Shareholder activism and company’s capital structure: analysis of relationship
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Аннотация
Introduction 9
Chapter 1. Shareholder activism of hedge funds 12
1.1. Hedge funds 12
1.1.1. Hedge fund: concept and definition 12
1.1.2. Active management 14
1.1.3. Hedge fund structure 14
1.1.4. Absolute income 16
1.1.5. Limited access to capital 17
1.1.6. Borrowed funds and derivatives 17
1.1.7. Investors of hedge funds 17
1.2. Shareholder activism 18
1.2.1. Fundamentals of a shareholder activism strategy 18
1.2.2. Features of hedge fund shareholder activism 21
Chapter 2. Capital structure of the company 28
2.1. Classical theories of capital structure of the company 28
2.1.1. The Modigliani-Miller theory 28
2.1.2. Trade off theory 31
2.1.3. Pecking order theory 33
2.1.4. Agency theory 33
2.1.5. Signaling theory 35
2.1.6. Market timing theory 36
2.2. Contemporary theories of capital structure of the company 38
2.3. Target capital structure 41
Chapter 3. Empirical study 45
3.1. Research hypotheses 45
3.2. Methodology of the study 46
3.2.1. Model to estimate the likelihood of becoming the target of an activist
campaign 46
3.2.2. Model for predicting the target capital structure 48
3.3. Sampling and descriptive statistics of variables 50
3.4. Results of econometric analysis 54
3.5. Analysis of the results 56
Conclusion 59
Reference List 62
Appendices 67
Appendix 1 67
Appendix 2 67
Introduction 9
Chapter 1. Shareholder activism of hedge funds 12
1.1. Hedge funds 12
1.1.1. Hedge fund: concept and definition 12
1.1.2. Active management 14
1.1.3. Hedge fund structure 14
1.1.4. Absolute income 16
1.1.5. Limited access to capital 17
1.1.6. Borrowed funds and derivatives 17
1.1.7. Investors of hedge funds 17
1.2. Shareholder activism 18
1.2.1. Fundamentals of a shareholder activism strategy 18
1.2.2. Features of hedge fund shareholder activism 21
Chapter 2. Capital structure of the company 28
2.1. Classical theories of capital structure of the company 28
2.1.1. The Modigliani-Miller theory 28
2.1.2. Trade off theory 31
2.1.3. Pecking order theory 33
2.1.4. Agency theory 33
2.1.5. Signaling theory 35
2.1.6. Market timing theory 36
2.2. Contemporary theories of capital structure of the company 38
2.3. Target capital structure 41
Chapter 3. Empirical study 45
3.1. Research hypotheses 45
3.2. Methodology of the study 46
3.2.1. Model to estimate the likelihood of becoming the target of an activist
campaign 46
3.2.2. Model for predicting the target capital structure 48
3.3. Sampling and descriptive statistics of variables 50
3.4. Results of econometric analysis 54
3.5. Analysis of the results 56
Conclusion 59
Reference List 62
Appendices 67
Appendix 1 67
Appendix 2 67
Shareholder activism is one of the most effective investment strategies. The main goal of shareholder activism is to maximize return on investment (The Economist, February 15, 2018). This strategy involves investors acquiring a stake in a company and then taking various actions to change the company's tendencies of development. The most common tactics taken by activist shareholders in targeted companies are: promoting their candidate to the company's board of directors, changing top management, private negotiations with company executives, pressure on companies through the media, "proxy fighting" (the right to vote at general meetings on behalf of other shareholders), maximizing company performance, in particular by changing the capital structure. Exactly, the sub-optimal capital structure of the target firm is the reason for the ineffective performance of the company, according to many activist shareholders (Ganguly, Ge, 2018).
There are many publications that examine both the shareholder activism strategy itself and its implementation by various institutional investors. Large institutional investors, such as hedge funds, pension funds, mutual funds, and private equity funds, have much more potential to exploit shareholder activism than do individual investors. This trend is mainly due to the enormous financial resources held by these types of funds and their significant impact on global economic growth. As practice shows, hedge fund activism is the most aggressive type of activism, as well as the most powerful and effective due to the special regulatory conditions provided at the legislative level (deHaan et al., 2019; Togan Egrican, 2022). For example, in the U.S.: hedge funds can afford to hold more than 10% of any company's equity and can invest more than 5% of their total capital in any stock market asset, also they are permitted to invest in illiquid assets. Therefore, the primary focus of this study is the manifestation of shareholder activism by hedge funds in relation to U.S. public companies.
A number of relevant studies (Brav et al., 2008; Brav et al., 2015; Coffee et al., 2016; Denes et al., 2017) argue that activist hedge funds have used tactics aimed at changing the capital structure in a fairly large number of target companies. A legitimate question arises: What kind of public companies do activist hedge funds target, in particular what share of borrowed funds in total company capital and how different it is from the target market capital structure?
In order to answer this question in this master thesis a study was conducted, the purpose of which was to establish the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the targeted company.
To achieve this goal, the following tasks were set and solved:
1. To introduce the concept of shareholder activism strategy, to highlight the peculiarities of shareholder activism by hedge funds and to present a review of modern scientific literature on the topic;
2. To provide a literature review devoted to the capital structure of the company, the question of its optimality and to analyze the preferences of activist hedge funds when choosing the target based on the capital structure of the company;
3. To conduct an empirical research aimed at identifying the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the targeted company;
4. To analyze the results of the econometric study, draw conclusions and provide managerial practical recommendations.
The object of this study is hedge fund and the subject of the paper is shareholder activism.
This master's thesis consists of an introduction, three chapters, a conclusion, a list of used sources and appendices. The first chapter is devoted to the study of the main approaches to the definition of shareholder activism strategy, as well as the analysis of the specifics of hedge fund activity as an institutional investor. This chapter introduces the concept and definition of hedge fund and considers its main characteristics and features: typical structure and legal form, peculiarities of depositors' investments management, specifics of top management's motivation policy. In addition, the first chapter of the paper considers the peculiarities of the manifestation of shareholder activism strategy by hedge funds. The second chapter of the research is devoted to the study of theoretical foundations of company’s capital structure. It presents the analysis of classical and new theories of company's capital structure, considers different views concerning the existence of optimal capital structure. The concept of target capital structure was also introduced. The third chapter is devoted to the description of the empirical research aimed at revealing the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the company, which became the object of investment of this type of funds. It describes all the stages of the empirical research: formulation of hypotheses, research methodology, description of the sample and descriptive statistics of the variables, analysis of the results and formulation of managerial practical implications.....
There are many publications that examine both the shareholder activism strategy itself and its implementation by various institutional investors. Large institutional investors, such as hedge funds, pension funds, mutual funds, and private equity funds, have much more potential to exploit shareholder activism than do individual investors. This trend is mainly due to the enormous financial resources held by these types of funds and their significant impact on global economic growth. As practice shows, hedge fund activism is the most aggressive type of activism, as well as the most powerful and effective due to the special regulatory conditions provided at the legislative level (deHaan et al., 2019; Togan Egrican, 2022). For example, in the U.S.: hedge funds can afford to hold more than 10% of any company's equity and can invest more than 5% of their total capital in any stock market asset, also they are permitted to invest in illiquid assets. Therefore, the primary focus of this study is the manifestation of shareholder activism by hedge funds in relation to U.S. public companies.
A number of relevant studies (Brav et al., 2008; Brav et al., 2015; Coffee et al., 2016; Denes et al., 2017) argue that activist hedge funds have used tactics aimed at changing the capital structure in a fairly large number of target companies. A legitimate question arises: What kind of public companies do activist hedge funds target, in particular what share of borrowed funds in total company capital and how different it is from the target market capital structure?
In order to answer this question in this master thesis a study was conducted, the purpose of which was to establish the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the targeted company.
To achieve this goal, the following tasks were set and solved:
1. To introduce the concept of shareholder activism strategy, to highlight the peculiarities of shareholder activism by hedge funds and to present a review of modern scientific literature on the topic;
2. To provide a literature review devoted to the capital structure of the company, the question of its optimality and to analyze the preferences of activist hedge funds when choosing the target based on the capital structure of the company;
3. To conduct an empirical research aimed at identifying the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the targeted company;
4. To analyze the results of the econometric study, draw conclusions and provide managerial practical recommendations.
The object of this study is hedge fund and the subject of the paper is shareholder activism.
This master's thesis consists of an introduction, three chapters, a conclusion, a list of used sources and appendices. The first chapter is devoted to the study of the main approaches to the definition of shareholder activism strategy, as well as the analysis of the specifics of hedge fund activity as an institutional investor. This chapter introduces the concept and definition of hedge fund and considers its main characteristics and features: typical structure and legal form, peculiarities of depositors' investments management, specifics of top management's motivation policy. In addition, the first chapter of the paper considers the peculiarities of the manifestation of shareholder activism strategy by hedge funds. The second chapter of the research is devoted to the study of theoretical foundations of company’s capital structure. It presents the analysis of classical and new theories of company's capital structure, considers different views concerning the existence of optimal capital structure. The concept of target capital structure was also introduced. The third chapter is devoted to the description of the empirical research aimed at revealing the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the company, which became the object of investment of this type of funds. It describes all the stages of the empirical research: formulation of hypotheses, research methodology, description of the sample and descriptive statistics of the variables, analysis of the results and formulation of managerial practical implications.....
As practice shows, many different investors use such popular investment strategy as shareholder activism (HBR, 2018). The meaning of this strategy is that the investor acquires a share of a public company, and then begins to take certain actions aimed at changing the vector of the firm's development and adjusting the operating activities. The main purpose of implementing the strategy of shareholder activism, is to maximize the return on invested funds, that is, in fact, activists are trying to increase the market capitalization of the company through their actions, which, in turn, leads to an increase in the wealth of the shareholders-activists themselves (The Economist, 2018). Although hedge funds initially rarely used this strategy, they are increasingly beginning to make active investments. Among the main motives of shareholder activism researchers highlight: restructuring the company's Board of Directors, changing the company's management team or changing their remuneration, changing dividend policy and others. Based on the analysis of academic articles, it can be concluded that hedge funds are increasingly beginning to actively target companies in order to change their capital structure (Ganguly, Ge, 2018). This raises a legitimate question: what kind of target companies do activist hedge funds target, in particular, what share of borrowed funds in total company capital and how much does it differ from the target market capital structure?
In the process of writing this master's thesis an empirical study was conducted, the purpose of which was to establish the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the targeted company. To achieve the stated purpose, the analysis of existing literature on the definition of the concept of shareholder activism strategy was performed, the activities of hedge funds as shareholder activists were reviewed and analyzed, the review of studies on the capital structure of the company and the question of its optimality was presented, the preferences of activist hedge funds in choosing a target company based on the capital structure were outlined. Moreover, an empirical study was conducted and the corresponding results were analyzed.
The first chapter analyzed the main approaches to defining the concept of shareholder activism. Since the empirical study was conducted on a sample of hedge funds that made active and passive investments in American public companies, the analysis of approaches to the definition of shareholder activism included the works of American researchers only. Further, the activity of hedge funds as institutional investors was analyzed and the specific characteristics of this type of fund (hedge fund concept, organizational structure, remuneration of managers, depositors and others) were examined. In addition, approaches to the definition of shareholder activism of hedge funds were considered in more detail. Based on the academic papers reviewed in this chapter, the definition of shareholder activism of hedge funds was defined and the method of sorting specific investments into active and passive ones was chosen.
In the second chapter the basic classical and modern theories of capital structure of the company were reviewed. These theories were checked for the definition of the optimal capital structure, the results are summarized in a comparative table (Tab.1). In addition, the concept of the optimal capital structure of the company was introduced and the main approaches to predicting the target market leverage were discussed.
The third chapter presents the results of an empirical study aimed at establishing the relationship between the probability of choosing a strategy of shareholder activism by hedge funds and the capital structure of the targeted company. The empirical study consisted of three stages and was conducted on a sample of 135 active and 135 passive investments of hedge funds covering the period from 2008 to 2016. The first stage of the study included a comparative analysis of descriptive variable statistics for actively targeted companies and passively targeted companies. It was found that there is a significant difference in the mathematical expectations of the financial performance of actively targeted companies by hedge funds and passively targeted companies. Thus, hedge funds are more likely to actively target companies with higher current market leverage than others. In addition, in determinants such as MVBV (Market-to-book ratio), ROA and Sales Growth, the mathematical expectations between target companies subgroups also differed significantly, indicating that hedge funds actively target undervalued and underperforming companies. In addition, hedge funds are more likely to actively invest in organizations whose shares are more liquid than those of the control group, thus reducing the costs of shareholder activism. At the second stage the annual target market leverage for all companies in the sample was estimated with the regression Tobit model and the annual deviations of the current leverage values from the target values were calculated. Based on the descriptive statistics of this indicator, it follows that hedge funds invest both actively and passively at a time when the deviation of current leverage values from the target is maximal. Moreover, target firms reduce most of this deviation in the first two years after hedge funds invest. The third step showed that the targets of hedge funds' shareholder activism strategy are more likely to be portfolio companies in which the current market leverage exceeds the target. Moreover, for overleveraged companies there is a direct relationship between the probability of an activist campaign against the target firm and the absolute value of the divergence of the current market leverage from the expected target capital structure. For underleveraged companies there is an inverse relationship between the probability of manifestation of shareholder activism strategy by hedge funds and the absolute deviation of the current leverage and target values.
The findings of the study can be valuable for hedge fund managers as well as managers of companies that may face activist scrutiny....
In the process of writing this master's thesis an empirical study was conducted, the purpose of which was to establish the relationship between the probability of choosing a strategy of shareholder activism by hedge fund and the capital structure of the targeted company. To achieve the stated purpose, the analysis of existing literature on the definition of the concept of shareholder activism strategy was performed, the activities of hedge funds as shareholder activists were reviewed and analyzed, the review of studies on the capital structure of the company and the question of its optimality was presented, the preferences of activist hedge funds in choosing a target company based on the capital structure were outlined. Moreover, an empirical study was conducted and the corresponding results were analyzed.
The first chapter analyzed the main approaches to defining the concept of shareholder activism. Since the empirical study was conducted on a sample of hedge funds that made active and passive investments in American public companies, the analysis of approaches to the definition of shareholder activism included the works of American researchers only. Further, the activity of hedge funds as institutional investors was analyzed and the specific characteristics of this type of fund (hedge fund concept, organizational structure, remuneration of managers, depositors and others) were examined. In addition, approaches to the definition of shareholder activism of hedge funds were considered in more detail. Based on the academic papers reviewed in this chapter, the definition of shareholder activism of hedge funds was defined and the method of sorting specific investments into active and passive ones was chosen.
In the second chapter the basic classical and modern theories of capital structure of the company were reviewed. These theories were checked for the definition of the optimal capital structure, the results are summarized in a comparative table (Tab.1). In addition, the concept of the optimal capital structure of the company was introduced and the main approaches to predicting the target market leverage were discussed.
The third chapter presents the results of an empirical study aimed at establishing the relationship between the probability of choosing a strategy of shareholder activism by hedge funds and the capital structure of the targeted company. The empirical study consisted of three stages and was conducted on a sample of 135 active and 135 passive investments of hedge funds covering the period from 2008 to 2016. The first stage of the study included a comparative analysis of descriptive variable statistics for actively targeted companies and passively targeted companies. It was found that there is a significant difference in the mathematical expectations of the financial performance of actively targeted companies by hedge funds and passively targeted companies. Thus, hedge funds are more likely to actively target companies with higher current market leverage than others. In addition, in determinants such as MVBV (Market-to-book ratio), ROA and Sales Growth, the mathematical expectations between target companies subgroups also differed significantly, indicating that hedge funds actively target undervalued and underperforming companies. In addition, hedge funds are more likely to actively invest in organizations whose shares are more liquid than those of the control group, thus reducing the costs of shareholder activism. At the second stage the annual target market leverage for all companies in the sample was estimated with the regression Tobit model and the annual deviations of the current leverage values from the target values were calculated. Based on the descriptive statistics of this indicator, it follows that hedge funds invest both actively and passively at a time when the deviation of current leverage values from the target is maximal. Moreover, target firms reduce most of this deviation in the first two years after hedge funds invest. The third step showed that the targets of hedge funds' shareholder activism strategy are more likely to be portfolio companies in which the current market leverage exceeds the target. Moreover, for overleveraged companies there is a direct relationship between the probability of an activist campaign against the target firm and the absolute value of the divergence of the current market leverage from the expected target capital structure. For underleveraged companies there is an inverse relationship between the probability of manifestation of shareholder activism strategy by hedge funds and the absolute deviation of the current leverage and target values.
The findings of the study can be valuable for hedge fund managers as well as managers of companies that may face activist scrutiny....
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