder activism the target companies have to be registered in Europe. Based on Thompson Financial’s Simon Tse most European hedge fund related shareholder activism has occurred in the following countries France, Germany, Italy, The Netherlands, Sweden, Switzerland and United Kingdom. Therefore all cases that were conducted in this research had to have occurred within these countries.

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Following Brav, Jiang, Partnoy and Thomas (2008) we started with assembling a comprehensive list of hedge funds engaged in activism. This list is largely based on hedge funds that are previously described in cases in other academic papers (de Jong 2007, Hermes & Postma 2008), the earlier mentioned Financial Times ‘100 Hedge Funds to watch’ list and the book written by R. Orol (2008). Furthermore we started performing searches in news databases such as Lexis-Nexis. Based on these cases and articles we were able to gather the names of around 20 world wide situated hedge funds that were operating in Europe. Unfortunately, in comparison to the US, the European Union does not have one strong central organization to control and promote transparency within its member states’ financial markets. Whereas Brav, Jiang, Partnoy and Thomas (2008) could search one central, the SEC EdgarHoover, database for substantial shareholder filings we had to search (if member states had these central

bases at all) for these filings in several databases. This also partially led to the specific

European countries as used in this study. Furthermore based on the report of Thompson Financial’s Simon Tse most European hedge fund related shareholder activism is situated in these European Member States. Furthermore with the exception of Spain this cluster of European Countries represents the most economically significant economies in Western Europe.

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5.2 The final sample characteristics

In the next paragraph we will shortly discuss the contents of our final data sample. After extensive research the total data sample that matched the previously described criteria consists of 99 cases whereby hedge funds purchase substantial share blocks in European companies. Table 1 provides an overview of the distribution of the filings over the different European countries.

Country France Germany Italy The Netherlands Sweden Switzerland UK

Number of Filings 16 19 4 11 5 4 40

Table 1. Distribution of Filings over the European Countries.

Furthermore as discussed earlier this paper tests the exact influence of the different event characteristics. Table 2 provides an overview of the distribution of the different variables over the 99 cases. For a complete overview of the specific event characteristics see the Appendix A.

As can be seen from Table 2, the first variable namely common law vs. civil law is quite equally distributed. Although the United Kingdom is the only common law country participating in this research it represents over 40% of the total sample.

Furthermore we indicate a dominance of ‘Unrelated to hedge fund’s home country investments’ which means that hedge funds do not have a particular appetite for home country related company investments. However this dominance of non home country related hedge fund shareholder activism in Europe can be explained through the historical dominance of American hedge funds and hedge funds presence in favorable tax-climates in countries, such as Barbados and the Cayman Islands.

Last interesting difference in the distribution of the different case variables has to do with the single operating hedge funds versus the wolf pack strategies. Since this wolf pack strategy whereby multiple hedge hunds operate together to convince target company’s management is a new phenomenon not many cases have been reported yet.

Total deals Divided into Common Law Civil Law Related to hedge fund’s home country Unrelated to hedge fund’s home country Wolf pack strategies Single hedge fund operation Percentage Of filing >5% Percentage of filing <5% Reputation Top 100 to watch Reputation Not top 100 to watch 99 40 59 36 63 13 86 54 45 38 61

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6. Results

In the following section the outcomes of this event study are presented. The outcomes of the different hypotheses are discussed in chronological order. Furthermore this section will discuss some primary results as can be concluded from this research sample.

6.1 Discussion of primary results.

Figure 3 and 4 represent an overview of the average 21-day (-10, t, +10) and 41-day (-20, t, +20) cumulative abnormal returns around the initial filing dates of Hedge Funds of the complete data set. As can be seen from Figure 4 the average CAR for the21-day interval period is 8.66%. Furthermore Figure 5 indicates an averagee9.28% CAR on the 41-day interval of the total European sample.

As can be seen from Figure 5 the steepest increase in CAR occurs right around the announcement date t= -1,t=0 and t=2. In the five days interval period, 2 days before and 2 days after the announcement date, an upward trend in cumulative abnormal returns of around 4,18% can be detected.

Ave rage 21-day CAR sample (N=99)

0 1 2 3 4 5 6 7 8 9 10 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 n days R e tu rn i n P e rc e n ta g e ( % )

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Average 41-day CAR sample (N=99) 0 1 2 3 4 5 6 7 8 9 10 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 n days R e tu rn i n P e rc e n ta g e ( % )

Figure 6. Average Cumulative Abnormal Returns over the 21-day TimeInterval.

Furthermore, as can be seen in Figure 5 and better in Figure 6 this initial peak in cumulative abnormal returns is followed by a second upward trend of positive abnormal returns. Based on previous research on Hedge Funds announcements in the US (Brav, Jiang, Partnoy and Thomas 2008) this ‘second wave’ upward trend (t+5-t+9) is most likely explained by the announcements of future plans and intentions of the Hedge Funds with the targeted company. However due to data limitations no proven explanations/conclusions can be provided for this ‘second wave’ of cumulative abnormal returns for our European data sample.

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However as can be seen from the graph, the cumulative abnormal returns can widely vary among the different countries. First there is Italy with a positive cumulative abnormal return of 2.11% during the 41day time window around the announcement day. With its positive return of 2.11% Italy represents the country with the lowest returns. Sweden on the other hand with its positive cumulative abnormal return of 17,65% represents the country with the highest returns.

Average CAR per Country

-5 0 5 10 15 20 -20 -18 -16 -14 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 n days R e tu rn i n P e rc e n ta g e ( % ) Dutch (N=11) UK (N=40) France (N=16) German (N=19) Swiss (N=4) Italy (N=4) Sweden (N=5)

Figure 7. Average Cumulative Abnormal Returns per Individual Country.

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6.2 Initial Filing and impact on subjected company’s share price

First hypothesis that is tested concerns a possible relation between hedge fund announcements and the returns on the subjected company’s share price. The following hypothesis was tested on the entire data sample of 99 cases of hedge fund announcements in Europe.

Hypothesis 1

A Hedge Fund announcement concerning an Initial filing of a substantial3 percentage of shares will lead to abnormal returns on the subjected company’s share.

Based on this hypothesis we conducted a One-Sample T-test of which the results can be obtained from Table 3. First of all as can be seen from Table 3 based on the different time intervals (21-day and 41-day) this study finds different cumulative abnormal returns.

Whereas for the 41-day time interval we find an overall mean of 9.27 % and for the 21-day time interval we find an overall mean of 8.66%.

Table 3. One-Sample t-test based on all events for both the 21-day and 41-day Time Interval

There are several possible explanations for these differences in cumulative abnormal returns. First of all the 41-day time interval consist of 20 extra trading days in which the news concerning the hedge fund related share filing can be in calculated in the share price.

3

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Another explanation for the higher average cumulative abnormal returns during the 41-day interval period could be the situation of other non filing related positive news that occurred during the 41-day time interval. This is the main argument by Boyson & Mooradian (2007) to opt for smaller time intervals in order to measure the exact impact of the share filing as accurate as possible. Indifferently to the differences based on the One-Sample T-Tests we conclude that the resulting p-value for both tests is 0,000 and therefore our first hypothesis is not rejected with a confidence interval of 95%. Based on this significance (p-value of 0.000) we can state that hedge fund related share filings do have a positive impact on the target company share value. In other words hedge fund related initial share filings do create value for target company’s shareholders.

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6.3 Testing the different event characteristics

Besides testing the impact of hedge fund related initial share filings this paper strives to explain the differences in the cumulative abnormal returns. Based on previous literature we compiled a selection of 5 different research variables (characteristics) that could impact the share returns during these filing processes. These variables were all based on the characteristics of either the hedge fund itself, its strategy or the institutional environment. Furthermore three target firm related control variables are tested that could influence the CAR’s. As presented earlier in the methodology section of this paper we used two-sample T-tests to answer the different hypotheses two, three, four, five and six. Table 4 represents an overview of the different test results concerning the research variables.

Table 4. Two-sample T-tests based on all events for both the 21-day and 41-day Time Interval

As can be seen from the results as presented in Table 4 in the columns of both CAR 41 and CAR 21 all different characteristics present different cumulative abnormal returns. Based on the existing literature as presented in the Research Framework and

Hypotheses section of this paper InvestorProtection, Hedge Fund COO and Reputation

all present the expected differences in cumulative abnormal returns.

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countries, home country related and for hedge funds within the Top 100 ‘HF to watch’ reputation.

However for the variables Percentage of Filing and Wolfpack Strategies we expected different cumulative abnormal returns whereby we predicted higher CAR’s for both; (1) multiple operating (wolfpacks) hedge funds and (2) initial share filings with higher percentages of shares. As can be seen for Table 4 for both time intervals (21-days and 41-days) this was not the case. As far as the 41-day CAR interval concerns only one of our stated hypotheses holds namely,

Hypothesis 2

Higher abnormal returns are to be expected during home country related hedge fund filings than in foreign country related hedge fund filings.

As can be seen from Table 4 the conducted two-sample T-test shows a p-value of 0.012 this test indicates a significant difference in the cumulative abnormal returns is found between local hedge fund announcements in the home country markets and foreign hedge fund announcements in the home country. Thereby indicating investors preferences for home country related hedge funds operating in their home country target firms. Therefore hypotheses 3 is not rejected.

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As far as the 21-day CAR interval concerns we find that two of our stated hypotheses hold. First of all in line with our findings for the 41-day-interval period for hypothesis 2 we also find a significant p-value of 0.001 for the 21-day CAR interval indicating that the evidence for investors preference for home country related initial filings is even stronger for the short run.

Second hypothesis that is not rejected for the 21-day CAR interval concerns hypothesis 5 namely,

Hypothesis 5

Higher abnormal returns are to be expected during hedge fund filings by hedge fund with a proven track record

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6.4 Testing the Control Variables.

Finally this paper presents the impact of the different control variables. Based on previous academic literature, besides the earlier mentioned characteristics, several other variables possibly influences the abnormal returns during shareholder filings. Whereas the research variables/characteristics were all based either the hedge fund itself, its strategy or the institutional environment the control variables all focus on target firm related characteristics that could possibly influence the CAR’s. Based on a paper by Boyson & Mooradian (2007) we selected firm size, growth and profitability as the most profound control variables.

In order to test whether the abnormal returns during initial share filings were influenced by the specific control variables we used an OrdinaryyLeasttSquares (OLS) regression. In the Tables 5 and 6 the outcomes of the OLS regression with the control variables are presented. Based on the formula;

CAR =α + (β InvestorProtection) + β Growth + β Profitability + β Firm Size +ε

This test focused on the covariance of the control variables and the different event characteristics on the average cumulative abnormal returns of the entire data sample. When looking at both Tables 5 and 6 we see no big immediate shifts in the p-values (Sign.) when adding the control variables to the regression model expect for the Reputation related characteristic concerning the 21-day interval, see Table 5.

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Table 6. Testing the Control Variables (41-day CAR interval)

For the earlier conducted two-sample T-test this paper tested a p-value (Sign.) of 0.036 hereby indicating a significant impact of the filing hedge funds’ reputation in the 21 days surrounding the initial filing. However by adding the target firm’s related control variables the OLS regression indicates a p-value (Sign.) of 0.111 and thereby invalidates the earlier accepted hypothesis 5 concerning the impact of hedge fund reputation during initial share filings. In other words taking into account the different target company related variables growth, size and profitability the impact of the filing hedge fund’s reputation fades making less impact as expected.

Finally based on the OrdinaryyLeasttSquares regression Table 5 and 6 present all different Adjusted R values. Adjusted 2 R values are used as a measure of goodness-2

of-fit of the linear regression. The value of 2

R is a fraction between 0.0 and 1.0 and helps to predict the linear relationship between the event characteristics and the cumulative abnormal returns whereby a 2

R value of 1.0 indicates the perfect fit. In

other words a R value of 1.0 indicates that knowing the event characteristic lets you 2

predict the CAR perfectly. As seen from the Tables 5 and 6 all Adjusted R values are 2

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7.1 Conclusion

In this study the effect of initial hedge fund related shareholder’ filings on target company share prices has been studied. Using the first large scale European related hedge fund activism data sample this study strived to detect certain patterns in the changing shareholder values during hedge fund related share filings. The sample was comprised of 99 hedge fund related filings which were all announced in the period between 1999-2007. The research was conducted using the event study methodology. The shareholder wealth effect in terms of cumulative abnormal return were measured using two different time intervals; (1). 21-day 10, t, +10) CAR and (2). 41-day CAR (-20, t, +20) time interval.

In the introduction of this paper we described how the overall aim of this study is to detect whether hedge fund related shareholder filings lead to a situations of significant positive cumulative abnormal returns. Furthermore the different events (all 99) were tested for different variables/characteristic that could have influenced the average cumulative abnormal returns both positive or negative. The characteristics that were tested are; (1) Investor protection, (2) COO of the filing Hedge Fund, (3) Wolf pack strategies, (4) Percentage of Filings, (5) Hedge Fund reputation.

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The analyses performed in this study also consisted of analyzing different characteristics that could have influenced the cumulative abnormal returns. In Table 7 an overview of the different results is presented. As can be seen from the Table 7 for both time intervals (21-day and 41-day) just one out of five hypotheses is not rejected. Based on our tests of the entire data sample (N=99) we indicate a significant positive return concerning country related shareholder filings.

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7.2 Future Research

After having summarized the results of this study in the previous paragraph. I now remain with future challenges in this field of academic research. First major argument for this paper and therefore a challenge for new academic writers still remains the significant data constrain. In the first place this paper strives to present an overall overview of the impact of hedge fund related share filings and its impact on share prices within the European continent. However based on the current data sample as used for this study it is difficult to make generalizations for the entire European continent.

Although we are positive that we covered the most significant hedge fund related share filings still many are missing. More important however is that this study focused solely on 6 European countries whereas the entire European Union has over 30 member states. So in order to come to a better generalizability of this paper more cases and most of all more EU member states need to be included in future research.

Second implication for future research concerning the impact of the share filings on the target company’s share prices. Within this paper two different relative short event windows were used in order to measure the cumulative abnormal returns related to the initial filing. Based on this research solely the short term impact of hedge funds related share filings is measured however the implications for the medium and long term share returns remain unknown. I believe this is an interesting challenge for new academics in order to reveal not only the short term impact of hedge funds share filings but to consider the long term as well.

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Hedge Funds activism and the impact on target Company share prices