Alon Brav

Payout Policy in the 21st Century

We survey 384 CFOs and Treasurers, and conduct in-depth interviews with an additional two dozen, to determine the key factors that drive dividend and share repurchase policies. We find that managers are very reluctant to cut dividends, that dividends are smoothed through time, and that dividend increases are tied to long-run sustainable earnings but much less so than in the past. Rather than increasing dividends, many firms now use repurchases as an alternative. Paying out with repurchases is viewed by managers as being more flexible than using dividends, permitting a better opportunity to optimize investment. Managers like to repurchase shares when they feel their stock is undervalued and in an effort to affect EPS. Dividend increases and the level of share repurchases are generally paid out of residual cash flow, after investment and liquidity needs are met. Financial executives believe that retail investors have a strong preference for dividends, in spite of the tax disadvantage relative to repurchases. In contrast, executives believe that institutional investors as a class have no strong preference between dividends and repurchases. In general, management views provide at most moderate support for agency, signaling, and clientele hypotheses of payout policy. Tax considerations play only a secondary role. By highlighting where the theory and practice of corporate payout policy are consistent and where they are not, we attempt to shed new light on important unresolved issues related to payout policy in the 21st century.

An Empirical Analysis of Analysts' Target Prices: Short Term Informativeness and Long Term Dynamics

Using a large database of analysts’ target prices issued over the period 1997^ 1999, we examine short-term market reactions to target price revisions and long-term comovement of target and stock prices.We ¢nd a signi¢cant market reaction to the information contained in analysts’ target prices, both unconditionally and conditional on contemporaneously issued stock recommendation and earnings forecast revisions. Using a cointegration approach, we analyze the long-term behavior of market and target prices.We ¢nd that, on average, the one-year-ahead target price is 28 percent higher than the current market

Hedge Fund Activism: A Review

This monograph reviews shareholder activism by hedge funds. We first describe the nature and characteristics of hedge fund activism, including the objectives, tactics, and choices of target companies. We then analyze possible value creation brought about by activist hedge funds, both for shareholders in the target companies and for investors in the hedge funds. The evidence generally supports the view that hedge fund activism creates value for shareholders by effectively influencing the governance, capital structure decisions, and operating performance of target firms.

The Long-Term Effects of Hedge Fund Activism

We test the empirical validity of a claim that has been playing a central role in debates on corporate governance — the claim that interventions by activist hedge funds have a detrimental effect on the long-term interests of companies and their shareholders. We subject this claim to a comprehensive empirical investigation, examining a long five-year window following activist interventions, and we find that the claim is not supported by the data. We find no evidence that activist interventions, including the investment-limiting and adversarial interventions that are most resisted and criticized, are followed by short-term gains in performance that come at the expense of long-term performance. We also find no evidence that the initial positive stock-price spike accompanying activist interventions tends to be followed by negative abnormal returns in the long term; to the contrary, the evidence is consistent with the initial spike reflecting correctly the intervention’s long-term consequences. Similarly, we find no evidence for pump-and-dump patterns in which the exit of an activist is followed by abnormal long-term negative returns. Our findings have significant implications for ongoing policy debates. Policymakers and institutional investors should not accept the validity of the assertions that activist interventions are costly to firms and their shareholders in the long term; such claims do not provide a valid basis for limiting the rights, powers, and involvement of shareholders.

Managerial Response to the May 2003 Dividend Tax Cut

We survey 328 financial executives to determine the effects of the May 2003 dividend tax cut on corporate payout policy. We find that the tax cut led to initiations and dividend increases at some firms, weakly more so at firms for which retail investors are particularly important. However, financial executives say that the tax rate reduction ranks behind stability of future cash flows and cash holdings (and for firms already paying dividends, taxes also rank behind the historic level of dividends) in a list of factors that affect dividend policy. Tax effects are of roughly the same importance as attracting institutional investors and the availability of profitable investments. We also search press releases and find that the dividend tax cut is only occasionally mentioned as the reason for an initiation, especially from 2004 onward. Overall, the evidence indicates that dividend tax rates are a second-order concern in setting payout policy.

The Returns to Hedge Fund Activism

Hedge fund activism is a new form of arbitrage. Using a large hand-collected data set from 2001 to 2006 we find that activist hedge funds in the U.S. propose strategic, operational, and financial remedies and attain success or partial success in two-thirds of the cases. The abnormal stock return upon announcement of activism is approximately seven percent, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. We also find large positive abnormal return to the self-reported hedge fund activists during our sample period. The abnormal return significantly exceeds the returns to all hedge funds, the returns to equity-oriented hedge funds and is robust to alternative risk adjustments and selection biases.

How Does Hedge Fund Activism Reshape Corporate Innovation

This paper studies how hedge fund activism reshapes corporate innovation. Firms targeted by hedge fund activists experience an improvement in innovation efficiency during the five-year period following the intervention. Despite a tightening in R&D expenditures, target firms experience increases in innovation output, measured by both patent counts and citations, with stronger effects seen among firms with more diversified innovation portfolios. We also find that the reallocation of innovative resources and the redeployment of human capital contribute to the refocusing of the scope of innovation. Finally, additional tests refute alternative explanations attributing the improvement to mean reversion, sample attrition, management’s voluntary reforms, or activists’ stock-picking abilities.We examine whether hedge fund activism affects corporate innovation. We find that firms targeted by hedge fund activists experience an improvement in innovation efficiency within three years after the intervention as evidenced by a significant drop in R&D spending but an increase in innovation output measured by both patent counts and citations. We then show that hedge fund activists improve target firms’ innovation efficiency via the reallocation of innovative resources and the redeployment of human capital. Finally, we show that the link between hedge fund interventions and improvements in innovation efficiency is potentially driven by firms’ assets reallocation triggered by activists. Our paper is the first study that sheds light on the real effect of strengthened shareholder power in reshaping corporate innovation. JEL Classification: G23, G34, O31

Evidence on the Trade-Off between Risk and Return for IPO and SEO Firms

Do the low long-run average returns of equity issuers reflect underperformance due to mispricing or the risk characteristics of the issuing firms? We shed new light on this question by examining how institutional lenders price loans of equity-issuing firms. We find that equityissuing firms’ expected debt return is equivalent to the expected debt return of non-issuing firms with similar characteristics, implying that institutional lenders perceive equity issuers to be as risky as similar non-issuing firms. We also find that institutional lenders perceive small and high book-to-market borrowers as systematically riskier than larger borrowers with low book-to-market ratios, consistent with the asset pricing approach in Fama and French (1993). Finally, we find that firms’ expected debt returns decline after equity offerings, consistent with recent theoretical arguments suggesting that firm risk should decline following an equity offering if equity is issued to exercise a real option. Overall, our analysis provides novel evidence consistent with risk-based explanations for the observed equity returns following IPOs and SEOs.

Hedge Fund Activism

This paper examines the causes and consequences of hedge fund activism. Hedge funds target profitable and healthy firms, with above-average cash holdings. The target firms earn significantly higher abnormal stock returns around the initial 13D filing date than a sample of control firm. However, they do not show improvements in accounting performances in the year after the initial purchase. Instead, hedge funds extract cash from the firm through increases in the target’s debt capacity and higher dividends. Examination of proxy fights and threats accompanying the activist campaign suggests that hedge fund managers achieve their goals by posing a credible threat of engaging the target in a costly proxy solicitation contest.

The Real Effects of Hedge Fund Activism: Productivity, Risk, and Product Market Competition

This paper studies the long-term effect of hedge fund activism on the productivity of target firms using plant-level information from the U.S. Census Bureau. A typical target firm improves its production efficiency within two years after activism, and this improvement is concentrated in industries with a high degree of product market competition. By following plants that were sold post-intervention, we also find that efficient capital redeployment is an important channel via which activists create value. Furthermore, our analyses demonstrate that measuring performance using the Compustat data is likely to lead to a downward bias because target firms experiencing greater improvement post-intervention are also more likely to disappear from the Compustat database. Finally, consistent with recent work in asset-pricing linking firm investment decisions and expected returns, we show how changes to target firms’ productivity are associated with a decline in systemic risk, particularly in competitive industries.