Why Activist Hedge Funds Target Socially Responsible Firms

Investors looking to prioritise sustainability would do well to ensure their investments are not supporting investment firms that undermine CSR. Activist hedge funds are becoming increasingly influential in the economy as they prioritise maximising shareholder value and minimising ‘wasteful’ spending, including spending on CSR. Researchers Dr Mark DesJardine of Penn State University, Dr Emilio Marti of the Rotterdam School of Management and the Dynamics of Inclusive Prosperity Initiative and Prof. Rodolphe Durand of HEC Paris were interested in exploring how increasingly influential activist hedge funds perceive CSR.

In the United States, more than 70 of the 500 biggest companies have been targeted by hedge funds between 2011 and 2015. Hedge fund activism – when investors purchase company shares to influence the company to become active in different ways – is also becoming increasingly important in Europe. In the Netherlands, activist hedge funds targeted companies such as ABN AMRO, DSM, Philips, TNT Express, and TomTom.

Why CSR matters for activist hedge funds

The business model of activist hedge funds is to target companies they deem ‘wasteful’ and reorient them toward maximising shareholder value in the short term. Yet activist hedge funds lack insider knowledge, so it is difficult for them to know whether companies are wasteful or not. To overcome this information asymmetry, activist hedge funds will use CSR as a signal that companies are engaging in activities that they deem unessential to producing shareholder value, and do not maximise shareholder value in the short term.

Drawing on data covering US-based activist hedge fund campaigns between 2000 and 2016, the study found that activist hedge funds are significantly more likely to target companies with strong performance in CSR. The likelihood of being targeted nearly doubles – from 3.04 per cent to 5.11 per cent – when a company’s CSR scores increase by two standard deviations above the industry average. The authors argue that activist hedge funds see CSR activities as a signal of wasteful spending that distracts companies from maximising shareholder value in the short term. Companies perceived to be wasting resources are ideal targets for activists whose business model is to generate significant profit by reorienting such companies towards maximising short-term shareholder value.

Emilio Marti – Assistant Professor Rotterdam School of Management

Practical implications

Prior research has already shown that CSR activities drop after companies become targeted by activist hedge funds. This study reveals that strong CSR activities make it more likely that companies become targeted in the first place. Together, these insights suggest that activist hedge funds are a problem for CSR: they target companies that excel in terms of CSR – as shown in this research – and subsequently force these companies to reduce their CSR activities, as shown in prior research.

The study suggests that protecting companies from hedge fund attacks may support companies’ CSR efforts. In the Netherlands, for example, policy makers are currently discussing whether companies should have the right to initiate a cooling-off period that would allow them to rethink their strategy and buy time when they become targeted by an activist hedge fund.

What many ordinary individuals and organisations may not realise is that their savings and assets are invested in activist hedge funds through pension funds and endowments, which have been a major driver of growth for activist hedge funds since 2009. Investors looking to prioritise sustainability would do well to ensure their investments are not supporting investment firms that undermine CSR.

Assistant professor
CV

Emilio Marti studies questions of corporate social responsibility in the context of financial markets. As part of the Dynamics of Inclusive Prosperity Initiative and in cooperation with researchers from Zurich and Oxford, Marti will do research on shareholder engagement as a driver of sustainability.

More information

Read the full paper, Why Activist Hedge Funds Target Socially Responsible Firms: The Reaction Costs of Signaling Corporate Social Responsibility here.