Hedge Fund Activist Role in Mitigating Agency Conflicts : Evidence from Loan Provisioning Choices in U.S. Banks

In this study, we explore the hedge fund activist influence on managerial decisions in opaque banking industry. Focusing on loan loss provisions (LLPs), a discretionary item that is subject to managerial manipulations as well as pressures from various regulatory agencies, we find that hedge fund activists (HFAs) alleviate the agency problems associated with bank loan provisioning decisions. The findings show that HFAs lead to a substantial reduction in overstatements but not understatements of LLPs at target banks, resulting in a prompt increase in bottom-line profitability, accompanied by increased stock returns. Furthermore, while pointing to no appreciable change in bank risk, our findings suggest a nontrivial increase in risk-adjusted returns at target banks. We conclude that the disciplinary effect of HFAs contributes to shareholder value by leading to a curtailment of excessive loan loss provisioning and a re-alignment of the LLP decisions with target bank shareholders’ interests