The Impact of Hedge Funds on Corporate Governance System

Abstract

Hedge funds do not often remain passive arm’s length investors and try to make substantial changes to firms’ business strategies and financial policies. For instance, in January 2005 the Anglo-Saxon hedge funds TCI and Atticus attacked the German security exchange firm Deutsche Börse arguing that management was not putting sufficient effort into creating shareholder value. As a result of this interference, the Deutsche Börse made important changes to its corporate governance as well as to its financing and investment policies. This example suggests that the increased activism by hedge funds can change the balance of power between managers and shareholders and therefore has significant implications for corporate governance. This growing influence of hedge funds in corporate governance raises some interesting questions. Most importantly, does this new form of shareholder activism make corporate governance more efficient? From an economic point of view, this is the case if hedge funds promote more efficient investment and financing decisions leading to a more efficient allocation of capital. For instance, the campaign by TCI and Atticus against the Deutsche Börse led to a substantial outperformance of its share price between the beginning of the activist campaign and the end of 2007. However, over the longer run the Deutsche Börse’s performance deteriorated when its share price suffered substantial losses during the recent subprime crisis. This raises the question of whether hedge funds really increase shareholder value or whether short-term increases in share prices reflect other effects. For instance, short-term increases in share prices might also be the result of wealth transfers from debtholders or from long-term shareholders.