Fundamental Investment Analysis

Under accounting principles, the recognition of earnings is path-dependent and the path depends on risk and its resolution: under the so-called realization principle, earnings are not booked until uncertainty is resolved. In asset pricing terms, the principle means that earnings cannot be recognized until the firm can book a low-beta asset such as cash or a near-cash discounted receivable. If the risk to which this accounting responds is priced risk, the accounting indicates the expected return.

When a proxy contest is looming, the rate at which CEOs exercise options to sell (hold) the resulting shares slows down by 80% (accelerates by 60%), consistent with their desire to maintain or strengthen voting rights when facing challenges. Such deviations are closely aligned with features unique to proxy contests, such as the record dates and nomination status, and are more pronounced when the private benefits are higher or when the voting rights are more crucial.

Hedge fund activism emerged as a major force of corporate governance in the 2000s. By the mid-2000s, there were between 150 and 200 activist hedge funds in action each year, advocating for changes in 200–300 publicly listed companies in the United States. In this article, we review the evolution and major characteristics of hedge fund activism, as well as the short- and long-term impacts of the performance and governance of targeted companies.

This paper studies the long-term effect of hedge fund activism on the productivity of target firms using plant-level information from the U.S. Census Bureau. A typical target firm improves its production efficiency within three years after the intervention, and this improvement is pronounced in industries with low concentration. By following plants that were sold post-intervention we also find that efficient capital redeployment is an important channel via which activists create value.

We test the empirical validity of a claim that has been playing a central role in debates on corporate governance — the claim that interventions by activist hedge funds have a detrimental effect on the long-term interests of companies and their shareholders. We subject this claim to a comprehensive empirical investigation, examining a long five-year window following activist interventions, and we find that the claim is not supported by the data.

A long stream of papers documents robust correlations between firm characteristics and future stock returns. Most of these characteristics involve accounting numbers. Usually, characteristics have been identified from data analysis, resulting in a proliferation of characteristics. A 2013 survey of published papers and working papers found 186 predictors — a number that the authors said likely under represents the total.

We analyze strategic speculators' incentives to trade on information in a model where firm value is endogenous to trading, due to feedback from the financial market to corporate decisions. Trading on private information reveals this information to managers and improves their real decisions, enhancing fundamental value. While this feedback effect increases the profitability of buying on good news, it reduces the profitability of selling on bad news, and thus has an asymmetric effect on trading behavior.

Effective monitoring by equity blockholders is important for good corporate governance. A prominent theoretical literature argues that the threat of block sale ("exit") can be an effective governance mechanism. Many blockholders are money managers. We show that, when money managers compete for investor capital, the threat of exit loses credibility, weakening its governance role. Money managers with more skin in the game will govern more successfully using exit. Allowing funds to engage in activist measures ("voice") does not alter our qualitative results.