Grey matters

Hedge Funds


Hedge Fund Activism, Poison Pills, and the Jurisprudence of Threat

William W. Bratton

U of Penn, Inst for Law & Econ Research Paper No. 16-20, in The Corporate Contract In Changing Times: Is the Law Keeping Up? (William Savitt, Steven Davidoff Solomon, Randall Thomas eds.), Forthcoming (September 2016) available at


This chapter in a forthcoming volume reviews the single high profile case in which twentieth century antitakeover law has come to bear on management defense against a twenty-first century activist challenge — the Delaware Court of Chancery’s decision to sustain a low-threshold poison pill deployed against an activist in Third Point LLC v. Ruprecht. The decision implicated an important policy question: whether a twentieth century doctrine keyed to hostile takeovers and control transfers appropriately can be brought to bear in a twenty-first century governance context in which the challenger eschews control transfer and instead makes aggressive use of the shareholder franchise. Resolution of the question entails evaluation of the gravity of two sets of threats, one at the doctrinal level and the other at the policy level. The doctrinal threats are exterior threats to corporate policy and effectiveness on which managers justify defensive tactics under Unocal v. Mesa Petroleum Co. Because some threats have greater justificatory salience under Unocal than do others, a question arises as to the nature and characterization of the threats allegedly held out by activist intervention. The policy threats implicate the new balance of power between managers and shareholders. The chapter appraises the threats. As regards Unocal, it demonstrates a serious problem of fit. The chapter goes on to conduct a thought experiment that reshapes and extends Unocal so that it does provide a robust basis for sustaining management defense against activist hedge funds, even shielding poison pills with 5 percent triggers. The extension amounts to radical reformulation of the conceptual framework of corporate law, thereby posing the policy threat. But the policy threat, on examination, proves un-compelling. Today’s corporate managers being disinclined to traverse shareholder preferences by promulgating standing poison pills. Given that, the chapter asks whether 5 percent poison pills could hold out policy benefits in the form of company-by-company shareholder-manager engagement on the question of suitability for activist intervention.

CFR comment:

One of the top corporate law scholars offers a clear analysis of a current problem in corporate governance related to fund activism. Everything Bratton writes is worth reading but this particularly so.


Hostile Resistance to Hedge Fund Activism

Nicole M. Boyson and Pegaret Pichler

Northeastern U. D’Amore-McKim School of Business Research Paper No. 2805493 (September 7, 2016) available at


Targets of hedge fund activism frequently employ defenses traditionally designed as takeover defenses. This resistance seems motivated by takeover concerns and to inhibit activists from coordinating with other shareholders. Hedge funds frequently counter-resist with a proxy fight or lawsuit. Without counter-resistance, positive outcomes of activism are muted: resisting targets are less likely to accede to hedge fund demands, be acquired, or show long-term operating improvements. Resisting firms frequently offer board representation to hedge funds, but with restrictive settlement agreements. When activists counter-resist, target firm outcomes do not differ relative to non-resisting targets of the same hedge funds.

CFR comment:

There are two good reasons for those in the funds industry to read this paper. First, it provides a terrific analysis of the responses of firms to activist fund investment, examining over 1,000 “activist events” between 2000-2012. Second, it examines the market impact of resistance to activist investors and finds that pushback by funds against the target’s resistance ameliorates the negative impact on price of the resistance.


Exit, Voice and Loyalty from the Perspective of Hedge Funds Activism in Corporate Governance

Alessio M. Pacces

European Corporate Governance Institute (ECGI) Law Working Paper No. 320/2016, Erasmus Law Review, forthcoming (July 7, 2016) available at


This article discusses the policy response to hedge funds activism in corporate governance based on Hirschman’s classic: Exit, Voice and Loyalty. From that perspective, the article argues that hedge funds do not create the loyalty concerns underlying the usual short-termism critique of hedge funds activism, because the arbiters of such activism are typically indexed funds, which cannot choose short-term exit. Nevertheless, the voice activated by hedge funds can be excessive for a particular company.

Furthermore, this article claims that the short-termism debate cannot shed light on the desirability of hedge funds activism. Neither theory nor empirical evidence can tell whether hedge funds activism systematically leads to short-termism or whether its absence lead management to the opposite bias, namely long-termism. The real issue with activism is a conflict of entrepreneurship, namely a conflict between the opposing views of the activists and the incumbent management regarding in how long an individual company should be profitable. Leaving the choice between these views to institutional investors is not efficient for every company at every point in time.

Consequently, this article argues that regulation should enable individual companies to choose whether to encourage or to curb hedge funds activism depending on the efficient time-horizon given the firm’s lifecycle. The recent European experience reveals that loyalty shares enable such choice, even in the midstream, operating as dual-class shares in disguise. However, loyalty shares can often be introduced without institutional investors’ consent. This outcome could be improved by allowing dual-class recapitalizations, instead of loyalty shares, but only with a majority of minority vote. This solution would screen for the companies for which temporarily curbing activism is efficient, and induce these companies to negotiate sunset clauses with institutional investors.

CFR comment:

Tackling the perspective underlying the continental European critique that is behind claims that funds are “locust” investors and the like, this paper explores the short-term investment critique of funds and finds that individual firm-level measures are superior to regulatory measures in matching investment time lines to firms’ funding needs. This should be mandatory reading in Brussels.


Political Cognitive Biases Effects on Fund Managers’ Performance

Marian W. Moszoro and Michael Bykhovsky, (August 18, 2016)

available at


Under rational agent hypothesis, financial industry practitioners should not be affected by political discourse, and investors cannot realize abnormal returns on publicly available information. Rare events, however, may silence rationality and potentiate cognitive dissonance on a spectrum of agents. The authors assembled a comprehensive dataset of hedge fund performance and matched equity hedge fund managers’ political affiliation by their partisan contributions. They document higher returns of equity hedge funds managed by Democrats for 10 subsequent months – from December 2008 to September 2009. This result is unique and robust to placebo time windows and random partisan affiliation shuffling.

The authors conjecture that the conjunction of the financial crisis, Obama’s election, and politically polarized interpretation of the U.S. central bank policy during that period had an asymmetric impact on hedge fund managers’ perception. In other periods, when the political discourse did not involve central bank policy, there was no statistically significant difference between the performance of equity hedge fund managers depending on their political beliefs.

CFR comment:

A terrific look at how hedge fund managers’ biases affect returns.


Hedge Fund Holdings and Stock Market Efficiency

Charles Cao, Bing Liang, Andrew W. Lo and Lubomir Petrasek, (May 2016)

available at


The authors examine the relation between changes in hedge fund equity holding and measures of informational efficiency of stock prices derived from intraday transactions as well as daily data. On average, hedge fund ownership of stocks leads to greater improvements in price efficiency than mutual fund or bank ownership. However, stocks held by hedge funds experienced extreme declines in price efficiency during liquidity crises, most notably in the last quarter of 2008, and the declines were more severe in stocks held by hedge funds connected to Lehman Brothers as a prime broker and hedge funds using leverage.

CFR comment:

This thoughtful, if technical, assessment of the impact of hedge funds on market efficiency finds that funds’ investments generally make markets more efficient by comparing price trends for traded stocks with large fund investments against those without. However, the paper also finds an important caveat: During liquidity crises, this effect is reversed. These results should be useful to those regulating and those defending the fund industry.


In for the Long Haul: Hedge Fund Activism and Fire Sale Risk

Julia Reynolds, (May 2, 2016)

available at


This paper explores the recent idea that a stock’s investors ex ante price the risk that large fire sales by liquidity-shocked blockholders will trigger negative price impacts, also known as “fire sale risk”. Contributing to this idea, this paper argues that fire sale risk should be lower for institutional blockholders who can credibly signal superior long-term liquidity management, and that this beneficial mitigation of risk can generate substantial abnormal returns. Especially considered is block acquisition by activist hedge funds, who are unique in terms of long lock-up and redemption notice periods. Using a hand-collected data set, this paper finds that comparatively higher abnormal returns of 30-100 basis points following activist hedge fund block acquisitions are at least partially due to these institutions’ mitigation of fire sale risk. A further analysis shows that this result extends beyond hedge funds to a broader sample of institutional investors.

CFR comment:

An excellent empirical investigation of the impact of activist hedge funds that points to a reason that their investments lead to improved performance in target firms: that hedge funds are better positioned than other institutional investors to avoid fire sales of assets. This suggests that fund lock up provisions influence the value of the investments funds make, which in turn might be something for investors to consider in evaluating those provisions.


Timing is Money: The Factor Timing Ability of Hedge Fund Managers

Bart Osinga, Marc Schauten and Remco C. J. Zwinkels (July 18, 2016)

available at


This paper studies the level, determinants, and persistence of the factor timing ability of hedge fund managers. The paper find strong evidence in favor of factor timing ability at the aggregate level, although we find ample variation in timing skills across investment styles and factors at the fund level. The cross-sectional analysis shows that better factor timing skills are related to funds that are younger, smaller, have higher incentive fees, have a smaller restriction period, and make use of leverage. An out-of-sample test shows that factor timing is persistent. Specifically, the top factor timing funds outperform the bottom factor timing funds with a significant 1 percent per annum. This constitutes 13 percent of the overall performance persistence in hedge funds. The findings are robust to the use of an alternative model, alternative factors, and controlling for the use of derivatives, public information, and fund size.

CFR comment:

A useful assessment of fund performance in terms of timing skills. Worth a read by fund of funds managers!


The Golden Leash and the Fiduciary Duty of Loyalty

Gregory H. Shill

UCLA Law Review, Vol. 64 (2017), forthcoming available at


Activist hedge funds have begun experimenting with a novel practice in corporate governance: offering their candidates for the board of directors millions of dollars in bonus pay through a device known as a “golden leash.” Such arrangements, which are highly controversial, award directors for accomplishing activist objectives. An emerging body of work views the golden leash through the same polarized lens as activism itself: either the leash locks directors in to a self-serving, “short-termist” agenda, or it creates incentives for them to be better advocates for shareholders. This binary framing obscures some of the golden leash’s most promising qualities.

Though associated with shareholder activists, the golden leash belongs to a larger class of well-established, mainstream legal structures that reduce agency costs and increase expertise at individual firms by, paradoxically, tying directors to multiple firms. These structures include corporate governance innovations in two other areas of the capital markets, the venture capital ecosystem and the practice of corporate directors sharing information with outside entities. Like the golden leash, both of these models create overlapping obligations for directors. Yet these arrangements are welcomed by scholars, courts, and firms on the grounds that they improve enterprise value and corporate governance by quietly blending loyalties, notwithstanding the fact that they also make conflicts of interest more likely.

The golden leash thus follows in a coherent, if unheralded, tradition of structures that forge ultra-close bonds between directors and outside shareholders. This article argues that the risks posed by this blending of duties should be discounted by the availability of mechanisms to manage the resulting conflicts and by advantages conferred in capital formation and governance. Properly designed and disclosed, the golden leash can promote not only superior returns but consensus-building, dialogue, and other values important to sound procedural corporate governance.

CFR comment:

A thoughtful analysis of the growing practice of fund incentives for board members that puts the practice into a larger context.


The Fallout from the Panama Papers

Academics continue to explore the data from the Panama Papers and topics inspired by them


Profit-Shifting Structures: Making Ethical Judgments Objectively, Parts 1 & 2

Jeffery M. Kadet & David L. Koontz

Part 1: Tax Notes, Vol. 151, No. 13, 2016 available at and Part 2: Tax Notes, Vol. 152, No. 1, 2016 available at


MNCs and their advisors have seemingly taken ethics out of the mix when considering the profit-shifting tax structures they have so prolifically and enthusiastically implemented over the past several decades. There may be a variety of reasons for this. First, U.S. tax law is a self-assessment system, meaning that in most cases taxpayers compute and pay tax without advance approval of their tax positions from the IRS. No third party technical test or propriety standard has to be passed on the front end for any tax strategy or structure. Second, direct personal benefits accrue to management and advisors from implementing such structures, often measured, either, directly or indirectly, by a structure’s short-term success. Stock options and stock issued under performance share plans become more valuable more quickly, bonuses are higher, promotions may be faster, and professional advisors earn more fees and enhance their reputations and client relationships. With no up-front objective test to determine if the planning will survive later scrutiny and the fact that everyone else is doing it, there’s an easy inference that it represents good business practice. Third, some Congressional actions have encouraged and enabled such questionable and problematic tax strategies.

MNC boards of directors, senior management, and professional advisors need an objective ethical benchmark to test the appropriateness of their profit-shifting structures and any new strategies they might consider. Given the strong motivation to implement such structures, a counterweight is needed to balance the unfettered acceptance and adoption of profit-shifting strategies based solely on the mere possibility that they might pass technical tax scrutiny by the government. Greater thought needs to be given to whether these plans are consistent with and serve the long term objectives of the MNC and its many global stakeholders. Stating this proposition more directly, it is time to ask if all of these stakeholders would accept the efficacy of these structures if they were made fully aware of and understood the technical basis, the strained interpretations, the hidden arrangements, the meaningless intercompany agreements, the inconsistent positions, and the lack of change in the business model for the schemes proposed or already implemented.

These articles present an objective ethical benchmark to test the acceptability of certain profit shifting structures. In addition, the benchmark is defined solely from a U.S. perspective, though it is applicable to all MNCs that conduct U.S.-centric businesses. Thus, it applies to non-U.S.-based MNCs that have inverted or that have acquired U.S. MNCs. The concept behind this benchmark could also be applied in other countries in which global businesses are headquartered and conducted.

In brief, this ethical benchmark requires an examination of the factual situation for each of an MNC’s low or zero taxed foreign group members regarding three factors, which are:
(a) identification and location of critical value-drivers,
(b) location of actual control and decision-making of the foreign group member’s business and operations, and
(c) the existence or lack thereof of capable offshore management personnel and a CEO located at an office of the foreign group member outside the U.S. who has the background and expertise to manage, and does in fact manage, the entity’s business.

Through this examination, it should be possible to determine whether a foreign group member is recording income that is economically earned through business decisions and activities conducted in the jurisdiction in which it claims to be doing business. Where, however, the facts indicate that a portion or all of the business of the foreign group member is done substantially in the U.S. by U.S. based affiliates, the Congressional intent is clear. And that clear intent is to directly tax such income through the effectively connected income rules of the Internal Revenue Code.

This benchmark should be used by MNCs with the active participation of board and management members. An MNC could also use this approach to proactively respond to critics or to demonstrate its tax bona-fides.

These articles conclude by suggesting a number of steps to be considered by MNC Boards, professional tax advisors, and the Congress, Treasury and the IRS, with a view to improving the quality and outcomes of tax strategies, corporate governance, and the equitable collection of taxes. The suggestions include actions that could be instituted by Treasury and the IRS without the need for any Congressional action.

CFR comment:

A good roadmap to current thinking about how tax authorities might approach profit-shifting efforts in the future.


The Demand for Fiduciary Services: Evidence from the Market in Private Donative Trusts

Adam S. Hofri-Winogradow, (September 7, 2016)

Hastings Law Journal, forthcoming, available at


Recent revelations on the use of fiduciary services by the wealthy and political leaders raise concerns regarding the use of such services for tax and creditor evasion. Yet given the secrecy shrouding much of the fiduciary industry, we do not know which fiduciary services are used for such purposes and to what extent. Shining a light on a particularly obscure part of the industry, this Article presents and analyzes the results of the first-ever global survey of professional service providers to private donative trusts and a series of interviews with professional trust service providers in five countries. This paper reports new and unprecedented data on four controversial features of current trust practice: perpetual and extreme-long-term trusts, trust terms exonerating trustees from liability to beneficiaries, tools rendering beneficiaries’ entitlements inaccessible to their creditors and the control of trusts by their creators. The author found that trusts drafted to subsist for more than a century are fairly common, especially offshore, but many such trusts are not in fact likely to survive that long. Trustee exculpatory terms are now standard in donative trusts serviced by professionals, with most settlors neither demanding nor receiving any quid-pro-quo for their inclusion. Anti-creditor techniques protecting beneficiaries’ entitlements are even more ubiquitous than trustee exculpatory terms, particularly so in trusts serviced by U.S.-resident providers. Many protected beneficiaries are not less able than the average person to take care of their financial affairs. Finally, express reservation of powers by trust settlors  is a majority phenomenon in the U.S., but a minority one elsewhere. The actual control of trusts by their settlors is likewise far mor e common in the U.S. than elsewhere. The author concludes the article with recommendations for law reform making trusts likelier to benefit their beneficiaries and less likely to avoid duties owed to creditors and the taxpaying public.

CFR comment:

A terrific piece of empirical work that replaces guessing with real knowledge.


Breaking Bad: What Does the First Major Tax Haven Leak Tell Us?

Arthur J. Cockfield, Tax Notes International, Vol. 83(8), p. 691, 2016,

available at


While there is now significant literature in law, politics, economics, and other disciplines that examines tax havens, there is little information on what tax haven intermediaries – so-called offshore service providers such as trust, finance and other financial service providers – actually do to facilitate offshore tax evasion and other global financial crimes. To provide insight into this secret world of tax havens, this article relies on the author’s study of the first major tax haven data leak obtained by the International Consortium for Investigative Journalists. A hypothetical involving Breaking Bad’s Walter White is used to explain how offshore service providers help non-resident investors engage in offshore tax evasion.

CFR comment:

Clever use of Breaking Bad-themed examples but the real benefit is the concise summary of the Panama Papers data.


Tax Information Exchange and Offshore Entities: Evidence from the Panama Papers

Jim Omartian, (September 2, 2016)

available at


Using new data from the Panama Papers, the author tests for an investor response to regulatory reforms that improve foreign asset transparency. He finds that immediately prior to its roll-out, affected investors roughly double offshore entity incorporations to circumvent the EU Savings Directive. However, Tax Information Exchange Agreements, the Foreign Account Tax Compliance Act, and the Common Reporting Standard for information exchange result in declines in offshore entity usage. The study provides a rare direct look at investors taking action to increase opacity and informs debate on the use of information exchange as a tool to combat offshore tax evasion.

CFR comment:

Empirical work is good as it makes the debates involve facts. This should start a debate over the impact of these regulatory measures, including over how to properly measure their impacts.


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Andrew P. Morriss

Andrew P. Morriss, Chairman, is the D. Paul Jones, Jr. & Charlene Angelich Jones – Compass Bank Endowed Chair of Law at the University of Alabama School of Law. He was formerly the H. Ross & Helen Workman Professor of Law and Business at the University of Illinois,Urbana-Champaign. He received his A.B. from Princeton University, his J.D. and M.Pub.Aff. from the University of Texas at Austin, and his Ph.D. (Economics) from the Massachusetts Institute of Technology. He is a Research Fellow of the N.Y.U. Center for Labor and Employment Law,and a Senior Fellow of the Institute for Energy Research, Washington,D.C., as well as a regular visiting faculty memberat the Universidad Francisco Marroquín,Guatemala. He is the author or coauthor of more than 50 scholarly articles, books, and bookchapters, including Regulation by Litigation (Yale Univ. Press 2008) (with Bruce Yandle and Andrew Dorchak), and is the editor of Offshore Financial Centers and Regulatory Competition (American Enterprise Institute Press 2010).

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