Study: Hedge Funds That Break Deals Rather Than Make Deals Make The Big Bucks

Activist investors tend to push management teams to sell their businesses to a rival or strategic buyer for a premium valuation. Yet according to a new academic study, the better strategy to profit from M&A deals is to prevent them from occurring in the first place.

What Happened

According to a study authored by the Columbia Business School's Wei Jiang, the University of Florida's Tao Li and Columbia Business School's Danqing Mei, hedge funds that block M&A deals generate higher average returns. 

When an M&A deal is proposed involving two public companies, shares of the target company typically rise while the acquiring company sees its stock fall. This is logical, as the acquirer is offering to buy the target company at a premium and may do so at the expense of dilution.

Activist investors who buy a stake in the acquirer to block the deal can do so through public criticism, proxy solicitations to veto the deal, proposing alternative options or by lobbying proxy advisory firms to influence the outcome, according to the study. 

The average profit in the time period following the deal announcement to the completion of an activist campaign to block the deal is 5.5 percentage points higher compared to what shareholders gain without activist intervention.

Why It's Important

The market's reaction to activists looking to block a deal is "also positive," the paper said. Specifically, there is sufficient evidence to suggest activists blocking a poor deal "serves as a governance remedy for acquiring firms' shareholders."

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