It looks as if hedge fund activists engineer not just a short-term pop in target firms’ stock prices but also long-term improvements in innovation.
“The output from innovation — patent quality and quantity — tend to improve. These improvements are concentrated in areas that are central to the firms’ business and technological expertise,” Alon Brav and Song Ma of Duke University, Wei Jiang of Columbia University and Xuan Tian of Indiana University write in a new working paper based on their research. “Thus, our evidence suggests that firms become ‘leaner’ but not ‘weaker’ subsequent to hedge fund interventions.”
The study looked at the money spent on R&D and the number of patents filed and how often they were cited — both before and after the interventions. Spending on R&D drops significantly in the five years after an activist event but most of the measures of quality and quantity of output improve “significantly,” implying that firms that activists are targeting get better and more focused at allocating assets to their core competencies.
This undermines the argument that activists are swashbuckling raiders who leave smoking and disabled ruins in their wake, but does it imply that this is actually the doing of the hedge funds involved?
It looks as if better husbanding of resources is central to the improvements. The patents taken out by the firms increase in number and are cited more often, and much of the improvement is found in areas of technology that are central to the firms’ core capabilities. In other words, it looks as if firms were prospecting in new areas, and not always successfully, before the arrival of an activist investor.
This is also shown in the fact that following an activist campaign, firms sell an unusual number of existing patents. Not only that, but the patents they sell then go on to get cited more when they belong to their new owners. This implies not just that the capital gained by selling the patents may be better deployed by the firms doing the selling, but that the firms doing the buying are able to make better use of the intellectual property, perhaps because it is in an area in which they are themselves more vital and competitive.
This improvement extends beyond a company’s patent bank to the productivity of inventors — both those who stay at the firm and those who find another employer.
Again, improvements in outcome are all round, not just at the target firm. The hedge funds could be genius at picking companies that are ripe to do this on their own, but the research shows that the activism contributes.