Working Paper: CEPR ID: DP9409
Authors: Mike Burkart; Amil Dasgupta
Abstract: We provide a theoretical model to explain the procyclicality of hedge fund activism. In our model, hedge funds which compete to retain investor flows excessively increase the net leverage of target firms in order to deliver high short-term payouts and signal their ability. Such excessive leverage leads to debt overhang in economic downturns, thereby destroying incentives for activism and engendering procyclicality. Our model thus provides a theoretical explanation that links the procyclicality of hedge fund activism with increases in the leverage or payouts ratios of target firms. In addition, the model generates several new testable implications and reconciles seemingly contradictory evidence on the wealth effects of activism for shareholders and bondholders.
Keywords: career concerns; corporate governance; hedge funds; shareholder activism
JEL Codes: G23; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| excessive leverage (G32) | debt overhang (H63) |
| economic booms (E32) | increased leverage (G32) |
| increased leverage (G32) | reduced activism (D72) |
| hedge fund activism (G34) | procyclicality (E32) |
| economic conditions (E66) | hedge fund activism (G34) |
| increased leverage (G32) | credit downgrades (F34) |
| increased leverage (G32) | increased default risk (G33) |