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Risk is present in any kind of investment. But activist hedge funds put their thumb on the scale, nudging their portfolio companies into a more profitable direction. The goal? Increase the company’s value to yield a greater return on investment.
Activist hedge funds exert their influence in several ways, but recently they’ve been trying something new: acquiring board seats on their portfolio companies. Once there, fund representatives can advise and monitor company leadership to maximize the company’s value.
Ipek Yavuz, Assistant Professor of Finance at the Desautels Faculty of Management, studied the impact of activist board members who perform advisory and monitoring roles in target portfolio companies.
Companies who took on an activist board member saw positive changes in shareholder value, R&D investment, asset acquisition, among other areas. These positive outcomes could explain why hedge funds are increasingly adopting this tactic.
“It’s gaining more prominence in the last decade,” said Yavuz on the McGill Delve podcast.
Over the past 20 years in the United States, hedge funds have secured 1,015 seats on boardroom monitoring committees and 598 seats on advisory committees.
Activist funds are seeing the potential benefits of acquiring board seats. They’re now increasingly willing to engage in the expensive and political process of presenting a nominee for election to a board.
The Power of the Committee
Normally, activist hedge funds exert their influence from the outside, such as through media campaigns or by lobbying shareholders. But now, they’re politicking their way into key board committees to influence the company from there.
Boards of directors can be quite large, but they typically have around 10 or 11 members. To facilitate easier decision-making, the group splits into smaller committees with more specific roles, critical to the management of the company.
There are many kinds of committees that support a board of directors, but Yavuz’s work focuses on two: advisory and monitoring.
Advisory committees are comprised of board members with unique skills, backgrounds, and expertise who can provide strategic advice to the rest of the board. When an activist member joins this committee, she has a direct line of influence on the company. Yavuz found in her research that activist advisory members had a positive effect on the company’s operations, financial metrics, and strategic decision-making.
Monitoring committees ensure that managers are acting in the best interest of shareholders. This is another area where activist hedge funds want to exert influence, to ensure that money is going towards projects that will enhance the value of the company.
Yavuz found that, when an activist board member is performing a monitoring role, they limit the company’s empire building tendencies. In other words, they refrain from buying up companies and other assets in favour of increasing shareholder payouts.
The placement of activist board members appears to be an effective strategy for increasing returns. But success depends on the activist members’ ability to win the support of her colleagues. Incumbent board members and management might be skeptical of an outsider on their board, which can lead to interpersonal friction.
“Even if an activist campaign is very friendly, there is always this tension between the activist hedge fund and their nominees and the incumbent board,” said Yavuz. “At the end of the day, there’s someone from outside telling you you’re not running the business right.”
To learn more about this dynamic, listen to Professor Yavuz’s full interview on the McGill Delve Podcast.
This article is written by Eric Dicaire.
McGill Delve is the official thought leadership platform of McGill University’s Desautels Faculty of Management. Subscribe to the McGill Delve podcast on all major podcast platforms, including Apple podcasts and Spotify, and follow Delve on LinkedIn, Facebook, Twitter, Instagram, and YouTube.
