Hedge Fund Activists: Do They Take Cues from Institutional Exit?

Abstract

Hedge fund activists achieve substantial improvements in the performance and governance of target firms. These activists accumulate most of their large ownership in the days immediately before their campaigns while other institutions heavily sell the targets. We show that institutional exit triggers the emergence of activism. At the daily frequency, we identify a causal relationship between institutional selling and activist purchases. We use each institution’s trading in non-target stocks as an instrument for its trading in the target. Our instrument is based on the observation that institution-specific funding needs, rather than target-specific information, explain most of the selling. Institutional sellers demand liquidity, allowing hedge funds to rapidly acquire shares with limited price impact and ultimately initiate a campaign at a lower cost. We formally show that sustained institutional selling significantly raises the odds of activist interventions, and hence plays an important corporate governance role.