Hedge fund activism is essentially a search by funds for investment returns by putting pressure on target firms to change their corporate governance. It began in the USA in the 1980s, spread to Europe and Asia in the following decades, and is increasingly seen as a global phenomenon. Although described by critics as a form of ‘extortion’, it has found support from a series of empirical papers identifying positive impacts of interventions on the performance of target companies in the US context (see also here, here and here).
In a recent paper we investigate whether activist hedge fund interventions in Japan produced similarly positive and enduring outcomes to interventions in the USA. We benchmarked the success of interventions using indicators measuring management effectiveness, managerial decisions, labour management, and market perceptions. To do this we built a dataset of interventions in 117 Japanese companies targeted by 17 hedge funds considered to have an activist agenda at the end of 2007. We compared the experience of these targets to those of comparable Japanese firms at three points in time, around 2007 then at one and three years after that.
We defined our outcome variables as follows. ‘Managerial effectiveness’ was measured by reference to return on assets and return on equity. For ‘managerial decision making’ we looked at the ratio of dividends to total assets, leverage, the ratio of cash to total assets, and the ratio of capital expenditure to total assets. ‘Labour management’ was assessed by changes in labour productivity and wage intensity. Finally, market perception was measured by the log of market capitalisation and by Tobin’s Q.
One year on from the initial interventions, there was no significant effect on management effectiveness, as we have defined it. The most notable change was in management decisions on dividend policy: the ratio of dividends to total assets had increased significantly, as might be expected from pressure on companies to increase payments to shareholders. Leverage rose slightly, which supports a picture of management raising gearing and increasing payouts. Labour management issues were in line with the situation at the matched samples, with no significant divergence. However, the reaction of the market, as evidenced by movement in Tobin’s Q, was unfavourable.
After three years, there had been a detrimental change in management effectiveness: the targeted companies were now slightly underperforming the matched samples. In terms of managerial decisions, our chosen indicators were not significantly different from those of the matched samples, with the increase in dividend payments no longer significant. Interventions appeared to have had no effect on wages and productivity. Market disfavour had increased, however, with the adverse reaction of investors persisting and intensifying.
These are very different outcomes from those observed in the US, where hedge fund interventions have been credited with changing firms’ strategies, improving labour productivity, and delivering higher returns for shareholders. The answer does not seem to lie in the funds’ targeting strategies: in both Japan and the US, the core targets were cash-rich firms with low leverage.
One possible cause is the regulatory framework. On the face of it, Japanese corporate law and corporate governance regulations have much in common with equivalent laws and standards in the US. A closer look, however, reveals that Japanese courts interpret the law in a distinctly less shareholder-friendly way. It is hard to envisage a US court describing an activist hedge fund as ‘an abusive acquirer seeking only self-interest’, as happened in the litigation in 2007 involving Steel Partners and one of its targets, a mid-sized food manufacturer, Bull-Dog Sauce.
Another possible factor is the structure of Japanese share ownership. Overseas share ownership has been steadily increasing in Japan since the 1990s and in the period we were examining represented around 20% of shares listed on the Tokyo and Osaka stock markets. However, the predominant shareholders in many of the companies targeted by the funds were other Japanese companies and financial institutions which were either in the same corporate group as the target or allied to it in some other way, often through business dealings. Shareholders like this were simply not interested in the increased financial returns promised by the funds.
Things may be changing in Japan. There is a debate going on about the desirability of increasing shareholder returns in order to improve the position of government-run pension funds which in the past have tended to be unassertive investors. In 2014 a new Stewardship Code and in 2015 a new Corporate Governance Code were introduced. But these changes may do little to alter a managerial culture which continues to reject the idea of shareholder value as a benchmark of corporate success. It seems that the long-awaited end of history for corporate law will be deferred for some time, in Japan at least.
John Buchanan is Research Associate at the University of Cambridge, Centre for Business Research.
Dominic Chai is Research Associate at the University of Cambridge, Centre for Business Research.
Simon Deakin is Professor of Law and Director of Research at the University of Cambridge, Centre for Business Research.