St. Petersburg University
Graduate School of Management
Master in Management
Institutional investor activism and value creation at emerging markets
Master’s Thesis by the 2nd year student
Concentration – International Business
Gleb S. Golubtsov
Research advisor:
Associate Professor, Julia B. Ilina
St. Petersburg
2016
ЗАЯВЛЕНИЕ О САМОСТОЯТЕЛЬНОМ ХАРАКТЕРЕ ВЫПОЛНЕНИЯ
ВЫПУСКНОЙ КВАЛИФИКАЦИОННОЙ РАБОТЫ
Я, _
Голубцов Глеб Сергеевич_____, студент второго курса магистратуры
направления «Менеджмент», заявляю, что в моей магистерской диссертации на тему
«Активизм институциональных инвесторов и создание ценности на развивающихся
рынках», представленной в службу обе спечения программ магистратуры д л я
последующей передачи в государственную аттестационную комиссию для публичной
защиты, не содержится элементов плагиата.
Все прямые заимствования из печатных и электронных источников, а также из
защищенных ранее выпускных квалификационных работ, кандидатских и докторских
диссертаций имеют соответствующие ссылки.
Мне известно содержание п. 9.7.1 Правил обучения по основным образовательным
программам высшего и среднего профессионального образования в СПбГУ о том, что
«ВКР выполняется индивидуально каждым студентом под руководством назначенного ему
научного руководителя», и п. 51 Устава федерального государственного бюджетного
образовательного учреждения высшего образования «Санкт-Петербургский
государственный университет» о том, что «студент подлежит отчислению из СанктПетербургского университета за представление курсовой или выпускной
квалификационной работы, выполненной другим лицом (лицами)».
_________________
_______________ (Подпись студента)
________________26/05/2016
___________________ (Дата)
STATEMENT ABOUT THE INDEPENDENT CHARACTER OF
THE MASTER THESIS
I, ___Golubtsov Gleb Sergeyevich____, (second) year master student, _MIB_program
«Management», state that my master thesis on the topic «Institutional investor activism and
value creation at emerging markets», which is presented to the Master Office to be submitted to
the Official Defense Committee for the public defense, does not contain any elements of
plagiarism.
All direct borrowings from printed and electronic sources, as well as from master theses,
PhD and doctorate theses which were defended earlier, have appropriate references.
I am aware that according to paragraph 9.7.1. of Guidelines for instruction in major
curriculum programs of higher and secondary professional education at St.Petersburg University
«A master thesis must be completed by each of the degree candidates individually under the
supervision of his or her advisor», and according to paragraph 51 of Charter of the Federal State
Institution of Higher Education Saint-Petersburg State University «a student can be expelled
from St.Petersburg University for submitting of the course or graduation qualification work
developed by other person (persons)».
___________________
_____________
26/05/2016
______________ (Student’s signature)
___________________ (Date)
2
АННОТАЦИЯ
Автор
Название
магистерской
диссертации
Факультет
Направление
подготовки
Год
Научный
руководитель
Описание цели,
задач и основных
результатов
Ключевые слова
Глеб Сергеевич Голубцов
Активизм институциональных инвесторов и создание ценности на
развивающихся рынках
Высшая Школа Менеджмента
Менеджмент – Международный Бизнес
2016
Юлия Борисовна Ильина
Цель данной магистерской работы заключается в исследовании влияния
активизма институциональных инвесторов на создание ценности в компаниях
на развивающихся рынках и выявлении стратегий, которые приносят
компаниям наибольшую ценность. Результаты работы показывают, что нет
существенной разницы между конечным влиянием хедж-фондов и фондов
частных инвестиций на ценность компаний. Однако, инвесторы частных
фондов имеет более долгосрочный фокус влияния и особые компетенции в
создании ценности от эффекта левериджа. Хедж-фонды ориентированы на
более короткую перспективу и способны создавать значительную ценность,
меняя руководство компании. Стратегические преобразования и понижение
уровня денежных средств являются важными источниками создания ценности
в компаниях для институциональных инвесторов. Понижение уровня
денежных средств представляет наибольший потенциал на развивающихся
рынках. В данном контексте операционные улучшения не имеют ярко
выраженного влияния на создание ценности.
Институциональные инвесторы, хедж-фонды, частные инвестиционные
фонды, активизм, стратегии создания ценности, развивающиеся рынки
ABSTRACT
Master Student's
Name
Master Thesis Title
Faculty
Main field of study
Year
Academic
Advisor's Name
Description of the
goal, tasks and
main results
Keywords
Gleb S. Golubtsov
Institutional investor activism and value creation at emerging markets
Graduate School of Management
Management - International Business
2016
Julia B. Ilina
The purpose of a given Master’s thesis is to investigate the value creation effects of
institutional investor activism on companies from emerging markets and identify
which strategies bring the biggest value. Our results suggest that there is no
significant difference in the overall value creation effect between private equity
and hedge funds. However, private equity investors have a more long-term focus in
effecting the value. They have strong capabilities in creating value from leverage.
Activists from hedge funds are more short-term oriented. They are particularly
capable at increasing the value by changing a CEO or a Chairman in their targets.
Both types of institutional investors are able to gain value by conducting strategic
engineering and decreasing the levels of cash. Сash reduction represents the biggest
source of value for companies in emerging markets. Operational improvements
have no substantial value creation effects in this context.
Institutional investors, hedge funds, private equity funds, activism, value creation
strategies, emerging markets
4
Table of contents
List of figures...................................................................................................................................5
List of tables.................................................................................................................................... 6
Introduction..................................................................................................................................... 7
1. Literature review..........................................................................................................................9
1.1 Nature of institutional investor activism............................................................................... 9
1.2 The difference in value creation of activist hedge funds and private equity funds.............14
1.3 The effect of private equity and hedge funds on the performance of target companies......16
2. Methodology and data............................................................................................................... 23
2.1 Research design................................................................................................................... 23
2.3 Econometric model..............................................................................................................24
2.2 Description of variables.......................................................................................................24
2.4 Data collection and sample..................................................................................................28
3. Empirical findings..................................................................................................................... 36
3.1 The effects of private equity and hedge funds activism...................................................... 36
3.2 Sustainability of value gains................................................................................................37
3.3 Value creation strategies...................................................................................................... 39
4. Discussion..................................................................................................................................52
4.1 Results................................................................................................................................. 52
4.2 Managerial implications...................................................................................................... 54
4.3 Limitations...........................................................................................................................54
4.4 Suggested directions for further research............................................................................ 55
Conclusion..................................................................................................................................... 56
References..................................................................................................................................... 57
Appendix 1. List of PE deals......................................................................................................... 59
Appendix 2. List of HF deals.........................................................................................................61
5
List of figures
Figure 1 Geographic sample distribution, number of deals...........................................................30
Figure 2 Geographic distribution of PE deals, percentage............................................................ 31
Figure 3 Geographic distribution of HF deals, percentage............................................................31
Figure 4 Sample distribution by industry, number of deals...........................................................32
Figure 5 PE subsample distribution by industry, percentage.........................................................33
Figure 6 HF subsample distribution by industry, percentage........................................................ 33
Figure 7 PE subsample distribution by purpose, percentage.........................................................34
Figure 8 HF subsample distribution by purpose, percentage........................................................ 35
Figure 9 Target’s accrued Tobin’s Q.............................................................................................. 36
Figure 10 Target’s Tobin’s Q dynamics......................................................................................... 38
Figure 11 Target’s accrued Tobin’s Q dynamics............................................................................38
Figure 12 Target’s leverage dynamics........................................................................................... 40
Figure 13 Target’s ATA dynamics, millions USD..........................................................................40
Figure 14 Target’s Cash/ATA ratio dynamics................................................................................ 41
Figure 15 Target’s Dividends/Cash ratio dynamics....................................................................... 42
Figure 16 Target’s ROA dynamics.................................................................................................43
Figure 17 Target’s EV/Revenue multiple dynamics...................................................................... 44
Figure 18 Governance engineering................................................................................................45
Figure 19 The share of Board changes.......................................................................................... 45
6
List of tables
Table 1 Description of variables – summary................................................................................. 26
Table 2 Descriptive statistics of variables – all activists............................................................... 27
Table 3 Descriptive statistics of variables - PE subsample............................................................28
Table 4 Descriptive statistics of variables - HF subsample........................................................... 28
Table 5 Results of non-parametric U-test – cumulative and annualized Tobin’s Q...................... 37
Table 6 Base regression model - model summary......................................................................... 46
Table 7 Base regression model - coefficients................................................................................ 46
Table 8 Regression model I – model summary............................................................................. 47
Table 9 Regression model I – coefficients.....................................................................................47
Table 10 Regression model II – model summary.......................................................................... 48
Table 11 Regression model II – coefficients..................................................................................48
Table 12 PE adjusted regression model II – model summary.......................................................49
Table 13 PE adjusted regression model II – coefficients...............................................................50
Table 14 HF adjusted regression model II – model summary....................................................... 51
Table 15 HF adjusted regression model II – coefficients.............................................................. 51
Table 16 List of PE deals............................................................................................................... 59
Table 17 List of HF deals...............................................................................................................61
7
Introduction
Activism is becoming a common phenomenon in a corporate world. Shareholders are
more willing to raise their voice when management lacks credibility or misses sound
opportunities for gaining value.
Private equity funds and activist hedge funds are the types of institutional investors that
seek return on their investments actively managing their target portfolio companies. In doing so,
they serve the monitoring role for the shareholders and reduce agency costs in their firms. Due to
the real value that these investors create, they are becoming more and more popular on the
financial landscape. Assets under management of hedge funds and private equity funds have
been rapidly growing from the early 2000s. Assets of private equity funds grew from
approximately 1 trillion USD in 2005 to over 4 trillion USD in 2014. 1 Such staggering pace
suggests that institutional investors are gaining much power in the ability to influence target
companies and bring their agendas into reality. The force that activists create in a corporate
world cannot be simply dismissed. It has to be understood, properly evaluated and directed
toward the creation of the overall value.
While there were a number of studies examining the effects of activist hedge funds and
private equity funds on the target companies in developed countries, the phenomenon has not
been considered from the perspective of emerging market companies. Our rationale for choosing
the context of emerging markets is that this group of countries has distinct features that could
require special capabilities of activist institutional investors and impact the way how they create
value in target companies.
Thus, the purpose of our research is to investigate the value creation effects of
institutional investor activism on companies from emerging markets and identify which
strategies bring the biggest value.
To serve our purpose we have three research objectives.
1. To determine the difference in value creation effects of hedge funds and private equity
funds.
2. Addressing the sustainability of value gangs, investigate the long-term effect of activism
on corporate performance.
3. Identify activist strategies that bring the biggest value for companies in emerging
markets.
1 The 2015 Preqin Global Private Equity & Venture Capital Report
8
In the latter research objective we aim to analyze strategies from the perspective of
institutional investors as well as hedge funds and private equity funds as distinct activist groups.
The methodology that we use is based on a multi-method quantitative study. In the
beginning we investigate the big picture of explored effects by conducting numerical analyses
for our target indicators. We then build an econometric model and conduct several regression
analyses to evaluate more precisely the existence and the significance of the effects.
Our study proceeds as follows. In the first chapter we introduce the nature of activism
and its theoretical foundations as well as empirical findings of recent research papers on the
effects of activism on target companies.
In the second chapter we develop our research framework, introduce key variables, build
econometric model, and describe our data analysis strategy and resulting research sample.
Third chapter is dedicated to the reporting and interpretation of our findings. Each part of
the third chapter is dedicated to consideration of the findings in light of one of the three
objectives that we pursue.
Fourth chapter is used to analyze and discuss the results with a focus on the context of
emerging markets as well as to provide managerial implications of our findings, limitations, and
suggested directions for further research in light of a given study.
9
1. Literature review
In this chapter we provide a theoretical background of institutional investor activism and
review the empirical studies on this subject. The goal of the first part is to make a theoretical
foundation of institutional investor activism for further research. We first refer to the definition
of activism and the main theory that serves the basis for this phenomenon. We then address the
role of institutional investors as activists and explain the roots of our close consideration of
activist hedge funds and private equity funds. We conclude the first part by describing the value
creation strategies employed by institutional activists.
The goal of the second part is to address the grounds of the difference in value creation
strategies of private equity and hedge funds activists. We first describe distinct structural features
of each type of investor from the perspective of an asset class. We then explore the differences
between the two types of institutional activists from the perspective of their investment
approach.
The goal of the third part is to investigate the phenomenon of institutional investor
activism in light of the latest empirical studies. In particular, we focus on the effects of activism
on the performance of a target company and value creation strategies employed by activists.
1.1 Nature of institutional investor activism
2.1.1 Theoretical foundation of activism and the role of institutional investors
Gillan and Starks (1998) provide an interesting concept regarding to the understanding of
activism phenomenon. They suggest that activism from a broad perspective be viewed as “…
representing a continuum of responses [by investor] to corporate performance”. At one extreme
of the continuum there are active shareholders, who by simply buying and selling shares actively
participate and express their opinions regarding corporate performance. At the other extreme side
of the continuum the authors place corporate takeovers who by taking control over the company
force fundamental changes in the structure of corporation. They highlight that in this continuum
the intermediate case of activism refers to the situation when activists purchase a minority stake
in target company in an effort to influencing the decision making process within the firm.
According to the most common definition provided by the authors, “activist is an investor who
tries to change the status quo through voice without change in control of the firm”.
10
Over the last years the definition of activism as well as activist investors has been
transforming as the industry has been elapsing. Hendrikse (2004) notes that “shareholder
activism involves influencing the behavior of companies using the power of ownership so that
companies develop and implement successful strategies and high standards of governance,
thereby maximizing returns for owners”.
One of the definitions in its modern understanding was provided by Klein and Zur
(2009). They give a special term for activists who conduct aggressive activism campaigns. The
authors refer to them as to entrepreneurial shareholder activists. They define the entrepreneurial
shareholder activist as “… an investor who buys a large stake in a publicly held corporation with
the intention to bring about change and thereby realize a profit on the investment”.
The problem of investor activism in scientific literature is most commonly investigated
from the perspective of the agency theory (Brav et al, 2008; Greenwood, Schor, 2009; Meitzner,
Schweiser, 2013; Katelouzou, 2013; Chan et al, 2013). According to this theory (Jensen,
Meckling, 1976), the organization structure of the firm is a network of agency relationships
between the owners of the firm (the principals) and the management (the agents). The authors
define agent relationship as a “… contract under which one or more persons (the principals)
engage another person (the agent) to perform some service on their behalf which involves
delegating some decision making authority to the agent”. In case both parties of the contract aim
at maximizing their utility, there is a potential that the agent will not always act in the best
interests of the principal. The authors note that there are two general ways for the principal to
minimize the abuse by the agent. First, the principal can incentivize the agent. Second, the
principal can increase control over the agent incurring a certain level of monitoring costs.
Additionally, in some case the agent itself can expend resources to guarantee and hedge the agent
from abuse incurring a certain level of bonding costs. It is pointed out that in the firm there will
always be some divergence of the decisions made by the agent from those that convey value
maximization for the principal. Such divergence brings a certain level of costs for the firm. It is
referred by the authors as a residual loss. The sum of the three types of costs described above
(monitoring costs by principals, bonding costs by agents and mutual residual loss) constitute
agency costs. Thus, the separation of ownership on behalf of shareholders and control on behalf
of managers is associated with the agency costs. In practice, these costs are induced by
management that could potentially pursue a self-serving agenda rather than seek to increase
shareholder value or promote corporate success.
11
Concentrated ownership structure is noted in many papers as a mean to reducing the
agency costs. Grossman and Hart (1980) and Shleifer and Vishny (1986) suggest that large
blockholders should carry a supervision function in a company. Thus, activist investors who
acquire a minority stake in a target company can execute a monitoring role reducing agency
costs to the benefits of all shareholders. Studies dedicated to examining the effectiveness of
solving the agency problem by large shareholders, prove that the blockholders can be successful
in executing such role (Barclay, Holderness, 1992). However, recent papers show that the
heterogeneity of large blockholders plays a more significant role in their ability to address
agency problem then the size itself (Cronqvist, Fahlenbrach, 2009). It is pointed out that this
ability varies meaningfully not only across different types of investors, but also within each
group due to investor-specific factors, such as the number of decision makers in a blockholder
company. The authors find out that large bondholders differ meaningfully in their investments
and governance styles. The effect on the target firm varies significantly across the types of the
bondholders. They also empirically prove that different types of large blockholders have distinct
approaches to corporate growth, appetite for financial leverage and CEO compensation.
1.1.2 Private equity funds and hedge funds as a distinct type of institutional investors
Of the types of large blockholders being investigated by academic researchers in
activism-related papers, two particularly stand out: private equity (PE) funds and hedge funds
(HF) (Brav et al, 2008; Kaplan, Stromberg, 2008; Meitzner, Schweiser, 2011; Chen et al, 2013;
Bebchuk et al, 2015).
These institutional investors have several important features that allow them to better
execute the monitoring role and pursue an active investment strategy. These features are
discussed in the work of Chen et al (2013) with a focus on PE funds. First, they have a strong
performance-oriented compensation scheme. Typically, fund managers in PE funds and HF earn
major part of their compensation from 20% of returns on investments. This fact represents a
structural difference in management compensations of other types of institutional investors such
as pension funds and mutual funds. Because assets under management (AUM) of investment
management funds (e.g. pension funds, mutual funds, sovereign funds) are significantly larger in
comparison to PE funds and HF, in these funds the major part of compensation comes from 2%
of AUM irrespective to the returns of their investments. As such, due to compensation policies
PE firms and HF have strong incentives to make high return on investments, which is mainly
done by increasing the performance of their portfolio companies.
12
Second, compared to other institutional investors, PE funds and HF are not restricted
from making concentrated investments and obliged to maintain a diversified portfolio. According
to SEC Diversification Rules, mutual funds, for example, cannot own more than 10% of a
publicly traded stock and invest more than 5% of assets in any one security. In contrast, PE and
HF investors can hold a significant part of a single company being actively involved in
monitoring its performance without allocating resources for diversification purposes. Chen et al
(2013) highlight that “… by concentrating their capital and resources in a small number of firms,
PE funds can have a sufficient time and influence to make substantial value-increasing changes
in their portfolio firms and improve these firms" long-run performance”.
Third, PE funds and HF are not restricted from risky investments. Most of other
investment management firms are prohibited by low to make investments in companies that have
a risk profile that is below an investment grade. Therefore, PE funds and HF are able to target
more risky underperforming companies, in which there is more space for value creation. The
latter fact was empirically investigated and proved on a sample of US companies targeted by HF
(Bebchuk et al, 2015).
1.1.3 Sources of value gains in active investments
Investigating the effects of leveraged buyouts on the performance of target portfolio
companies in PE transactions, Kaplan and Stromberg (2009) suggest three types of value
creating strategies in active investments: financial, governance and operational engineering.
Traditionally, PE funds and other active investors were mainly concentrated on making
financial and governance engineering in portfolio companies. Kaplan and Stromberg (2009) note
that these two practices were common by the late 1980s. Consequently, academic studies at this
time were focused on investigation of financial and governance engineering in PE investments
(Kaplan, 1989; Jensen, 1989). The authors find out several important features associated with the
changes in governance of target companies. First, PE investors pay close attention to
management incentives and remuneration policies. They tend to significantly increase equity
ownership of management team by shifting the compensation from salary base to stock and
options base. In addition, PE funds require the management to invest heavily their own resources
in a target company. The latter measure provides management not only with the upside of the
performance of a target, but also with its downside. As a proof for these conclusions, the authors
find out that management ownership percentage increase four times in public-to-private
13
transactions. Also, the authors highlight the positive effect of illiquidity of stocks during the time
when the target is private on its performance. They note that illiquidity reduces the incentives of
management to execute short-term manipulations in the sake of long-term performance. The
significant increase in management ownership and equity based compensation in target
companies remain in effect ever since (Kaplan, Stromberg, 2009).
Second, according to Kaplan (1989) and Jensen (1989), leverage used by PE funds
represents another substantial source of value gains in a target company. The authors highlight
two features that lead the value to unfold due to leverage. First, a meaningful increase in
leverage induces the proportional increase in tax shield, i.e. the deductible base in interest
payments. Second, positive pressure that the increased leverage has on management makes a
positive effect on the performance of a target company. Due to the leverage the management has
much little space to waste additional company’s resources while having to pay principal and
interest to the lenders. The authors refer to these kinds of problems as a “free cash flow
problems”. It is shown in the work of Jensen (1986) that the management teams of companies in
mature industries with weak corporate governance are particularly prone to the “free cash flow
problems”. They tend to “… dissipate the cash flows rather than returning them to investors”.
Third, the value is accrued to portfolio companies in governance engineering due to
particular abilities of PE funds for controlling the management of target companies (Kaplan,
Stromberg, 2009). The authors note that PE funds are more actively involved in governance than
public company boards. In addition, they highlight several important features of PE fueled
boards. First, the boards are smaller and meet more frequently than the boards of public
companies. Second, PE funds are more inclined to replace underperforming management.
However, due to increased competition between investors, the level of price premiums
paid for portfolio companies increased as well making it much harder to make profitable exits. In
addition, the access to cheap financial resources has been substantially reduced. As a result,
active investors had to find new sources of value gains in their portfolio companies. Such source
is presented by operational engineering (Kaplan, Stromberg, 2009). The authors refer to this type
of engineering “… the industry and operating expertise that they [PE funds] apply to add value
to their investments”. They highlight that the PE funds are now tend to hire professionals not
only with financial background, but also with the industry expertise. The competencies that these
professionals bring to the funds allow them to concentrate on a particular industry and
successfully realize more value than just from financial and governance engineering. With
industry specific operating knowledge PE funds can execute a repeatable model of value creation
14
by identifying attractive investments, developing strict-to-the-point value enhancement agenda
and implementing the changes according to the agenda. According to the authors, the operational
engineering value enhancing measures may include cost-cutting and productivity improvement,
strategic repositioning and acquisition opportunities, among other initiatives. In his study
Clifford (2008) states that operational improvements associated with HF activism campaigns
were largely related to assets sell-offs. He finds that companies targeted by activist investors
experience much more assets divestures than companies targeted by passive investors.
In the following parts of the chapter we investigate more in details recent developments in
the field of empirical research of institutional investors activism immediately focusing on the
difference in activism and its effects on the performance of portfolio companies of HF and PE
funds.
1.2 The difference in value creation of activist hedge funds and private equity funds
Before discussing the difference of PE funds and HF as activist institutional investors, it
is worth to describe their structural organizational features as asset classes.
1.2.1 Structural differences of PE funds and HF
In his work Kaplan (2009) provides a description of PE funds with a perspective on PE
firms and transactions. PE firms typically have a partnership or limited liability organization
structure. PE funds serve as special investment vehicle through which PE firms raise their
capital. These vehicles have a close-end structure in which the investors (limited partners)
commit to provide certain amount of capital as well as to pay management fees to PE firms
(general partners). Limited partners are usually presented by institutional investors, such as
pension funds and mutual funds, and wealthy individuals. General partners have their own share
in the fund above certain hurdle rate. PE funds have a constrained life cycle of up to ten years
with the possibility for extension for several years. Usually, during the first half of the fund’s life
PE firms make investments in their target companies. During the second half they return the
capital to limited partners. The authors also highlight that after commitment of capital limited
partners have little power over the way how the investments are deployed as long as the
covenants are followed. It is worth to point out that the close-end form of PE funds allows them
to avoid the risk of withdrawing the capital during their investment horizon.
15
HF are very similar in terms of their organization to PE funds. However, there are two
differences that are noted by previous researchers (Fung, Hsieh, 1999). First, general partners in
HF are represented by the fund managers. While it could potentially undermine an increased
centralized role of one individual played in HF investments compared to PE funds, with the
development of various investment vehicles and the appearance of funds of hedge funds, we
could arguably refer to this fact as a distinct feature. Moreover, a centralized role played by
CEOs of major PE firms further mitigates this feature.
Second, HF are open-end investment vehicles. This fact represents an important distinct
characteristic of HF. With this form limited partners are considerably more flexible in moving
their capital in and out of HF. While this feature allows HF to attract more capital form investors
and provide different risk-return characteristics to them, at the same time it imposes constraints
to the horizons of investments and strongly affects the way the capital is deployed as well as the
strategies used for value creation. By some researchers this fact was the main rationale to blame
HF activists for short-terminism and gains at the expense of other shareholders of target
companies. However, the results of the research are controversial on this matter. Some papers
find no evidence for this blame of activist HF (Bebchuk et al, 2015).
1.2.2 Differences between PE funds and HF as institutional investors
While activist hedge funds and private equity funds represent a distinct group of
institutional investors with certain features that allow them to better execute the monitoring role
and reduce agency costs, they, in turn, have particular qualities that distinguish the character as
well as potential ability of serving the role. Such qualities are described by Chen et al (2013). In
his work he points out three distinctive features between PE funds and HF. First, PE investors
tend to acquire larger stakes in target companies and hold more concentrated investments in their
portfolio. The author finds that the median equity ownership in PE based investments is larger
than in the investments made by HF (11,7% vs. 6,3% respectively).
Second, it is noted in the paper that PE funds tend to hold their investments for a longer
time period (7-9 years vs. 1 year on average). Chen et al highlights that, according to his sample,
45% of PE funds hold their investments longer than three year period. He also points out that
hedge funds are known to seek for short-term gains and invest in more liquid assets.
Third, the author emphasizes that PE funds are more focused on value maximization of
target companies by allocating more resources to monitoring and advising their portfolio
16
companies. In addition, PE funds are more likely to provide operational expertise and oversight
to the companies. According to Cheng et al, HF apply more diversified value creation strategies
to their targets. For the purposes of our study it is worth to mention that this paper compares
hedge funds in general and not only activist hedge funds.
1.3 The effect of private equity and hedge funds on the performance of target companies
Brav et al (2008) conducted one of the first comprehensive research focused on the
investigation of the effects of contemporary activism of HF on the performance of target
companies. Based on a sample of the U.S. target companies, the authors find out a number of
important features and outcomes of HF activism. First, HF activists tend to invest in companies
with low market value relative to book value, but which are profitable and have stable operating
cash flows and return on assets. The authors note that the payouts in these companies are lower
in comparison to non-target firms and CEO compensations are higher. In addition, targets
represent significantly higher institutional ownership and trading liquidity, which facilitates
quick entry by acquiring high stakes.
Second, it is proved that the market reacts positively on activism interventions and target
companies experience significant positive abnormal returns (7% to 8%) in the event window of
-20 and +20 days in relation to the announcement. The authors find no effect for the reversion of
these positive returns one year after the engagement of activists.
Third, the largest positive abnormal returns are associated with the funds that pursue the
sale of the company or strategic changes such as refocusing or spinning-off noncore assets.
Consequently, the authors conclude that HF are successful in creating value when there are major
allocative inefficiencies. However, there is no statistically significant market reaction to financial
engineering and governance engineering initiatives. The former group includes debt
restructuring, recapitalization, dividends and share repurchase. The latter group includes
takeover defense, CEO replacement, change in CEO compensation, enhancement of board
independence. In addition, hostile activist campaigns outperform non-hostile initiatives as well
as activists with a track record of successful investments. Overall, according to this study
activists achieve most of their goals in about two-thirds of the cases.
Finally, the authors highlight that according to their empirical research, activists do not
shift the value from creditors to shareholders. However, there is evidence that HF shift the value
away from corporate executives.
17
An important study concerning the investigation of value creation in PE minority
investments was conducted by Chen et al (2013). According to the concept of activism by Gillan
and Starks (1998), which was described earlier, minority active investments represent an
intermediate case of activism. The authors report the following results of their research. First, PE
investors tend to purchase larger stakes in target companies and hold their investments for longer
period compared to other types of investors. Second, PE investors are more likely to promote
their representatives into the boards of target portfolio companies and appoint them into different
committees, such as executive, nominating, compensation, and stock options committees. In
addition, the authors highlight that in cases when target companies have low performance or high
agency problems, PE acquirers tend to appoint their representatives with financial background or
with experience in related industry. Third, PE-backed targets experience higher positive
abnormal returns upon investment announcement and better operating performance in
subsequent years. In particular, those PE investors that appoint their representatives with
financial or operating background into the boards of target companies are able to gain the biggest
value. Thus, the authors conclude that value creation in target companies by minority PE
investments is correlated with the experience and expertise of PE representatives. In addition,
their note that, while operational and governance engineering have a strong effect on value
creation, financial engineering – in particular, changes in CEO compensation and financial
leverage – provides no evidence for value gains in target firms.
Because of the fast growth in AUM and considerable success of their investments, PE
funds and HF gain the popularity in recent academic studies. However, there was little
investigation conducted with a focus on comparison between the outcomes of the activism of PE
funds and HF on target companies.
One of the first such empirical studies was done by Klein and Zur (2009). In the paper the
authors investigate the effects of activism on target companies based with comparison of two
samples of activists - HF and other private entrepreneurial activists. They report the following
outcomes of activism. First, there are positive abnormal stock returns for both groups of activists
upon the announcement of investments. Specifically, companies targeted by HF experience
10.2% average abnormal stock return. Companies targeted by other private activists experience
5.1% average abnormal stock return. Second, there is no reversion of the returns one year
following the interventions. Instead, HF targets earn an additional 11.4% abnormal return during
the subsequent year, and other activist targets realize a 17.8% abnormal return over the year
following the interventions of activists. Third, activists are successful in forcing the management
to facilitate the changes and achieve desired results. HF are successful in 60% of cases and
18
private investors in 65%. Fourth, the market is able to initially differentiate between successful
and unsuccessful activists campaigns. These results are consistent with the results of the previous
studies (Brav et al, 2008).
However, the authors point out two surprising outcomes of their research that highlight
the differences between HF and private activists. First, HF target more profitable and financially
healthy firms than other activists. HF targets are characterized by higher initial level of cash.
Moreover, HF demand more frequently distribution of cash through dividends, share repurchases
and decrease in CEOs compensation. As a result, these companies significantly increase debt-toassets ratio and significantly decrease their cash and short-term investments. Contrary to HF
targets, companies targeted by other private activists experience significant decrease in R&D
investments and capital expenditures. The authors state that the main reason for such an effect is
that private activists are more likely to redirect their investment strategies into portfolio
companies and, consequently, are more focused on the changes in operating strategies of their
targets.
Another comparative study of institutional investor activism was done by Meitzner and
Schweizer (2013). They explore the differences of the impacts of PE and HF on the performance
of target companies in German context. The authors provide the comparative analysis of the
funds and empirically prove the existence of the divergence between the effects of these two
types of investors. The authors conclude that PE funds are more successful in creating the value
for target companies. They argue that PE funds have stronger incentives and capabilities of being
an active blockholder and subsequently reduce agency costs. According to the authors, possible
reasons for these discrepancies in capabilities could be the “… longer-term perspective and
higher adaptability to the surrounding corporate governance system” of PE funds. They conclude
that HF were unable to create the value for shareholders from their active investments.
Moreover, they point out that the benchmark-adjusted performance of HF targets is characterized
by statistically significant negative abnormal returns in the long term. They think that one of
possible reasons could be unrealized returns from the reduction in agency costs that were
initially expected by the market. The authors also highlight that, based on the market reaction,
PE funds are less likely to create value and reduce agency costs in target companies when such
companies already have blockholder investors.
In his work Wong (2016) conducted a comparative analysis of HF and PE activist
investments based on a sample of companies from Hong Kong. The author finds a number of
similarities as well as discrepancies in the effects of activism of institutional investors on target
19
companies compared to previous US and international studies. First, he observed a strong and
robust value creation effect in the short-term period. The mean cumulative abnormal returns in
the event window of 20 days before and after the announcement of the transaction accounted for
increase by 9,9%. The author notes that the short-term abnormal returns to shareholders are
consistent and slightly higher than that reported in US and international studies. However, the
effect of positive abnormal returns is characterized by the following reversion within the first six
months of the investments and is statistically not different from zero. As such, the author
concludes that the long-term value creation effect in target companies is questionable. Moreover,
according to Wong, the results of short-term cash earnings by activists show that activists are
good at market timing rather than stock-picking.
Second, the author highlights based on empirical results that the market is able to
distinguish very soon which activism events will eventually lead to activism outcomes. He notes
that the rate of successful activism outcomes on the 2 nd year is substantially lower in Hong Kong
compared to US and international evidence (26% vs. over 50%). Wong finds out that the highest
performance of target firms in terms of cumulative abnormal returns was connected with
takeover outcomes of activism campaigns. In addition, target companies with restructuring or
pay-out outcomes of activism are also high performers in terms of cumulative abnormal returns.
The author provides a conclusion that the activists create long-term value when they are able to
successfully facilitate the changes in target firms.
Third, Wong finds that in contrast to the international studies on activism, shareholder
coordination on behalf of other institutional investors does not play a significant role in activism
outcomes. The short-term cumulative abnormal returns are lower for target firms where there
were other institutional investors before the entry of activist as compared to the situation when
there were not. In the long-run there is no any difference in terms of abnormal returns. The
author further provides the judgment that this effect is connected to the family ownership of the
most companies and holds true in Asian context. Interestingly, these conclusions are correlated
with the conclusions stated by Meitzner and Schweizer (2013) for target companies in German
context.
Fourth, with empirical evidence the author states that a number of indicators including
high book-to-market equity ratio, small size, low return on assets, low leverage, and low betas
and especially low dividend yield are associated with high long-term returns in activism. These
results show that underperforming companies serve as good targets for activists. The latter is
correlated with the outcomes of previous studies (Brav et al, 2008; Bebchuk et al, 2015).
20
Kim et al (2009) investigate the effects of activism in Korean market. The paper is
focused on special type of activist investors to whom the authors refer as “switchers”. They
define the switchers as outside blockholders who switch from passive investments to active
investments in their targets. According to the authors, traditional activism that aims at acquiring
control over the target and its active monitoring represents a “high-cost” activism. While
theoretically such investors can be effective in reducing various forms of agency costs, in
practice, the authors argue, this is far from reality. They address this problem to several
drawbacks of traditional activist investments. The main drawback is that in many developing
countries hostile takeovers are far less likely due to a widespread family control through pyramid
ownership and dual-class equities. In these circumstances the increase in equity ownership does
not necessarily lead to an increase in the probability of taking corporate control. Thus, the
authors investigate the type of activism in which control-related effect are not expected, while
other value creation activities can be implemented. There are several interesting findings
observed in the paper. First, the authors find out that there are positive abnormal returns of
3.73% in the event window of -5 and +5 days in relation to the disclosure of switching from
passive to active investments by the blockholder. Second, the returns are higher in case when the
investor is the outside blockholder who intends to increase the scope of activist measures. Third,
target companies that are more likely to benefit from activism (those targeted by switchers with a
broader agenda and higher free cash flow) tend to have increased dividends payouts.
Malaysia represents a particular interest for the research of shareholder activism for the
reason that it is the only emerging market in East Asia, where a traditional form of shareholder
activism is institutionalized. The company called Minority Shareholder Watchdog Group
(MSWG) provides proxy-voting services on behalf of minority shareholders at the annual
general meetings.
There are two main studies regarding the effect of activism on the performance of target
companies in Malaysia. The first paper (Ameer, Rahman, 2009) made several important
contributions to the study of activism on developing countries. First, the authors find out that
MSWG-targeted firms experience statistically significant positive abnormal returns compared to
control group consisted from non-targeted companies (the means exceed by 2,24% in a short-run
and by 2,8% in a long-run). Second, it is observed that the campaigns backed by mergers and
acquisitions or assets disposal initiatives have a significantly stronger positive effect on target
companies compared to activism campaigns motivated by the changes in corporate governance.
Third, there is a significant increase in earnings and operating cash flows in the firms targeted by
activists compared to the companies from a control group one year after initial engagement.
21
Fourth, the results show that target companies remained profitable two years after the initial
engagement of activists.
In the second paper (Azizan, Ameer, 2012) the authors investigate the effects of activism
in the light of concerns regarding entrenched family ownership in Asian companies, which are
raised in previous studies (Kim et al, 2009). The authors point out the following outcomes of
their research. First, even though there is no proof of positive abnormal returns on the event
window of activism interventions, there are significant positive abnormal returns in the long-run,
which indicates the lagged effect of activism in target companies. Second, there are significant
improvements in financial performance of target companies. As a result, the authors conclude
that shareholder activism is an important value creation vehicle in developing countries, where
corporate governance codes are unable to “shuffle staggered boards of incumbent family
members”.
Hamao et al. (2011) explore the activism on a sample of Japanese companies. Close
proximity of Japan to a number of Asian actively developing markets makes this study of
particular interest for our research. The authors address two main issues that activists face in
Japanese market. First, strong traditional corporate culture of Japanese companies makes it
unlikely that shareholders will confront management. Second, the market for corporate control is
undeveloped and there is low opportunity for activists to exit their investments through mergers
and acquisitions. According to the authors, the latter poses serious challenges for the
development of activism in Japan. There are studies that show that the returns of activists are
driven by the ability of activists to force the target into a takeover (Greenwood, Schor, 2009).
However, the authors highlight that there are other sources of value creation for activist in Japan.
Since many companies in the market have high cash balances, activists can create value in target
companies by forcing the management to distribute the cash to the shareholders in the form of
dividends or allocating the cash into valuable projects. In their study the authors provide
empirical support of this assumption stating that companies targeted by activists are
characterized by increased payouts. However, there is only some evidence on the changes in
corporate governance. Interestingly, it is found in the study that the market reactions are higher
for the interventions of hostile funds than friendly activists. In addition, positive long-term
effects in target companies remain only for hostile funds.
Taking into account common concerns about the short-terminism of HF activists,
Bebchuk et al (2015) conducted a research with a purpose of investigating the long-term effects
of this type of activists on target companies. In their work they address so-called “myopic22
activists” claim. According to this claim “…activist shareholders with short investment horizons,
especially activist hedge funds, push for actions that are profitable in the short-term, but are
detrimental to the long-term interests of companies and their long-term shareholders”. Based on
a sample of the U.S. activist HF universe of 2000 interventions, the authors did not find any
evidence supporting the claim. First, initial improvements in operating performance of target
companies are not followed by long-term (up to five years) decline in performance. Indeed, there
are improvements in operating performance of target companies even in the long-term period.
Second, initial stock gains are not followed by the reversion in the long-run (up to five years).
Further, the long-term effects of HF activism were explored by Goodwin (2016). The
author claims that there is a substantial difference between those activists who seek board
representation and those who do not. Accordingly, using empirical research design, he conducts a
comparative analysis of these two groups of activists in the long-run in the U.S. context.
Goodwin provides several interesting conclusions that contribute to the study of HF activism.
First, there is statistically meaningful empirical evidence that HF activism generates substantial
long-term value for target companies and their shareholders, when activists are concentrated on
monitoring management through active board engagement. Second, HF activists that seek board
representation are focused on long-term value creation rather than on short-term gains.
As it follows from the literature review, overall the effect of institutional investor
activism on target companies tends to be positive. However, it varies significantly from country
to country depending on such factors as the strength of corporate governance systems and the
specifics of corporate cultures. Moreover, PE and HF activists tend to have certain features and
exploit rather distinct investment strategies for value creation.
23
2. Methodology and data
2.1 Research design
The purpose of a given research is to provide an explanatory study of the effects of
institutional investor activism on the performance of target companies in the context of emerging
markets. In particular, we aim at finding out as well as explaining to a certain degree the
relationships between two groups of institutional investors that commit active investments –
hedge funds and private equity funds, their activism strategies and the value gains in target firms.
According to the purpose of our study and research objectives, we use a multi-method
quantitative study, which reflects our data collection and analysis procedures. This method
allows us to investigate our research phenomenon from a number of perspectives and
complement our body of knowledge with different pieces of data.
In our research we use an event study that was widely accepted by the researchers in
previous works dedicated to the analysis of the effects of activism on target companies (Brav et
al, 2008; Bebchuk et al, 2015). We have two experimental groups of target companies – those
backed by HF activists and those backed by PE activists. Each target company is controlled for
the initial performance in the year of commitment of the investments by activists. As our study
aims at exploration of the effects of activism in the long-term as well as in the short-term, we
establish a six year time horizon of examination for every target. Thus, the performance of every
target company is investigated on the year of intervention of activists and five years following
the intervention (Bebchuk et al, 2015).
For the purposes of investigating the most recent
advances in the behavior of activist institutional investors and the effects of their strategies, we
include the companies that were targeted up until 2014 year. Consequently, we use annualized
adjustments for the data when we aim at evaluating the overall cumulative effects across all
sample deals to control for available years of observation.
Data analysis is conducted in two stages. During the first stage we conduct a comparative
analysis of the examined phenomenon using numerical as well as graphical tools of MS Office
Excel. This stage helps us to initially capture the existence and magnitude of the effect between
experimental groups of investors.
During the second stage we build regression models and conduct a comparative statistics
test. Our regression models allow us to observe the existence and the scale of the relationship
between experimental groups of institutional investors as well as between different strategies and
24
the performance of target firms. During this stage we additionally aim to find out whether there
is a statistical significance of the effects identified in the first stage.
2.3 Econometric model
Our investigation of the effects of institutional investor activism on the performance of
target companies is based on the following econometric model:
Q it = β 0 + β1 TF it + β 2 BM it + β 3 Strategyit +uit ,
where:
TF it - binominal variable that describes the type of institutional investor (0 - PE fund,
1 – HF ) targeting the company;
BM it - vector that includes variables of base model;
Strategy it - vector that describes a strategy used by institutional investor;
i=1, 2, ..., - indicator that refers variable to a particular company;
t=0 , 1, ..., 5 - indicator that refers variable to a particular point of time relative to the
intervention of activist: 0 – refers to the year of intervention; 1, 2, … 5 – number of years after
the intervention;
β 0 - unknown scalar value;
β 1 , β 2 , β3 - vectors of unknown coefficients ( β 1=0 for the model when the effects for the
whole sample of institutional investors are evaluated)
uit - random value.
2.2 Description of variables
2.2.1 Dependent variable
Among financial economists there are a number of indicators to measure performance of
companies. However, Tobin’s Q is the most commonly used measurement for studying the
effectiveness with which the firm operates as well as creates value for shareholders. In recent
studies Tobin’s Q is used to evaluate the effects of HF activism on the performance of target
25
companies (Bebchuk et al, 2015). Tobin’s Q is designed to measure the success with which the
firm turns its book value of assets into market value accrued to investors. Thus, Tobin’s Q
includes both accounting and market indicators and helps to better evaluate the overall effect on
target companies that can be made through different channels.
In a given work Tobin’s Q is used in its simplified version for measuring the value
creation effects in target companies (Chung, Pruitt, 1994):
Q it =
where:
NDit
MV it + NDit
ATA it
,
MV it - market value of company i in time t ;
- net debt of company i
in time t
calculated as difference between total long-term
debt and cash and cash equivalents;
ATA it - average total assets of company i in time t .
2.2.2 Independent variables – base model
The base model in our analysis consists of two variables. First variable describes the
perception of the company by the market. We use market capitalization as an indicator of market
perception. Market capitalization equals total market value of company’s shares. Second variable
reflects the size of the company. We use average total assets as an indicator of target’s size.
To strengthen our econometric model and avoid collinearity between base variables and
dependent variable we use natural logarithm forms of the variables in the base model (Bebchuk
et al, 2015).
2.2.3 Independent variables – strategy
Investigating the effects of a chosen strategy on the value created in target companies we
refer to the previous academic studies (Kaplan, Stromberg, 2009) with some adjustments
according to the purposes of our research. Thus, we aim at investigating the effects of four
principal types of improvements: financial engineering, operational engineering, strategic
engineering, and governance engineering.
Financial engineering refers to the changes in target’s capital structure, levels of debt and
cash available to shareholders. We use the leverage (debt-to-equity ratio) as the most direct proxy
for financial changes in a company. In addition, we assess financial engineering by tracking
cash-to-average-total-assets (Cash/ATA) and dividends-to-cash (Div/Cash) ratios.
26
Operational engineering refers to the initiatives that are focused on strengthening the
operations of a target company. We use return on assets (ROA) as the indicator of operational
engineering. ROA shows the effectiveness with which the company uses its assets to generate
earnings to their investors.
Strategic engineering refers to the initiatives that are focused on repositioning the
business of the company. We use a multiple of enterprise vale to revenue (EV/Rev) as a proxy
indicator for strategic improvements. More often, EV multiple of earnings before interest, tax,
depreciation and amortization (EBITDA) is used for evaluation of company’s strategic value.
However, due to a number of cases with negative earnings and not available data, the purposes of
our research will be better served by the former ratio.
Governance engineering refers to the changes in corporate governance of the company.
We use two base indicators for tracking the effects of this type of engineering – change of CEO
or Chairman and the share of Board changes. First indicator is a binominal variable that
highlights the cases where at least one of the two directors was changed by activists. Second
indicator shows what percentage of the total number of directors within the Board was replaced
shortly after the intervention.
Table 1 shows the summary of the description of the variables.
Table 1 Description of variables – summary
Variable
1
Q
Description
2
Dependent variable
Variable that describes the effects on the value in a target company:
Q=
TF
Ln ATA
MV +ND
ATA
Independent variables
Binominal variable that describes the type of institutional investor (0
- PE fund, 1 – HF ) targeting the company
Variables comprising vector BM
Variable that equals the natural logarithm of average total assets of a
ATA =(TA +TA
)/2
t
t
(t −1 )
company in a particular year ( t ): (
)
Variable that equals the natural logarithm of a market value of the
Ln MV
total shares outstanding of a company in a particular year
Table 1 Description of variables – summary (continued)
Leverage
Variables comprising vector Strategy
Variable that describes financial engineering in a company:
Leverage=Debt /Equity
27
Div /Cash
Cash/ ATA
ROA
Variable that describes financial engineering in a company. It equals
the ratio of dividends paid to cash.
Variable that describes financial engineering in a company. It equals
the ratio of cash to average total assets.
Variable that describes operational engineering in a company:
ROA=Net Income / ATA
EV /Rev
Variable that describes strategic engineering in a company. It equals
the ratio of enterprise value to revenue.
Binomial variable that describes governance engineering in a
CEO/Chairman
company. It equals 1 if there is a change of CEO or Chairman in a
target company shortly after the intervention of activist, otherwise –
0.
Share of Board change Variable that describes governance engineering in a company. It is
calculated as the ratio of the directors that are changed by activists to
a total number of the directors in the Board.
Tables 2-4 represent descriptive statistics of the whole sample and each activist group.
Table 2 Descriptive statistics of variables – all activists
Variable
Q
Mean
Median
1,16
0,89
Standard
Deviation
0,98
5,56
5,51
2,02
5,11
4,98
2,05
1,41
0,56
2,99
Leverage
0,00112
0,00
0,00517
Div /Cash
0,149
0,111
0,133
Cash/ ATA
-0,015
0,016
0,170
ROA
3,75
1,87
5,32
EV /Rev
0,34
0,25
0,32
Share of Board change
Table 3 Descriptive statistics of variables - PE subsample
Ln ATA
Ln MV
Variable
Q
Ln ATA
Ln MV
Leverage
Div /Cash
Cash/ ATA
ROA
EV /Rev
Share of Board change
Mean
Median
1,16
0,94
Standard
Deviation
1,02
5,75
5,23
1,67
0,00145
0,147
-0,006
3,21
0,30
5,95
5,23
0,59
0,00
0,121
0,030
1,70
0,24
2,42
2,41
3,29
0,00695
0,120
0,186
4,22
0,29
Minimum
Maximum
-0,29
7,34
0,54
0,20
0,00
0,00
0,00
-0,829
-0,09
0,00
9,86
10,52
22,45
0,06527
0,545
0,604
36,13
1,00
Minimum
Maximum
-0,05
7,34
0,54
0,20
0,00
0,00
0,00
-0,829
0,16
0,00
9,80
10,52
22,45
0,06527
0,419
0,386
36,13
1,00
Table 4 Descriptive statistics of variables - HF subsample
28
Variable
Q
Ln ATA
Ln MV
Leverage
Div /Cash
Cash/ ATA
ROA
EV /Rev
Share of Board change
Mean
Median
Minimum
Maximum
0,87
Standard
Deviation
0,95
1,17
-0,29
4,92
5,39
5,01
1,22
0,00086
0,151
-0,022
4,17
0,37
5,37
4,85
0,52
0,00
0,106
0,008
2,34
0,28
1,58
1,66
2,74
0,00309
0,143
0,156
6,02
0,34
1,81
1,72
0,00
0,00
0,00
-0,718
-0,09
0,00
9,86
10,16
19,85
0,03283
0,545
0,604
35,91
1,00
2.4 Data collection and sample
Secondary data for the research is collected using Thomson-Reuters Eikon database.
There are four major criteria that are used for data collection.
First, the investments are made by private equity fund or hedge fund. The reason for
using this criterion is that these types of institutional investors accounts for the majority of active
investments. Other institutional investors - investment banks, pension or mutual funds - are
reluctant to make such investments themselves and instead use private equity and hedge funds as
proxies for activist deals. Therefore, the paper investigates the topic in a frame of these two types
of institutional investors.
Second, the target portfolio company belongs to emerging market and is publicly traded
for at least one year after activism event. This limitation directly relates to the object of the
research. The reason for investigating the activist investments in emerging markets is due to a
number of distinct features of business environment. Consequently, the activism of institutional
investors and its strategies can have different effects form that in developed countries. We use a
Morgan Stanley Capital International Emerging Markets (MSCI EM) index for referring the
country to an emerging market. Public status of a company allows collecting the data that we
need in our analysis and tracking better its corporate performance over time.
Third, the investor enters the target through minority investments. The very essence of
investor activism refers to the ability of a minority shareholder to execute much influence over
the company while having no formal control. Therefore, in collecting the data for the research it
is necessary to exclude the deals, in which the investor acquired a controlling stake in a target
portfolio company. In such case the investor can directly influence performance of the company
29
without using activism. These types of deals are common for private equity industry, where
gaining control over the company is traditionally made by acquisitions of large stakes or LBOs.
Thus, for the purposes of our research we limit acquired stakes to 40% even though there were
cases when higher stakes were considered minority. In addition, acquisition of a minority stake
serves as a proxy for referring the investor to an activist type as usually the stakes acquired for
diversification purposes are much more diluted.
Fourth, there is no initial stake of investor in the company where the minority
investments are made. In these cases the effects of activism are dispersed across untracked time
period. In addition, such situations could signal about switching type of activism (Kim, 2009)
that is not in the scope of a given research. Moreover, we intentionally insert an upper cap for
investments on the level of 40%. While such investments are identified in the database as
minority, the owners of the stakes have by definition much power in the companies. They are
able to execute this power without necessarily
Fifth, investments are active in their nature, meaning they are directed on reducing the
agency costs in target firms. Therefore, investments made for the purposes other than that of
activism are excluded. Such investments, for example, include the mitigation of the conflicts
with the creditors, proceeds used to repay debt or to comply with changing regulation norms.
Finally, to be up to date in our research and to provide more actual conclusions about the
phenomenon we deliberately exclude the deals that were made before the year of 2008
Hence, in a final sample only the deals made by activist private equity and hedge funds
where the target company is from emerging market are left. There are no constrains regarding
the size or country of origin of investor.
Final sample contains 86 target companies – 37 companies are targeted by PE activists
and 49 are targeted by HF. The sample has on average 300 unique observations for every
variable that we investigate in our research (except for variables that are common across all years
of the time period for a deal, such as the type of fund and governance changes).
In order to grasp more insight about our research subject and make more qualified
conclusions in our paper, we need to gain a broad understanding about the data before we
proceed to analyze it in subsequent steps. In doing so, we will describe the deals in our sample
from three perspectives: geography and industry of a target company; the purpose of the deal
reported by investor.
30
Figure 1 Geographic sample distribution, number of deals
35
30
25
20
15
10
5
0
h
ut
So
ea
or
K
i
Ch
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ia
ss
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s
d
ne
an
i
l
p
p
Po
ili
h
P
i
Ch
le
o
ic
ex
M
Figure 1 shows the distribution of the deals in a sample according to the domestic country
of a target company. The majority of the deals of activists PE funds and HF in emerging markets
comes from Asian countries. This can be primarily explained by particularly high economic
activity and growth that these countries experienced during the investigated period (YY 2007 –
2014). Another reason could be a lower level of transparency and, consequently, potential
missing of the data about PE and HF deals in other countries.
Figure 2 Geographic distribution of PE deals, percentage
24.32%
35.14%
South Korea
China
Turkey
India
Other
18.92%
8.11%
13.51%
31
Figure 3 Geographic distribution of HF deals, percentage
10.20%
10.20%
44.90%
12.24%
South Korea
China
Indonesia
Taiwan
Other
22.45%
Figures 2 and 3 shows geographic distributions of the deals according to the type of
activist involved. According to figure 2, the majority of the deals of PE investors are made in
South Korea and China. This reflects the overall focus of activist investors in emerging markets.
Interestingly, Turkey and India tend to be also attractive markets for PE funds.
Figure 3 shows that HF investors rely heavily on South Korean and Chinese markets –
the deals from these markets account for almost 70% of all investments in our sample. In
addition, slightly more than 20% of the deals are made in Indonesia and Taiwan.
Comparing figures 2 and 3 we can conclude that, according to our data, activist
investments made by PE funds are more geographically diversified, while that of HF are more
consolidated. In addition, the data in our sample shows that 31% of PE deals represent crossborder transactions while such transactions of hedge funds account for only 10%. The data could
potentially mean that activist PE funds are less geographically dependent and are more willing to
commit foreign investments. Regarding the subject of our research, it could be a sign that the
capabilities that PE investors bring to their target companies are more unified across countries
than capabilities of HF activists.
Figure 4 shows the distribution of sample deals with regard to industry of a target
company.
Figure 4 Sample distribution by industry, number of deals
32
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15
10
5
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it
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The majority of deals are made by activists in the following five industries: Real Estate
and Industrials, Telecommunications and IT, Machinery and Equipment, Consumer products, and
Electronics.
Figure 5 PE subsample distribution by industry, percentage
33
10.81%
18.92%
5.41%
8.11%
16.22%
10.81%
13.51%
Real Estate & Industrials
Telecom & IT
Machinery and Equipment
Electronics
Banks & Credit Institutions
Consumer products
Biotech, Pharma and
Healthcare
Other
16.22%
Figure 6 HF subsample distribution by industry, percentage
18.37%
18.37%
6.12%
16.33%
6.12%
8.16%
10.20%
Real Estate & Industrials
Telecom & IT
Consumer products
Machinery and Equipment
Metals & Mining
Electronics
Biotech, Pharma and
Healthcare
Other
16.33%
Figures 5 and 6 show the distribution of the deals in our sample according to the industry
of a target company. Comparing figures 5 and 6 we cannot see any substantial differentiation
between the character of investments made by PE and HF investors with regard to the industry.
Both groups prefer to have a similar focus on two industries: Real Estate and Industrials,
34
Telecommunications and IT. Moreover, they have similar distributions clustering slightly more
than 60% of their investments around four major industries. However, PE funds have a stronger
focus on Machinery and Equipment and Electronics industries while HF have more deals in
Consumer products. This fact could reflect a more short-term orientated character of HF
investors with the intention for a quicker return of their investments. PE funds, in contrast, seem
to be more willing to commit investments in industries with higher capital expenditures and
stronger R&D requirements that have a long-term horizon.
Figures 7 and 8 show the distributions of PE and HF investments according to the
purpose reported by investors.
Comparing figures 7 and 8 we can observe rather different objectives stated by PE and
HF activists. Investors from PE funds tend to make their investments with the objectives of
growing their target company through M&A, penetrating or expanding its market, or
strengthening its operations. The primer focus of PE funds tends to be a non-organic growth.
Figure 7 PE subsample distribution by purpose, percentage
21.62%
56.76%
10.81%
M&A
Market
penetration/expansion
Strengthen operations
Other/not disclosed
10.81%
Figure 8 HF subsample distribution by purpose, percentage
35
22.45%
8.16%
55.10%
8.16%
Strengthen operations
Raise cash through
disposal
Investment opportunities
Increase shareholder
value
Other/not disclosed
6.12%
Investors from HF have slightly more diverse objectives. Particularly, they intend to
strengthen operations of their portfolio company, raise cash through disposal, pursue a general
strategy of sound investment opportunities, or increase shareholder value. The focus of HF
investors is largely shifted toward strengthening company’s operations.
The differences between the purposes of PE and HF activists can be also explained by the
discrepancy in the time horizons of investors and demands for liquidity. PE investors are more
willing to commit large resources with longer payback period. Moreover, their emphasis on
M&A could be explained by stronger capabilities of PE activists in this field. Operating their
portfolios PE funds tend to be highly involved in M&A activities by acquiring new companies,
relocating and spinning their assets, and selling the companies in order to return their
investments. Very often, they realize substantial synergies by merging a new target company
with one of their portfolio firm. HF investors are more concentrated on short-term gains and,
consequently, the strategies that require less commitment and bring faster returns. Because of the
open-end structure of their funds, HF tend to have higher concerns for liquidity levels of their
investments than PE investors. As such, they are more likely to squeeze the liquidity from target
companies by forcing the management to spinoff some assets and focus on strategies that bring
the value faster with considerably lower investments such as strengthening operations.
However, there are a couple of things to pay attention in analyzing the purposes of
investors. First, in more than a half of the deals the purposes of the investors are not disclosed.
Second, there is no guarantee that the investors directly followed the intentions that were
reported in the database. Meanwhile, this data provides a good perspective and a starting point
for an empirical analysis of the value creation effects of active investments in emerging markets.
36
3. Empirical findings
3.1 The effects of private equity and hedge funds activism
The first part of our analysis is focused on addressing the first research question and to
identify whether there is a difference in value creation effects of PE and HF investors on target
companies in the context of emerging markets. We begin our investigation by calculating
cumulative and annualized accrued Tobin’s Q indicators across both groups of investors. For
each target company cumulative value equals the difference between Tobin’s Q calculated at the
final year of observation and the year of activist intervention. Annualized accrued Tobin’s Q
represents cumulative value adjusted for a number of years during which the coefficient was
effected (i.e. the value was gained or destroyed). This adjustment helps us to track most recent
activist deals – up to 2014 year – and make a qualified comparison across the sample. As most of
our data is significantly skewed, for comparison purposes we use median values of examined
indicators across the groups. Figure 9 shows the results of this step.
Figure 9 Target’s accrued Tobin’s Q
0.10
0.087
0.08
0.062
0.058
PE
HF
0.05
0.03
0.012
0.00
Cumulative
Annualized
Based on the figure 9 we can make two important initial statements. First, target
companies of HF investors outperformed the firms targeted by PE investors. Second, HF need
much less time for the value creation effect to realize than PE funds.
37
During the next step of our analysis our goal is to check whether the effect identified
above is statistically significant. In doing so, we use a non-parametric Mann-Whitney U-test to
check the difference between two independent groups, in which the data is not normally
distributed.
The results of the test are shown in table 5.
Table 5 Results of non-parametric U-test – cumulative and annualized Tobin’s Q
Cumulative
Annualized
Mann-Whitney U
Delta_Q
859,000
Delta_Q
839,000
Wilcoxon W
1562,000
1542,000
Z
-,414
-,589
Asymp. Sig. (2-tailed)
,679
,556
According to the test, there is no statistically significant difference between the groups of
investors for both cumulative and annualized Tobin’s Q.
Therefore, we cannot conclude that there is a significant difference in value creation
effects of PE and HF investors on companies from emerging markets.
3.2 Sustainability of value gains
In this part of our research we investigate the sustainability of the effects of activist
investments in the long-term period addressing the second research question. In doing so, we
track the dynamics of Tobin’s Q across five years following the intervention. As in the previous
part, we use median values for comparison between groups with not normally distributed data.
Figure 10 shows that the targets backed by HF activists gains maximum value on the
second year following the intervention. However, this effect tends to be not sustainable in the
long-term period and eventually, five years after the engagement, HF activist targets have much
lower Q than on the year of investments. The decline in Tobin’s Q suggests that HF activists are
more likely to have a value destroying rather than creating effects on companies from emerging
markets.
In addition, according to the figure PE investors target more underperforming companies
in terms of Tobin’s Q.
38
Figure 10 Target’s Tobin’s Q dynamics
1.6
1.4
1.2
PE
HF
1.0
0.8
0.6
0.4
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
Figure 11 Target’s accrued Tobin’s Q dynamics
0.15
0.10
0.05
0.00
1
2
3
4
5
PE
HF
-0.05
-0.10
-0.15
Relative time, years
39
Figure 11 visually demonstrates the magnitudes of the effects stated previously. PE
investors are able to increase Tobin’s Q on the fifth year almost by a factor of three compared to
HF activists. Meanwhile, HF are able to create slightly more than two times the value of PE
funds on the second year.
Overall, HF have slightly stronger cumulative effect due to the fact that PE investors
loose much value on the third year and are not able to reasonably compensate it, at least, during
the observed period of five years. The effect is much stronger with annual adjustment, which
shows that HF are able to gain positive impact on Q much faster.
3.3 Value creation strategies
3.4.1 Descriptive analysis
In the third part of our research we investigate the strategies that are used by active
investors to drive the value in target companies, addressing the third research question.
This part is done in two steps. During the first step we provide a big picture of the
dynamics of the indicators used to track four principal categories of activist engineering –
financial, operational, governance, and strategic – for both groups of activists. Following this
step we investigate the magnitude of relationships of each type of engineering as well as its
significance with value creation effects measured by Tobin’s Q. This process is done on the level
of the whole sample in order to identify the best type of engineering (i.e. value creation strategy)
for activists and on the level of distinct type of investors for the purpose of finding out the
strategy that works best for a particular type of activist.
We begin the first step with exploration of financial engineering strategy. As it was stated
in chapter 2, we use a leverage ratio (the ratio of debt to equity) as a key indicator of the effects
of financial engineering on target companies.
Figure 12 shows the development of the median values of the ratio for HF and PE target
companies during five years following the activist intervention.
We can observe that during most of the observed time PE investors tend to increase rather
than decrease the leverage in target companies. The decline in the fifth year can be explained by
a sharp increase in the level of average total assets (figure 13).
40
Figure 12 Target’s leverage dynamics
3.0
2.5
2.0
PE
HF
1.5
1.0
0.5
0.0
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
The increase in the ATA level of companies targeted by PE investors can be potentially
explained by the intention of the investors to grow companies through M&A.
Figure 13 Target’s ATA dynamics, millions USD
4000
3500
3000
2500
PE
HF
2000
1500
1000
500
0
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
41
Figure 13 also shows that HF investors are less likely to increase the assets of their target
portfolio companies. This reflects the purposes and characters of their investments discussed in
previous chapter.
In addition, we use the ratios of cash-to-average-total-assets and dividends-to-cash to
evaluate the effects of financial engineering initiatives. Here and further using cash we refer to
the value of cash and cash equivalents, as it is indicated in the database.
On the figure 14 we can observe the dynamics of cash-to-assets ratio. The ratio indicates
the share of cash on a balance sheet. The data shows that PE investors decrease the level of cash
during the first year following the intervention. However, they tend to sustain the status quo in
the ratio during the following several years and substantially increase it during the fifth year.
Referring back to figure 13 we can conclude that for the cash-to-assets ratio to grow
while the assets, which constitute substantially larger portion of the ratio, grow significantly
during the fifth year, the cash portion of the ratio must grow significantly faster the assets
portion. The first decrease in levels of cash can be explained by potential use of the cash by PE
investors for non-organic growth of their companies through M&A.
Figure 14 Target’s Cash/ATA ratio dynamics
20.0%
17.5%
15.0%
PE
HF
12.5%
10.0%
7.5%
5.0%
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
42
The sharp increase of the ratio in the fifth year could be an indicator of the realization of
synergies, from one side. From the other, it could potentially be a signal of PE investors starting
preparation for the liquid exits of their investments.
According to the figure, HF investors tend to quickly lift the levels of cash during the first
year following the intervention and constantly decrease it during the rest of the period. Similar to
PE investors, an increase in the levels of cash could indicate the intention to boost liquidity for
subsequent safe exits. However, as we discussed previously, HF are more inclined to exit their
investments in a short-term period. Therefore, we need to be cautious in making firm conclusions
about their long-term effects on the indicators that we investigate.
Concerning the initial values of the ratio, we can observe that PE investors target
companies with higher levels of cash than HF investors.
Figure 15 shows the dynamics of dividends-to-cash ratio during the observed period. This
ratio represents the share of cash that is distributed to shareholders in the form of dividends.
According to the figure, it is clear that HF activists tend to be much more manipulative
regarding the distribution of cash to shareholders.
Figure 15 Target’s Dividends/Cash ratio dynamics
0.14%
0.12%
0.10%
0.08%
PE
HF
0.06%
0.04%
0.02%
0.00%
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
Moreover, the data in the figures 14 and 15 shows that during the first year HF investors
increase the share of dividends in addition to increasing the levels of cash. It indicates that during
that year HF activists squeeze the most cash out of their target companies. This observation
43
provides the rationale and lays certain evidence for the support of the myopic claim of HF
activist investors discussed earlier.
Contrary to HF investors, PE activists do not elaborate much on dividends as an
instrument of value creation in target companies. They target companies with much lower levels
of dividends and tend to decrease rather than increase the share of cash distributed to
shareholders through dividends. This fact suggests that PE investors could relocate this excess
cash to different valuable projects.
Figure 16 shows that PE target companies perform much better in terms of ROA.
The results of the figure contradict the analysis of reported purposes in the previous
chapter. First, despite the fact that the majority of HF investors, who disclosed their intentions,
concentrate on strengthening operations of their target companies, we cannot observe significant
effects of such intentions. Second, companies targeted by PE investors seem to experience more
value creation effects in their operations, despite the fact that the majority of disclosed purposes
characterize PE investors as being more concerned about growing assets rather than
concentrating on operational improvements.
Figure 16 Target’s ROA dynamics
6.0%
5.0%
4.0%
PE
HF
3.0%
2.0%
1.0%
0.0%
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
44
Figure 17 Target’s EV/Revenue multiple dynamics
5.0
4.5
4.0
3.5
PE
HF
3.0
2.5
2.0
1.5
1.0
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
Relative time, years
Figure 17 demonstrates that both groups of target companies experience significant
strategic improvements that result in higher EV/Revenue multiples. However, HF tend to have a
stronger strategic impact on target companies in absolute terms. Moreover, HF investors are able
to conduct strategic improvements faster than PE investors.
To evaluate the influence of governance engineering we use two basic indicators: change
of CEO or Chairman and the share of Board changes. Change of CEO or Chairman suggests that
activists have high level of influence on the company. The share of Board changes is calculated
as a ratio of new directors relative to the overall number of directors in the Board. The higher the
indicator the more influence activists have in the Board and on the company overall.
Figure 18 shows the relationship of the first indicator (change of CEO or Chairman) with
the change of CEO, change of Chairman, and any Board change. These indicators represent the
percentage of changes in our sample according to a particular type of investor.
According to figure 18 we can infer several observations. First, PE and HF activists tend
to pursue the change of Chairman with a similar probability – in our sample they make the
change in slightly more than 20% of the deals.
Second, HF investors are much more likely to change CEO of a target company than PE
investors.
45
Figure 18 Governance engineering
70.0%
60.0%
50.0%
40.0%
PE
HF
30.0%
20.0%
10.0%
0.0%
Chairman
CEO
Chairman or CEO
Board change
Third, the difference is even bigger regarding the change of Chairman or CEO. The
increase in difference means that HF activists have more cases of unique changes of CEO or
Chairman (i.e. when they change only one of the top executives) relative to PE investors. Fourth,
the overall probability of changes in the Board of directors (not necessarily CEO or Chairman) is
similar for both groups of investors – they tend to conduct the changes in governance in 70% of
cases, according to our data.
Figure 19 The share of Board changes
40.0%
30.0%
20.0%
37.5%
26.7%
PE
HF
10.0%
0.0%
46
Figure 19 demonstrates the median values of the shares of Board changes of PE and HF
investors. It shows that HF tend to change slightly more than 1/3 of the Board after committing
their investments and PE investors – approximately 1/4 of the total number of directors.
3.4.2 Regression analysis – best activism strategies
We begin our regression analysis with building a base model. Our base model consists of
two variables – natural logarithms of market value and average total assets of the company.
Table 6 Base regression model - model summary
Model
1
R
,789a
R Square
,622
Adjusted R
Square
,620
Std. Error of
the Estimate
,606
a. Predictors: (Constant), Ln_ATA, Ln_MV
Table 7 Base regression model - coefficients
Model
1
(Constant)
Unstandardized Coefficients
B
Std. Error
1,193
,103
Standardized
Coefficients
Beta
t
11,610
Sig.
,000
Ln_MV
,724
,033
1,514
21,853
,000
Ln_ATA
-,667
,033
-1,388
-20,031
,000
Dependent Variable: Q
The base model is statistically significant (table 7) and helps explain slightly more than
60% of the variability in the dependent variable – Tobin’s Q (table 6).
We proceed with the addition of independent variables, the effects of which we aim to
investigate. In our first model we include all the examined variables.
The results of regression analysis of the first model are presented in tables 8 and 9. The
model explains approximately 76% of the variability of Tobin’s Q.
Table 8 Regression model I – model summary
47
Model
1
R
Adjusted R
Square
R Square
a
,874
,764
Std. Error of the
Estimate
,753
,444
a. Predictors: (Constant), Cash/ATA, CEO/Chairman, Ln_ATA, EV/Rev, Div/Cash,
Type of fund, Leverage, ROA, Governance change, Ln_MV
Table 9 Regression model I – coefficients
Unstandardized Coefficients
Model
1
B
(Constant)
Std. Error
1,181
,112
Ln_MV
,677
,036
Ln_ATA
-,663
Type of fund
Standardized
Coefficients
Beta
t
Sig.
10,555
,000
1,382
18,885
,000
,034
-1,415
-19,711
,000
-,009
,064
-,005
-,140
,889
Leverage
,031
,010
,113
3,116
,002
ROA
,147
,243
,023
,607
,544
EV/Rev
,051
,007
,294
7,685
,000
Share of Board
change
-,046
,126
-,017
-,369
,712
CEO/Chairman
,149
,083
,084
1,801
,073
Div/Cash
,092
4,673
,001
,020
,984
Cash/ATA
-,540
,228
-,082
-2,371
,019
Dependent Variable: Q
Based on the regression analysis of the first model, we can make the following
conclusions about the factors influencing our dependent variables. First, ROA, the share of
Board change, and the level of dividends relative to cash are statistically insignificant in
determination of Tobin’s Q coefficient. It means that the corresponding initiatives do not have a
strong influence on the value in target companies. Second, the value created in the companies is
not determined by the type of investor. Rather it is determined by a particular strategy pursued by
the investor. Third, leverage, change of CEO or Chairman, the ratio of enterprise-value-to48
revenue, and the ratio of cash-to-assets are significant factors in determining the value in target
companies for all activists in our sample.
In an effort of achieving more accuracy in evaluation of the effects of our examined
variables, we build the second regression model, from which we exclude insignificant variables.
We deliberately not exclude the ROA indicator to track whether operational engineering do not
influence the value for both groups of investors in our subsequent analysis.
The results of the regression model II are presented in tables 10 and 11.
Table 10 Regression model II – model summary
Model
R
a
,873
R Square
,763
Adjusted R
Square
,756
Std. Error of the
Estimate
,873a
,455
a. Predictors: (Constant), Cash/ATA, Leverage, ROA, CEO/Chairman, EV/Rev,
Ln_ATA, Ln_MV
Table 11 Regression model II – coefficients
Unstandardized Coefficients
Model
1
B
(Constant)
Std. Error
1,119
,100
Ln_MV
,685
,033
Ln_ATA
-,648
Leverage
Standardized
Coefficients
Beta
t
Sig.
11,181
,000
1,472
20,511
,000
,032
-1,371
-19,968
,000
,028
,010
,092
2,710
,007
ROA
,110
,231
,017
,477
,634
EV/Rev
,052
,007
,281
7,866
,000
CEO/Chairman
,074
,059
,040
1,262
,208
-,646
,226
-,095
-2,856
,005
Cash/ATA
Dependent Variable: Q
49
We can observe that after excluding insignificant variables (except for ROA), change of
CEO or Chairman becomes much more insignificant. We will further investigate the effects of
this initiative from the perspective of PE and HF investors.
Now we can more accurately evaluate the effects of the examined variables on the value
creation in target companies.
Considering the level of influence on the value creation, our regression analysis suggests
the following inferences regarding activism of both PE and HF investors. First, the decrease in
the share of cash relative to assets has the strongest value creation effect. Second, strategic
engineering expressed by EV/Revenue multiple has the most statistically significant impact,
though the level of influence is lower. Third, value creation is significantly dependent from
leverage in target companies, though its effect is lower than from previous initiatives.
3.4.3 Regression analysis – best PE strategies
Next we proceed with the regression analysis of model II with the consideration of only
PE group of investors. In doing so, we aim at identifying the best value creation strategies for PE
activists in emerging markets.
The results of the model are presented in tables 12 and 13. According to the results, our
model explains approximately 70% of the variability of Tobin’s Q for PE investors.
Table 12 PE adjusted regression model II – model summary
R
Model
,840a
Type of fund =
0 (Selected)
,706
R Square
,685
Adjusted R
Square
,475
Std. Error of
the Estimate
,840a
a. Predictors: (Constant), Cash/ATA, CEO/Chairman, EV/Rev, Leverage, ROA, Ln_ATA,
Ln_MV
Based on the analysis (table 13) we can provide the following conclusions. First, decrease
in levels of cash is a very significant and powerful source of value creation for PE investors in
emerging markets. Second, leverage appears to be the second strongest instrument of value
creation for this type of investors.
Table 13 PE adjusted regression model II – coefficients
50
Unstandardized Coefficients
Model
1
B
(Constant)
Std. Error
1,207
,134
Ln_MV
,660
,052
Ln_ATA
-,609
Leverage
Standardized
Coefficients
Beta
t
Sig.
9,023
,000
1,822
12,691
,000
,050
-1,701
-12,106
,000
,042
,017
,171
2,512
,014
ROA
,434
,357
,084
1,216
,227
EV/Rev
,036
,013
,180
2,810
,006
-,031
,112
-,017
-,279
,781
-1,336
,443
-,196
-3,014
,003
CEO/Chairman
Cash/ATA
Dependent Variable: Q
Selecting only cases for which Type of fund = 0
Third, strategic repositioning is a significant, though slightly less influencing source of
value. Fourth, while operational improvements can bring much value for target companies, it is
still statistically insignificant meaning that this kind of initiatives has high probability of not
impacting the value. In practice, it suggests that only a limited number of PE investors have the
ability to accrue value through operational improvements in emerging markets. Finally,
according to the data, changes of CEO or Chairman by PE activists do not create value for their
target companies.
3.4.4 Regression analysis – best HF strategies
The last part of the regression analysis is dedicated to the investigation of the best HF
activism strategies. The results are shown in Tables 14 and 15. According to the data, we can
state that predictability of our model is much higher for HF group of investors (approximately
90%).
Based on the regression analysis (table 15) we can provide the following conclusions
regarding the activism of HF institutional investors in the context of emerging markets. First,
reduction of cash levels relative to assets remains the strongest source of value in case of HF
activists, though much lower than for PE investors.
51
Table 14 HF adjusted regression model II – model summary
R
Model
Type of fund =
1 (Selected)
R Square
a
1
,904
Adjusted R
Square
,816
Std. Error of
the Estimate
,807
,428
a. Predictors: (Constant), Cash/ATA, Ln_MV, CEO/Chairman, Leverage, EV/Rev,
ROA, Ln_ATA
Second, change of CEO or Chairman represents a strong source of value creation for HF.
It suggests that HF investors could have more solid skills in identifying the targets where top
executives should be removed and/or placing the best candidates for one of executive positions.
Third, strategic engineering is even more influencing and significant value creation instrument
for HF activists than for those of PE funds. Fourth, contrary to PE investors, HF overall are not
able to create value for their targets through increase in leverage. This suggests that HF could
lack the skills necessary for extracting the value in leveraging their targets, which PE investors
possess.
Table 15 HF adjusted regression model II – coefficients
Unstandardized Coefficients
Model
1
B
(Constant)
Std. Error
1,074
,160
Ln_MV
,670
,045
Ln_ATA
-,642
Leverage
Standardized
Coefficients
Beta
t
Sig.
6,710
,000
1,147
15,032
,000
,045
-1,043
-14,177
,000
,012
,014
,033
,856
,393
-,289
,317
-,037
-,913
,363
EV/Rev
,058
,008
,329
7,712
,000
CEO/Chairman
,167
,075
,085
2,222
,028
-,571
,279
-,084
-2,046
,043
ROA
Cash/ATA
Dependent Variable: Q
Selecting only cases for which Type of fund = 1
52
4. Discussion
4.1 Results
First, the overall effect on value gains within the timeframe of five years is similar for
both groups of activists. However, our results suggest that in the context of emerging markets HF
investors have higher probability for creating value for target firms than PE investors. These
results contradict the outcomes of the investigation of activism in the context of Germany
(Meitzner, Schweiser, 2013), where PE investors tend to outperform HF activists. This suggests
that the context plays an important role in the effects of activism. One playground can be more
suitable for PE investors where they can elaborate their strongest capabilities and another one –
for HF activists.
Second, our results prove a common point of view regarding the investment horizons of
HF and PE funds active investors: HF tend to have more short-term focus, while PE investors are
more shifted toward long-term value gains. The results are largely correlated with the outcomes
of previous studies stressing a common perception about the structural features of these two
types of investment vehicles and the mechanisms of their functioning. In addition, a sharp shortterm increase and subsequent decrease in Tobin’s Q of HF activist targets suggest that HF in
emerging markets could potentially be short-sighted making changes that are profitable in a
short-run but detrimental in the long-run. Furthermore, HF tend to be more skewed toward
manipulation of dividends in their target companies than PE investors. There are two potential
explanations for the phenomenon. First, it could reflect the shareholder value creation purposes
of HF investors. Second, it could be a sign that HF use dividends as an instrument for enhancing
the returns on their investments. Indeed, we find out that this measure does not create significant
value for target companies. Moreover, HF tend to squeeze the most of the cash out of their
targets during the first year. These facts provide an additional evidence for the support of the
myopic-activism claim of HF activism in the context of emerging markets. Thus, while HF
myopic-activism claim did not gain an empirical support in such developed markets as the U.S.
(Bebchuk et al, 2015), our results suggest that this claim can have an effect in emerging markets.
Third, there are two principal strategies that work well regardless the type of activist
entering the company in emerging markets. Our findings suggest that value creation effects are
more dependent from such initiatives as strategic repositioning, increase in leverage and decrease
in the levels of cash rather than from operational improvements or governance engineering.
54
Meanwhile, only strategic repositioning and the decrease in levels of cash represent significant
sources of value irrespective to a particular type of institutional investor.
Strong value creation effects from cash reductions mean that companies from emerging
markets usually have high levels of excess cash that do not necessarily contribute to their healthy
functioning. With the background of weak effects from the increase in dividend payments, it
suggests that activist investors are able to gain more value by allocating this excess cash to
valuable projects rather than distributing to the shareholders in the form of dividends. It is
reasonable for emerging markets where the very economic growth provides strong perspectives
for the companies to gain value, especially in the context of Asian nations, which represent the
majority of the countries in our sample. The latter fact also means that excess cash has high
opportunity costs in the context that we investigate. Therefore, by addressing the excess cash
issues in target companies, activists can virtually create much value in emerging markets. Thus,
the reduction of levels of cash relative to assets brings the biggest value for institutional activists
in the context of emerging economies. This finding correlates with the outcomes of the study of
activism conducted in Japan (Hamao et al, 2011).
Strategic repositioning represents another big source of value for activists in emerging
countries. This type of engineering includes but not limited to such initiatives as product
portfolio differentiation or consolidation, market expansion or penetration, and distribution
channels switching or optimization. In the context of dynamic development of the markets and
environmental shifts building strong capabilities in such initiatives can be particularly valuable
for companies. It is worth to highlight that the value creation effects from operational
improvements are not significant for both types of activists. It suggests that in emerging markets
the focus of changes on internal side of the business itself cannot be a sustainable source of
value.
Fourth, there are some fundamental differences in strategies that can bring the value for
HF and PE activists. PE investors are able to create value by leveraging their target companies.
With a long-time experience in leveraged buyouts (LBOs), this type of activists has strong skills
necessary to extract value from leverage instrument. In contrast, HF investors tend to decrease
rather than increase the leverage in their target companies and fail to provide a sound track
record in creating value from leverage. Based on our results, we can state that the sharp increase
in leverage in the fifth year have no value creation effects for target companies backed by HF
activists. This could suggest that the companies become too leveraged and their risks profiles
change significantly posing downward pressure on their attractiveness for the market.
55
HF activists are able to bring the value to their target firms by conducting governance
engineering, in particular, changing CEO or Chairman. This type of investors is capable in
identifying top managers that have to be changed and/or the candidates that can enhance the
performance of their targets. In contrast, PE activists fail to provide significant value creation
effects from this type of changes. A possible explanation for this phenomenon could be the fact
that usually PE investors nominate representatives of their funds on executive positions in target
firms rather than outside professionals, who indeed could have stronger company-specific
competencies and be more suitable for such roles.
4.2 Managerial implications
Our findings have a broad range of managerial implications that boil down to the
following.
First, it provides a certain direction for initiatives that have high potential for value gains
in emerging markets. These findings are applicable not only to institutional investors, but also to
shareholders, on behalf of whom they act, and managers, who bring their changes into reality.
Second, our study contributes to the body of knowledge about active investors and allows
managers to better understand and distinguish the needs, competencies and behavior of potential
owners who seek influence over their companies.
Third, anticipating the agenda of a particular type of activist investor helps mangers to
better mitigate the risks of activism and ultimately avoid intervention in case of potential
undesirable results for the company.
4.3 Limitations
Our findings should be carefully considered due to a number of topic-specific and
methodology-specific limitations.
First, there are certain constraints to the ability of researchers to track activism per se. In
our paper we assumed based on characteristics of investors that the changes that were happening
after their interventions were induced and connected to their activities. While it is a logical
premise, there is no guarantee for other factors to not have the effects correlated with activism.
56
Second, due to the natural constraints of availability of data, our sample includes a
limited number of deals from emerging markets. For the same reasons, our sample is skewed
toward the Asian region.
Third, the evaluation of strategies that we investigate in our research is based on certain
indicators. While we consider these indicators instrumental for the purposes of our study, they
have certain natural limitations in fully encompassing the concepts of strategies being explored.
As such, it is useful to conceive our findings with a clear understanding of the indicators that are
used to derive the outcomes.
4.4 Suggested directions for further research
Further research could contribute to our study in three fundamental ways.
First, the validity of our results could be improved by increasing the number of deals in
our sample, in particular, the deals from the emerging markets, which are not presented or
presented weakly.
Second, our research could be deepen by investigating lower levels of initiatives that
contribute to the value creation in target companies. We explored the effects of the four
fundamental types of engineering – strategic, financial, operational, and governance – in
activism. Going further, it will be useful to know what specific measures contribute to the
influence of the strategies that we studied and how they differentiate between HF and PE
activists.
Third, as the phenomenon of institutional investors activism is relatively new in the
context of emerging markets and is highly dynamic, further studies of the evolution of activism
over time could strongly contribute to the research that we conducted. In particular, it will be
useful to observe the dynamic of capabilities of HF and PE activists and understand how this
development influences the value creation effects in target companies.
57
Conclusion
This paper analyzes the value creation effects of institutional investor activism on
companies from emerging markets. Our paper contributes to the study of the phenomenon of
activism in a sense that it investigates and compares the impact of two most active types of
investors in a special geographic context. We provide several important findings.
First, there is no statistically significant difference in the levels of value created in target
companies between HF and PE investors. The overall effect on value gains within the timeframe
of five years is similar for both groups.
Second, PE funds tend to create most of the value in the long-term while HF activists
gain the biggest value during the first two years. In addition, our research highlights that there
are signs of short-term gains at the expense of a long-term value in case of HF activists. Their
value tends to be not sustainable.
Third, there are two principal strategies that work well for both types of investors in
emerging markets. Reduction of levels of cash relative to assets brings the biggest value for
institutional activists in the context of emerging economies. Apart from the distribution of cash
through stock repurchases, our results suggest that activists tend to invest excess cash into
valuable projects rather than distributing it to shareholders in the form of dividends. Strategic
repositioning represents another big source of value for activists in emerging countries.
Fourth, there are some fundamental differences in strategies that can bring the value for
HF and PE activists.
PE investors are able to create value by leveraging their target companies. This type of
activists has strong skills necessary to extract value from leverage instrument. In contrast, HF
investors fail to provide a sound track record in creating value from leverage.
HF activists are able to bring the value to their target firms by conducting governance
engineering, in particular, changing CEO or Chairman. This type of investors, in contrast to PE
activists, is capable in identifying top managers that have to be changed and/or the candidates
that can enhance the performance of their targets.
Finally, the value creation effects from operational improvements are not significant for
both types of activists. It suggests that in emerging markets the focus of changes on internal side
of the business itself cannot be a sustainable source of value.
58
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61
Appendix 1. List of PE deals
Table 16 List of PE deals
Acquirer Name
Target Name
Gozde Girisim Sermayesi
Yatirim Ortakligi AS
Tano India Private Equity
Fund II
Tencent Industry
Investment Fund Co Ltd
Ripplewood Holdings
LLC
Makina Takim Endustrisi
AS
Safari Industries(India)Ltd
HB Investment Inc
Hony(Shanghai)Equity
Investment Fund
Center(LP)
Lone Star Funds
Ventura Capital Privado
SA de CV
TMG Servicos de Gestao
Ltda
TPG Capital LP
Petra Capital Management
Inc
Nalanda Capital Pte Ltd
Corner Stone Global
Investment Co Ltd
Universe Capital Partners
LLC
K3 Samho Private Equity
Co Ltd
KIG Inc
Gozde Girisim Sermayesi
Yatirim Ortakligi AS
Universe Capital Partners
LLC
Alkor Trade Sp zoo
Northstar Equity Partners
Gozde Finansal Hizmetler
AS
Trinugraha Capital & Co
SCA
Target
Nation
Turkey
Target Industry
Year
Machinery
2014
India
Textiles & Apparel
2014
NavInfo Co Ltd
China
Aerospace & Defense
2014
Sixth of October
Development & Investment
Co SAE
Woori Technology Inc
Egypt
Other Real Estate
2014
South
Korea
China
Other Industrials
2014
Water and Waste
Management
2014
Globe Trade Centre SA
Maxcom
Telecomunicaciones SAB
de CV
Biomm SA
Poland
Mexico
Other Real Estate
Telecommunications
Services
2013
2013
Brazil
Biotechnology
2013
Xinyuan Real Estate Co Ltd
Daechang Forging Co Ltd
China
South
Korea
India
South
Korea
Turkey
Other Real Estate
Metals & Mining
2013
2013
Other Industrials
IT Consulting &
Services
Automobiles &
Components
Electronics
2013
2013
Electronics
2012
Machinery
2012
Turkey
Home Furnishings
2012
Poland
Indonesia
2012
2011
Turkey
Software
Automobiles &
Components
REITs
Indonesia
Credit Institutions
2011
Shanghai Chengtou
Holding Co Ltd
NRB Bearings Ltd
Signal Information &
Communication Corp
Transturk Holding AS
Humax Co Ltd
InnoChips Technology Co
Ltd
Makina Takim Endustrisi
AS
IDAS Istanbul Doseme
Sanayii AS
Finhouse SA
PT Multistrada Arah Sarana
Tbk
Saglam Gayrimenkul
Yatirim Ortakligi AS
BFI Finance Indonesia Tbk
PT
South
Korea
South
Korea
Turkey
2012
2012
2011
Table 12 List of PE deals (continued)
62
Milestone Longcheng Ltd
Acacia Partners LP
Kofc Skylake Groschamp
2010 No.4 Private Equity
Inc
SEAVI Advent Private
Equity
Job Creation Industrial
Investment Private Equity
Inc
Volga Resources SICAVSIF SA
HTIC-M&A Investment
Partner
KTIC Global Investment
Advisory Co Ltd
Silver Lake Management
LLC
Actis Capital
Quilvest SA
Gavea Investimentos Ltda
China BCT Pharmacy
Group Inc
Net 4 India Ltd
China
Other Retailing
2011
India
2011
SCD Co Ltd
South
Korea
Internet Software &
Services
Electronics
Hu An Cable Holdings Ltd
China
Metals & Mining
2010
Moreens Co Ltd
South
Korea
Electronics
2010
NOVATEK OAO
Russia
Oil & Gas
2010
Clunet Co Ltd
South
Korea
South
Korea
China
IT Consulting &
Services
Software
2010
Semiconductors
2010
Egypt
Banks
2009
Chile
Brazil
Banks
Discount and
Department Store
Retailing
Healthcare
Equipment &
Supplies
Other Industrials
Banks
2009
2008
Barunson Games Corp
Spreadtrum
Communications Inc
Commercial International
Bank Egypt SAE
Grupo Security SA
Lojas Americanas SA
Warburg Pincus LLC
WuXi
PharmaTech(Cayman)Inc
China
Lombard Investments Inc
Brysam Global Partners
San Shing Fastech Corp
Bank Vozrozhdenie PAO
Taiwan
Russia
2010
2010
2008
2008
2008
63
Appendix 2. List of HF deals
Table 17 List of HF deals
Acquirer Name
Target Name
Han Bat Consulitng Co
Ltd
Kwang Hee Development
Oriented
SelfAdministered REIT
Dong A Hwa Sung Co
Ltd
Service&Quality
Technology Co Ltd
Bioland Ltd
Caymus One Ltd
Yueh Feng Investment Ltd
Paratus the 1st Special
Purpose Co LLC
Shenzhen Qianhai
Hongshan Guangming
Investment Management
Centre(LP)
Jiangxi Yonglian
Investment Co Ltd
K Global Partners No 1
Co Ltd
Kyungnam BV
Shenzhen Jinzhi
Changshun Investment
Development Co Ltd
Alpa Craft Ltd
Tsai Chin Investment Co
Ltd
Happy Tomorrow 10th Co
Ltd
Seneal International
Agency Ltd
Shanghai Kainan
Investment Development
Co Ltd
Jiangyin Hanying
Investment Co Ltd
Tsan Kun Investment Co
Ltd
Wuhan Dangdai
Technology Industry
Group Co Ltd
Target
Nation
South Korea
Target Industry
Year
REITs
2014
South Korea
Other Consumer
Products
Semiconductors
2014
Other Consumer
Products
Healthcare
Equipment &
Supplies
2014
Agriculture &
Livestock
Building/Constructio
n & Engineering
2014
Taiwan
South Korea
2014
Jiangsu Yuyue Medical
Equipment&Supply Co
Ltd
China
Jiangxi Zhengbang
Technology Co Ltd
Kolon Global Corp
China
Kyungnam Energy Co
Ltd
Yantai Xinchao Industry
Co Ltd
South Korea
Oil & Gas
2014
China
Other Real Estate
2014
Alphachips Corp
South Korea
2014
Right Way Industrial Co
Ltd
Doosan Engineering &
Construction Co Ltd
Exillon Energy PLC
Taiwan
Russia
IT Consulting &
Services
Automobiles &
Components
Transportation &
Infrastructure
Oil & Gas
Shanghai Xinmei Real
Estate Co Ltd
China
Other Real Estate
2013
Jiangsu Chengxing
Phosph- Chemicals Co
Ltd
Star Comgistic Capital
Co Ltd
Wuhan Sante Cableways
Group Co Ltd
China
Chemicals
2013
Taiwan
Other Industrials
2013
China
Transportation &
Infrastructure
2013
South Korea
South Korea
2014
2014
2014
2013
2013
Table 13 List of HF deals (continued)
64
Merit Alliance Investment
Ltd
Nara ACE Holdings Co
Ltd
G Tree No 1 Corp
B&F Holdings Co Ltd
Advanced Power
Electronics Corp
KIC Ltd
Taiwan
Semiconductors
2013
South Korea
Machinery
2013
Digital Aria Co Ltd
Curoholdings Co Ltd
South Korea
South Korea
Software
Food and Beverage
2013
2013
Fleur Growth Fund Ltd
China Gaoxian Fibre
Fabric Holdings Ltd
Guangdong Xinhui
Meida Nylon Co Ltd
Yantai Xinchao Industry
Co Ltd
China
Textiles & Apparel
2013
China
Textiles & Apparel
2013
China
Other Real Estate
2013
GornoMetallurgicheskaia
Kompaniia Noril"skii
Nikel" PAO
NARA KIC Inc
Russia
Metals & Mining
2013
South Korea
Machinery
2013
STCube Inc
South Korea
Other Industrials
2013
Lifestyle Global
Enterprise Inc
Xinjiang Chalkis Co Ltd
Taiwan
Home Furnishings
2013
China
Food and Beverage
2013
Polyvision Co Ltd
South Korea
Textiles & Apparel
2013
Kanglim Co Ltd
Skynewpharm Co Ltd
South Korea
South Korea
Machinery
Pharmaceuticals
2012
2012
YNK Korea Inc
South Korea
Software
2012
SUNDOSOFT Inc
Daesung Energy Co Ltd
South Korea
South Korea
Software
Oil & Gas
2012
2011
New Delhi Television Ltd
Timo Technology Co Ltd
India
South Korea
2011
2011
ATPK Resources Tbk PT
Genebiotech Co Ltd
Indonesia
South Korea
Broadcasting
Telecommunications
Equipment
Metals & Mining
Biotechnology
OAO Aptechnaya set
36,6
Russia
Other Retailing
2011
Indonesia
Broadcasting
2011
Jiangmen Tianchang
Investment Co Ltd
Beijing Guangtongchuan
Investment Management
Co Ltd
Crispian Investments Ltd
Nara ACE Holdings Co
Ltd
Bio Science Holdings Co
Ltd
Lifestyle Universal Pte
Ltd
Xinjiang Wujiaqu City
Construction Investment&
Operation Co Ltd
Double U Global
Investment Co Ltd
Callas Holdings Co Ltd
Saebyeok No 1 Investment
Combination
Naeway Asset Investment
Co Ltd
Soma Gross Co Ltd
Daesung Value Investment
Co Ltd
Oswal Greentech Ltd
DE & M Investment No 1
Co Ltd
Trillion Markets Ltd
Hyundai-Dongyang Agrifood Co Ltd
Hybrid Investments
Capital Corp
2011
2011
Table 13 List of HF deals (continued)
Adikarsa Sarana PT
Elang Mahkota Teknologi
Tbk PT
65
FNT Co Ltd
GoodWin Investment Pte
Ltd
Neptune Inc
Golden Zaga Indonesia PT
Bondholders
Two Rivers Pacific
Holdings Corp
Fujian Yili Investment
Development Co Ltd
Investa Dharma Putera PT
Poongsan Microtec Corp
Resource Alam Indonesia
Tbk PT
Celltrion Pharm Inc
Gozco Plantations Tbk
PT
Mobile-8 Telecom Tbk
PT
Philex Mining Corp
South Korea
Indonesia
Semiconductors
Metals & Mining
2011
2010
South Korea
Indonesia
2010
2010
Indonesia
Pharmaceuticals
Paper & Forest
Products
Wireless
Philippines
Metals & Mining
2009
Fujian Sunshine
Industrial Development
Co Ltd
Humpuss Intermoda
Transportasi Tbk PT
China
Other Real Estate
2009
Indonesia
Transportation &
Infrastructure
2008
2009
66
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