Hedge funds : regulation, activism and corporate decisions

Rights statement
Awarding institution
  • University of Strathclyde
Date of award
  • 2022
Thesis identifier
  • T16264
Person Identifier (Local)
  • 201558478
Qualification Level
Qualification Name
Department, School or Faculty
  • The hedge fund industry has expanded at a spectacular growth rate in terms of assets under management and the number of active hedge funds. The stake and ability of hedge funds to influence the board and managerial decisions make it optimal for them to engage in costly information search, thereby performing monitoring and disciplining roles. Similarly, the influence of hedge funds on corporate decisions and their potentially destabilising power, specifically when they themselves maintain a high degree of opacity at the core of their strategy and specialism, has attracted regulatory concern. Motivated by these concerns that are significant to regulators and policy-making bodies, my thesis examines important aspects of hedge funds which is divided into three empirical chapters. This PhD thesis, comprised of three empirical chapters, assesses the activity of hedge funds and the regulatory environment facing hedge funds and offers new insights on hedge funds' behaviour and corporate consequences. The first empirical chapter sheds light on the ongoing debate of whether a hedge fund needs to be regulated. To do so, the first empirical chapter conducts a comparative study of before and after hedge fund regulations in Europe and the US (namely DoddFranc Act (DFA) in the US and Alternative Investment Fund Managers Directive (AIFMD) in Europe). An empirical investigation in my first chapter documents the stark effect of hedge fund disclosure regulations on fund performance in Europe in contrast to what is documented in the US studies. The post AIFMD period in Europe experiences an increase in performance contrary to a decline in performance documented in a previous study in the US. The results show that the increase in performance in the European hedge fund is not limited to the firms affected by the AIFMD alone and has a positive spillover effect on the small funds unaffected by the regulation. The second important revelation of my first empirical chapter is that AIFMD in Europe seems to favour smaller funds as the post-AIFMD-period witnesses improvement in the performance of smaller funds. As such, European evidence is suggestive of the distributional effect of hedge fund regulation benefitting the performance of otherwise constrained small funds. In my third and final set of enquiries, I investigate the volatility consequence of hedge fund regulation and document that the overall fund return volatility has fallen both in the US and Europe. In the ongoing debate in the literature on the merits and demerits of hedge fund regulation, the findings shed important light on the positive volatility outcome of hedge fund regulation. The second empirical chapter examines firm and industry antecedents of hedge fund activism and documents that the propensity to be an activist target positively depends on the firm and industry characteristics related to agency and information-related problems. This chapter further examines whether competitive forces positively or negatively affect the propensity to attract hedge fund activism. The economic arguments present an unsettled prediction of the effect of industry-level competition and hedge fund activism. According to one side of this debate, competition minimises the danger of asymmetric information to less-informed investors by allowing informed investors to trade together, resulting in more information being captured in the equilibrium price. Therefore, competitive force substitutes, at least in part, the negative effect of asymmetric information. The central postulation of this view is that Hedge Fund activists could specialise as informed investors lowering the information asymmetry. The alternative view is that, in a monopolistic market, firms possess market power to the extent of coercing prices and output. This may lead to a situation where the value of activism may not translate into eliminating underperformance and undervaluation in the concentrated sectors. The chapter's empirical findings suggest that hedge fund activism is negatively associated with market competition in support of the substitutive argument. The third important revelation in this chapter is the empirical investigation of antecedents of hedge fund activism before and after the change in regulatory and information environment facing hedge funds, i.e. before and after hedge fund regulations (HFRs, henceforth). The empirical enquiry documents that the regime change in the information environment created by hedge fund regulations has enabled activist hedge funds to target firms that are more conservative or are financially constrained. Therefore, hedge fund regulations could be considered to complement and support the information environment for a hedge fund to assess a target and do not necessarily play a substitutive role in information creation as speculated in the literature. The third empirical chapter investigates the impact of hedge fund activism (HFA) on corporate risk-taking and documents that hedge fund targeted firms would pursue investment conservatism, however aggressive debt policy, thereby directing firms toward short-termism. However, the market seems to reward this short-termistic risk-taking in the form of positive market reactions to hedge fund activism announcements. The second important revelation of the empirical study is that passive hedge funds that turn activists in the later stage would take their familiarity with internal dynamics to further increase short-term oriented risk-taking by exposing the firm to higher earnings volatility and a more levered balance sheet while shunning investment and dividends. This study implies that the policy discussion should take into account risk-taking consequences that would have long-term costs of hedge fund activism. Taken together, the thesis highlight the merit of regulation to produce, at least in part, positive market outcomes of lowering return volatility. Return volatility of hedge funds could destabilise the market as they could trigger liquidity dry-ups and volatility spill-overs to the corporate sector. To this end, the thesis underscores the merit of regulating hedge funds. This thesis also sheds important insights on drivers of hedge fund activism and documents the success of hedge funds in correcting firm-level frictions of underperformance and undervaluation of the target firms. However, notwithstanding their success in identifying and correcting underperformance and undervaluation, in the aftermath, they increase the risk-taking of target firms to pursue corporate short-termism. Thus this thesis provides insights to regulators and investors to assess the long term consequences of hedge fund activism in the debate of the overall merit of the wolves (hedge funds) at the door (activism).
Advisor / supervisor
  • Paudyal, Krishna N.
  • Tang, Leilei
Resource Type

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