Bill Ackman, ceo of Pershing Square Capital Management, is photographed on February 6 2012 prior to a town hall meeting in Toronto to introduce nominees for CP Rail.Fred Lum/The Canadian Press
When you imagine investor activism, what comes to mind?
Do you picture hedge funds swooping in on firms in bankruptcy protection, only to leave behind a pile of picked-over bones months or years later? Well, according to new research it may be time to retire the vulture metaphor when it comes to hedge funds. Distressed firms actually stand a better chance of surfacing from bankruptcy when these activists get involved: the companies are saved more often than they're dismantled.
The study was based on U.S. research, but conducted by finance Professor Kai Li and her team at Sauder School of Business at UBC. It looked at 474 Chapter 11 filings from 1996 to 2007 and focused on companies with more than $100-million (U.S.) in assets. They charted factors such as rate of change in CEO, ability to retain key talent, asset liquidation, debt recovery and whether the company ever emerged.
Some of Li's findings were striking, especially the prevalence of hedge funds in the beleaguered U.S. firms. "We found their influence in 87 per cent of the sample cases," said Ms. Li. "In these cases companies had a better chance of emerging from Chapter 11."
She also notes that "failed" CEOs were removed more often. "In the Canadian Pacific case the initiative is to fire the current CEO and replace the board," Ms. Li suggested as an example, although the CP case doesn't involve bankruptcy proceedings. "Eliminating the CEO who allowed the company to enter bankruptcy will often encourage other key employees to stay and help with the restructuring process," she added. And thanks to the presence of a hedge fund, stock prices went up higher, and debt recovery by other lenders was consistently enhanced.
The research also explored the idea of hedge funds as peacekeepers that balance the power between the debtor and secured creditors. "We find that hedge funds are more like mediators than predators," says Ms. Li. "They improve efficiency."
So what can Canadians take from these American results? With both CP and Telus waging very public battles with activists investors, the topic is on the minds of many. "Canadians need to embrace investor activism," Ms. Li emphasizes. She goes on to say that companies also need to be open-minded about the involvement of hedge funds. Corporate managers must also be mindful that if they underperform, their company might become a target of activist investors who, according to Li's research, often begin digging in when they sense bankruptcy is close at hand (although the numbers show they're nearly as likely to get involved once the proceedings are already under way).
But one caveat from Ms. Li: Hedge funds' heterogeneous nature means that many are still purely focused on the short-term. "The research paints a positive picture of hedge fund intervention and improved operating performance, but there are also many hedge funds looking to push the stock price up quickly and sell." Hedge funds can create value, but they can also take that value with them when they exit.