We investigate the valuation effects of German firms targeted by hedge funds and by private equity investors. We argue that both types of investors differ from other blockholders by their strong motivation and ability to actively engage and reduce agency costs. Consequently, we find positive abnormal returns following a change in ownership structure. However, these effects differ markedly between both investors, as proxy variables for agency costs only explain the market reaction for our private equity subsample. We conclude that private equity funds seem to be more successful at creating shareholder value, which could be due to their longer-term perspective and a higher adaptability to the surrounding corporate governance system.
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A large shareholder (blockholder) is defined as an entity that owns at least 5% of a firm’s outstanding shares.
For an overview, see, e.g., Shleifer and Vishny (1997).
Furthermore, almost every hedge fund employs a high watermark, meaning the manager does not earn the performance fee unless the fund value exceeds the previously achieved high value.
Hedge fund managers are among the most highly compensated people in the world. Annual compensation of more than $100 million is not uncommon. In 2005, the top 25 hedge fund managers each made more than $130 million. In 2006, James Simons, the founder of Renaissance Technologies, earned $1.7 billion. The carry is a high incentive for private equity managers and can be above $100 million per year. In comparison, in 2006, Stephen A. Schwarzman, chairman, CEO, and cofounder of The Blackstone Group, a leading investment and advisory firm, earned about $400 million.
As a robustness check, we investigate whether our results are affected by the choice of data source. We find that the results remain quantitatively and qualitatively similar when we use market data directly from the German Stock Exchange (Deutsche Börse Group). Tables are available from the authors upon request.
The CDAX® index is based on all German companies listed in the Prime and General Standard segments.
Although the BaFin database dates from 1995, we were unable to identify a hedge fund deal before 2001.
Note that our private equity subsample contains more manufacturing firms, but hedge fund activism is clustered in the service industry. The difference might be enough to cause a sample bias, and could drive our valuation effects of hedge fund and private equity block purchases. To counter this potential sample bias, we construct two subsamples for the different acquirers (manufacturing versus non-manufacturing for private equity transactions, and services versus non-services for hedge fund targets). We then compare their mean and median abnormal returns. We detect no statistically significantly different market reactions to either private equity or hedge fund targets in different industries. Thus, we believe our results are not affected by an industry sample bias. Tables are available from the authors upon request. We thank the referee for this important point.
For robustness, we controlled for whether the results of the event study were affected by these events. We found that our results remained stable. Tables are available from the authors upon request.
Low trading volume might influence the estimation of the systematic risk factor βi. Therefore, we re-estimate the abnormal returns for our time intervals using a mean-adjusted return model as proposed by Brown and Warner (1985). Our results remain robust. We also calculate cumulative abnormal trading volumes for the different time intervals using the mean-adjusted event study approach described above to control for volume-induced stock price increases.
In unreported tables, we use variance decomposition according to Belsley et al. (1980) to detect collinearity problems. We found no multicollinearity. In addition, the maximum variance inflation factors (VIF) are reported in our cross-sectional regression tables.
Note that we cannot compare shorter event windows because of the distortion from the acquisition disclosures of at least 5% of the voting rights in publicly listed companies within the BaFin database. As we noted earlier, funds are obligated to report block acquisitions no later than 9 days after they have reached or exceeded a 5% level (in January 2007, the minimum threshold was lowered to 3%).
In robustness checks, we also perform a regression analysis using cash over year-end market capitalization as an additional proxy for free cash flow. However, the number of observations in our cross-sectional analysis becomes too small for a satisfactory analysis. Tables are available from the authors upon request.
Means may be influenced by single observations, i.e., outliers. Therefore, we pay more attention to medians.
The results remain stable when we control for time effects. However, the BHARs are less negative for the 2005–2007 period.
Note that two J-curves exist. The fund’s J-curve has already been discussed. The target’s J-curve results from underperformance in the first years after the acquisition that may result from, e.g., restructuring. The subsequent outperformance is based primarily on increased efficiency from the restructuring.
The major shareholders of German firms are other corporations, insurance companies, and individuals, not strictly profit-oriented banks (Hackethal et al. 2006). On 14 July 2000, the capital gains tax on sales of large stakes held by corporations was abolished, making it attractive for corporations to sell their blocks. Ownership concentration dispersed, which should favor the business models of active investors. However, and regardless of other blockholders, active shareholders are required to align their interests with those of the advisory board.
Note that small shareholders are not part of what Schmidt (2004) calls the “governing coalition.”
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We are indebted to the referee and the editor for their efforts to improve the paper. We would like to thank Yakov Amihud, Andreas Hackethal, Dieter G. Kaiser, Lutz Johanning, Rainer Lauterbach, April Klein, Christian Koziol, Robert M. Mooradian, Juliane Proelss, Dirk Schiereck, Marcel Tyrell, and Urs Wälchli as well as the participants of the Eastern Finance Association 44th Annual Meeting, Academy of Economics and Finance (35th Annual Meeting), Midwest Finance Association (57th Annual Meeting), European Conference of the Financial Management Association International (12th Annual Meeting), European Financial Management Association (17th Annual Meeting), Financial Management Association (Annual Meeting 2008), Campus for Finance 2009, for helpful comments and suggestions. All remaining errors are our own.
Appendix: variable definitions and descriptive statistics for target characteristics
Appendix: variable definitions and descriptive statistics for target characteristics
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Mietzner, M., Schweizer, D. Hedge funds versus private equity funds as shareholder activists in Germany — differences in value creation. J Econ Finan 38, 181–208 (2014). https://doi.org/10.1007/s12197-011-9203-x
- Abnormal Returns
- Corporate Governance
- Hedge Funds
- Private Equity
- Shareholder Activism