Hedge Fund Activists : Pessimists in a World of Managerial Optimism

I analyze hedge fund activism within a simple behavioral finance framework where managers are excessively optimistic about their firm's long-run prospects, the market is efficient, and hedge fund activists are excessively pessimistic as a result of a behavioral winner's curse. This generates a mechanism for both target selection - the matching of pessimistic hedge fund activists and targets - and campaign outcome - where pessimistic hedge fund activists are sometimes too pessimistic about target prospects to persuade other shareholders. The model predicts: (1) activist campaigns that are not associated with positive abnormal returns are unsuccessful; (2) hedge fund activists are more likely to act together (form "wolf packs") when targets are performing sub-optimally; and (3) as the number of activists increase, the percentage of unsuccessful campaigns increases. In this framework, hedge fund activism is never detrimental to firms because hedge fund activists are unable to persuade the efficient market shareholders to force abandonment of positive net present value long-term projects