Gap Filling, Hedge Funds, and Financial Innovation

In this paper, we examine changes in financial instruments and institutions by contrasting the successes and failures of institutional shareholder activism during the 1990s with more recent developments in hedge fund activism and the use of financial innovation. We find that although institutional investor activism was the watch word of the 1990's, overall traditional institutional activism has been of marginal importance at targeted firms. In contrast, there is evidence of real monitoring in the more aggressive recent activism of hedge fund managers, in part because financial innovation has generated a host of new opportunities that did not exist a decade ago.To illustrate these points, we compare institutional activism and hedge fund activism with respect to voting, litigation, and change of control contests. We also categorize the costs and benefits of four major types of strategies activist hedge funds recently have pursued: information asymmetry and convergence trades; capital structure motivated trades; merger and risk arbitrage; and, most controversially, governance and strategy. We conclude with a discussion of the policy implications of our work, pointing out some of the regulatory challenges created by this new wave of investor activism