NEW YORK – For years, researchers and regulators have debated the impact of activist investors and hostile corporate takeovers on the fate of corporations. High-profile investors like Carl Icahn (think: Yahoo, Netflix, and Clorox), have given third-party activism a formidable reputation. Intervention of this kind is often portrayed in the news and entertainment media as corporate raiding driven by a slash and burn approach, leaving layoffs and company turmoil in its wake in the pursuit of short-term gains over long-term sustainability.
Research from Columbia Business School’s Professor Wei Jiang, Arthur F. Burns Professor of Free and Competitive Enterprise finds that these outside shareholders can deliver positive results. Examining the effects of hedge fund interventions specifically on corporate innovation, Jiang reveals that third-party interventions can actually increase the longevity and sustainability of a company’s innovation – particularly with inventors and inventions. Hedge fund activism leads to companies using R&D dollars more efficiently, contradicting commonly held beliefs that hedge fund activism focuses companies on unsustainable short-term goals.
“We can no longer say that third-party activism has a one-size-fits-all result,” said Professor Jiang. “It is relatively easy to analyze hedge fund activism on the short-term effects; but considering how activism can actually work in the long run is more of a challenge. The evidence shows that in the case of corporate innovation, hedge fund activists can help companies become leaner, more focused, and more efficient in their innovation.”
The study, How Does Hedge Fund Activism Reshape Corporate Innovation?, co-written by Professor Alon Brav of Duke University’s Fuqua School of Business, Assistant Professor Song Ma of Yale School of Management, and Professor Xuan Tian of Tsinghua University’s PBC School of Finance, was recently published in the Journal of Financial Economics. The researchers analyzed publicly traded companies listed on the NYSE from 2000 – 2013 that have been targeted by hedge funds, measuring their innovation activities before and up to five years after hedge fund intervention, a process defined by trimming unproductive and peripheral assets, unbundling business segments, and opposing diversifying acquisitions. The study uses both R&D expenditures and patenting activity to evaluate the innovation process, finding an increase in output of patent quality and quantity metrics following intervention.
“Rather than fearing third-party involvement, investors should recognize the positive long-term effects of hedge funds on innovation potential,” Jiang said. “Research shows that companies’ patent sales increase after hedge fund activism, and lead to the arrival of new inventors who strengthen the core competence of the company. Hedge fund activism should be seen as a catalyst, not a calamity.”
Other key takeaways include:
- INNOVATION EFFICIENCY INCREASES FOLLOWING INTERVENTION – Post-intervention, not only do patent counts and citation counts per patent increase, they also concentrate more heavily in areas central to the core capabilities of the firm. Patent quantity and quality improved most in firms that refocused their priorities after the arrival of activists.
- INVENTORS BENEFIT FROM INTERVENTION – During and after intervention, the inventors at target firms are more productive than those at non-target peers in terms of the quantity and quality of the patents they file. These results show that intervention promotes shifting human capital to support efficiency, as key innovative personnel are matched or re-matched to their most optimal environment.
- INTERVENTION PROMOTES SUSTAINABLE MANAGEMENT – While activism shakes up leadership, researchers find that the resulting hierarchies are more sustainable and better-suited to the firm. After intervention, new and retained top executives enjoy longer expected tenure, and the corporate boards of those companies bring on new directors with more technology or industry-based experience relative to other firms.
To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.
About the researcher
Wei Jiang is Arthur F. Burns Professor of Free and Competitive Enterprise in the Finance Division at Columbia Business School.  ...Read more.