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Does Hedge Fund Short-Termism Shape up MergerPayment?
Ning Gao, Olga Kolokolova, Achim Mattes∗
January 15, 2018
Abstract
Using a sample of mergers and acquisitions (M&As) from 1995 to 2009, we find that the
proportion of cash payment increases with hedge fund holdings in the target firms. This positive
effect is more pronounced when bidder stocks are less liquid, hedge-fund shareholders in the
target firms have greater asset turnover, or there is a smaller number of hedge funds holding
the target. Target announcement returns have no significant relation with hedge-fund holdings
however. Further, targets with greater hedge fund holdings are more likely to accept the
payment in the form of bidders’ overvalued equity. Our results suggest that hedge fund short-
termism leads to a choice of the payment method that may be inefficient for long-term target
shareholders.
Key words : Hedge funds, holdings, short-termism, mergers and acquisitions, means of pay-
ment.
∗Ning Gao (ning.gao@manchester.ac.uk) and Olga Kolokolova (olga.kolokolova@manchester.ac.uk) are at theUniversity of Manchester, Alliance Manchester Business School, Achim Mattes (achim.mattes@uni-konstanz.de)is at the University of Konstanz. We thank Ashwini Agrawal, Vikas Agarwal, Michael Brennan, Xiao Jia,Emmanuel Jurczenko, Roberto Mura, and all the participant at the AMBS research seminar in Manchester,9th Annual Hedge Fund and Private Equity Research Conference in Paris, 5th Paris Financial ManagementConference 2017 for helpful comments. All errors remain our own.
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Does Hedge Fund Short-Termism Shape up Merger Payment?
Abstract
Using a sample of mergers and acquisitions (M&As) from 1995 to 2009, we find that the
proportion of cash payment increases with hedge fund holdings in the target firms. This positive
effect is more pronounced when bidder stocks are less liquid, hedge-fund shareholders in the
target firms have greater asset turnover, or there is a smaller number of hedge funds holding
the target. Target announcement returns have no significant relation with hedge-fund holdings
however. Further, targets with greater hedge fund holdings are more likely to accept the
payment in the form of bidders’ overvalued equity. Our results suggest that hedge fund short-
termism leads to a choice of the payment method that may be inefficient for long-term target
shareholders.
Key words : Hedge funds, holdings, short-termism, mergers and acquisitions, means of pay-
ment.
2
1 Introduction
Hedge fund involvement in the market for corporate control often fuels controversial public
discussions. For example in 2010, when Cadbury, a well-known British confectionery was
acquired by Kraft Foods, the Guardian questioned if it was time to regulate hedge funds’
activities to protect UK premier companies from inefficient takeover bids.1 At the time of
the bid, 5% of shareholders of Cadbury were hedge funds.2 According to Roger Carr, the
chairman of Cadbury at the time of acquisition, in the final stage of the deal, short-term hedge
fund traders owned 31% of the company, making it extremely hard for the target to avoid the
unwanted deal. The popular fears are that the involvement of hedge funds with short-term
investment horizons harms long-term investors and other stakeholders in the target firms. The
deal was eventually completed at a valuation of GBP11.5 billion, nearly 51% of which was paid
in cash.
According to Officer (2004) and Faccio and Masulis (2005), merger price and the choice of
the means of payment are the two most important decisions made during merger negotiations.
These decisions have serious consequences on corporate control, tax, and the cash flows to
bidders and targets. At the same time, the objectives of long- and short-term shareholders
related to these decisions may be, however, in conflict (Shleifer and Vishny, 2003). Hedge
funds are important market players. At the end of 2007 they held around 10% of the U.S.
stock market (Cao et al., 2017). They are also likely to have shorter investment horizons than
typical long-term investors. Griffin and Xu (2009), for example, suggest that short-termism is a
prominent feature of hedge funds. They find that the hedge funds’ portfolio turnover is twice as
large as that of mutual funds. In this paper, we examine how hedge fund short-termism shapes
merger payments. In particular, we test whether and how hedge-fund holdings impact the
cash-stock split offered to targets and whether this effect contradicts the interests of long-term
shareholders.
Prior literature highlights several important determinants of the means of payment, including
tax (Gilson et al., 1988), information asymmetry (Myers and Majluf, 1984; Hansen, 1987;
Fishman, 1989; Berkovitch and Narayanan, 1990; Eckbo et al., 1990), capital structure (Harford
1https://www.theguardian.com/business/2010/feb/09/hedge-funds-mergers-takeovers2https://www.ft.com/content/1cb06d30-332f-11e1-a51e-00144feabdc0
3
et al., 2009; Uysal, 2011), corporate control concerns (Amihud et al., 1990; Martin, 1996; Ghosh
and Ruland, 1998; Faccio and Masulis, 2005) and stock market valuation (Shleifer and Vishny,
2003; Rhodes-Kropf and Viswanathan, 2004).
However, there is little evidence on how hedge fund short-termism impacts essential deci-
sions in M&A. A priori, short-term investors prefer liquidity. Consequently, other things being
equal, they try to resolve a merger deal faster, and, conditional on there being a deal, they
prefer cash payment to stock. Had the market been frictionless, the means of payment should
not matter. The short-term target shareholders could always instantly cash in bidder stocks
received as payment. Liquidity concerns and transaction costs, however, are serious impedi-
ments to such immediate conversion. When bidder stocks are illiquid, the price impact of a
trade will considerably reduce the proceeds when the hedge funds sell the stocks receive as
payment (Amihud, 2002). Trading costs also make it more difficult to sell the shares as the
demand for assets is sensitive to these costs (Constantinides, 1986). In a similar vein, Keim
and Madhavan (1997) demonstrate that transaction costs are economically significant and add
to trading difficulty. Therefore, short-term investors in targets have incentives to demand a
higher proportion of cash payment. Indeed, in the Cadbury case, the initial offer from Kraft
contained only 42% of cash and it increased to 51% in the final offer.
Consistent with these arguments, in this paper we find that the proportion of cash payment
in the consideration increases with the pre-merger hedge fund holdings in the target, after
controlling for other determinants of the means of payment suggested in the existing literature.
In particular, one standard deviation increase in hedge fund holdings leads to three percentage
points increase in cash payment in the consideration on average. Further, this effect is stronger
when bidder stock is less liquid, supporting our hypothesis of the liquidity preference of the
short-term hedge fund investors.
There are two possible economic channels, which are consistent with the positive association
between hedge fund holdings and the proportion of cash in the consideration. The first is a
negotiation channel, in which hedge funds in the target firm actively negotiate with the bidder
and push for cash payment. The second is a prediction channel, in which hedge funds are able
to predict cash payment and establish long positions in the target accordingly beforehand.
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We find that, keeping the level of holdings constant, the proportion of cash payment is
higher when the target has a smaller number of hedge fund shareholders. This result suggests
the presence of the negotiation channel. To achieve the desirable outcomes, shareholders need
to coordinate their efforts and influence merger payment via voting in shareholder meetings
or private communications with bidder and target managers. A smaller number of hedge fund
shareholders reduces the coordination cost and makes it easier for these hedge funds to monitor
each other’s behavior. From the bidder’s perspective, ceteris paribus, a smaller number of
target shareholders also makes cash payment more desirable. In particular, a smaller number
of target shareholders increases the risk of introducing a new block holder after the transaction
and dilute the incumbent shareholders’ control rights (Chang, 1998). It also increases the risk of
an adverse price impact on bidder stocks because of potential simultaneous selling of bidder’s
stocks post deal completion by a smaller number of short-termist hedge-fund shareholders
holding a relatively larger positions.
As far as the prediction channel is concerned, we do not find any evidence that the change
in hedge fund holdings before deal announcement is related to the percentage of cash payment,
thus, ruling out this alternative explanation. The result above on the number of hedge fund
shareholders also points against this alternative channel. If hedge funds were predicting cash
payment and taking positions accordingly, more hedge funds should be holding the target before
the deal announcement, and we should have found a positive association between the number
of hedge fund shareholders and proportion of cash in the consideration.
Several additional findings further confirm the short-termist nature of target hedge fund
holdings. In particular, a merger is completed sooner and a tender offer is more likely in
the presence of greater target hedge fund holdings. These results are consistent with the
interpretation that on average hedge funds are less resistant than other shareholders to merger
bids and are more prepared to deal sooner in a transaction, because of their short-termism.
Merger efficiency for long-term shareholders is at the center of the controversy over hedge
fund involvement. Firms populated by short-term investors may have a weaker bargaining
position in acquisitions from the point of view of long-term shareholders (Gaspar et al., 2005).
The conflict between hedge fund short-termism and the interests of long-term shareholders is
intensified when a bidder offers its overvalued equity as a payment. Short-termist hedge funds,
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which are keen to cash out, are more ready to accept bidders’ overvalued equity at the expense
of long-term shareholders (Shleifer and Vishny, 2003). Specifically, hedge funds shareholders
still prefer cash payment for the reasons discussed above, but they rationally trade off the extent
of cash payment with the probability of a deal failure due to disagreement over payment terms.
The target hedge fund shareholders cannot realise their gains from an unsuccessful bid. This
tension over the desirable means of payment is most serious when a transaction is motivated
by the bidders’ overvalued stocks (Shleifer and Vishny, 2003). Under this circumstances, the
short-termist hedge funds are aware that, if the bidder cannot meet their demand for cash, the
deal will fail. Consistent with this intuition, in a regression of cash payment we find a negative
coefficient on the interaction term between the target hedge fund holdings and a measure of
bidder stock overvaluation. When a bidder offers its overvalued equity, the target hedge fund
shareholders are ready to compromise on their desire for cash.3 Their readiness to accept
overvalued equity is not in line with the long-term shareholders’ interests.
Further along the line of merger efficiency for target long-term shareholders, we find no
significant relation between the target hedge fund holdings and the target abnormal returns at
deal announcement. Several previous studies report that cash payment usually involves a higher
premium paid to the target, hence higher target announcement returns. This is either because
of the extra capital gain tax paid immediately after a cash offer (Gilson et al., 1988; Betton
et al., 2008) or because of lower financing costs on the bidder’s side when cash payment is used
(Vladimirov, 2015).4 Our evidence that target hedge fund holdings increase the proportion
of cash payment but not the target returns suggests that target hedge fund shareholders are
willing to forego a topically higher premium for instant cash and liquidity. This is an inefficient
decision from the perspective of long-term shareholders.
Our paper contributes to a burgeoning literature on hedge funds’ influence on the financial
markets and the real economy. Prior studies find that hedge fund holdings have profound effects
on share returns and volatility (Mitchell et al., 2004; Aragon and Martin, 2012; Ben-David
et al., 2013). As for the impact on the real economy, prior studies largely focus on the impact
3Rhodes-Kropf and Viswanathan (2004) build on the assumptions of value-maximizing managers, double-sided information asymmetry, and rational investors. This is less relevant in our case, as our analysis hereinvolves the conflicts of interests between short- and long-term shareholders.
4In the case of a stock offer, a bidder passes the higher cost of equity financing to the target and lowers thepremium.
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of hedge fund activism on corporate governance or investment decisions. The research spans
firm performance and productivity (Brav et al., 2008), impact on firm bondholders (Xu and Li,
2010; Klein and Zur, 2011), and other related firms (Aslan and Kumar, 2016; Gantchev et al.,
2016). There are only a few studies on hedge funds’ roles in the market for corporate control,
despite M&As being the largest and most visible type of corporate investment and one of the key
corporate actions shaping the business world. The closest study we are aware of is Boyson et al.
(2017), who focus on the role of hedge fund activism in M&As. However, activism is hardly
the most common type of hedge fund investment. According to the Hedge Fund Research
(HFR) industry report, as of the second quarter of 2015, the assets under management of the
activist hedge funds reached about USD 130 billion, whereas the total estimated size of the
hedge fund industry over the same period was approaching USD 3 trillion. Rather, hedge fund
short-termism is a more pronounced feature of hedge fund investment (Griffin and Xu, 2009).
Our papers fills the gap by studying how hedge fund short-termism impacts the essential terms
of M&A deals.
We also contribute to the literature on the determinants of the means of payment in M&As.
We show that hedge fund holdings in a target firm have a significant impact on the means
of payment agreed between the bidder and the target. We further show that hedge funds’
preference for cash payment due to short-termism is inefficient for long-term target shareholders.
Higher hedge fund holdings lead to more cash payment, but not higher target returns. This
is at odd with the prediction of Gilson et al. (1988); Betton et al. (2008); Vladimirov (2015)
that cash payment indicates a higher premium paid to target shareholders. These suggest that
short-termist hedge fund shareholders are ready to trade value for liquidity, which compromises
long-term shareholders’ objectives. On the practical side, we provide systematic empirical
evidence validating the concern that hedge fund involvement in M&As might compromise long-
term shareholders value. Our study suggests that policies governing the involvement of hedge
funds in M&As might be necessary.
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2 Related literature
2.1 The determinants of means of payment in M&As
The choice of the payment method (or means of payment) is an important decision during
merger negotiations (Officer, 2004; Faccio and Masulis, 2005). It can have a significant impact
on a bidder’s shareholder base, financing capacity and security issuing activities. It can also
influence the share price, risk profile, control rights and tax payment of both the bidder and
the target. The existing literature largely segregates the determinants of means of payment
into five groups, namely, (1) information asymmetry, (2) target capital gain tax, (3) capital
structure and financing capacity, (4) control concerns, and (5) bidder stock market valuation.
Information asymmetry has received notable attention as a determinant of means of payment.
In the first instance, the one-sided information asymmetry framework of Myers and Majluf
(1984) is applied to the choice of means of payment. In particular, when a company has
difficulty conveying its value to the market, issuing stock sends a negative signal that its stocks
are overvalued. The prediction here is that stock offers lead to lower bidder announcement
returns. Indeed, a sizeable literature finds that stock offers are related to worse bidder returns at
deal announcement (Travlos, 1987; Brown and Ryngaert, 1991; Smith and Kim, 1994; Martin,
1996, among others). Hansen (1987) and Fishman (1989) build on a two-sided information
asymmetry framework. In their works, information asymmetry exists on both the bidder’s and
the target’s value. A bidder can use a stock offer as a “contingent pricing mechanism” to force
target shareholders to share the risk of the future cash flows of the combined firm. The target
may reject a stock offer if it believes the bidder’s stock is overvalued. Officer, Poulsen, and
Stegemoller (Officer et al.) find that bidder returns are significantly higher in stock acquisitions
when the target is more difficult to evaluate. Chang (1998) finds that higher stock payment is
related to higher bidder returns when the target is not a publicly listed company. These findings
are consistent with the notion that stock offers are a contingent pricing mechanism, which reduce
acquirer cash flow risk and enhance acquire shareholders’ value in the combined firm. In Eckbo
et al. (1990), target value uncertainty motivates bidders to pay in stock while bidder value
uncertainty motivates target to push for cash. The bidding company uses the proportion of
cash payment to signal the value of its own assets in place, as well as the value of deal synergy.
8
A higher proportion of cash payment indicates greater value and larger expected synergy. In
Berkovitch and Narayanan (1990), bidders use cash payment to pre-empt competition from
other bidders. Betton et al. (2008) and Chemmanur et al. (2009) provide empirical evidence,
consistent with these arguments.
Several early studies report that target capital gain tax significantly impacts the choice of
means of payment. Gilson et al. (1988) maintain that, in a cash offer, target shareholders have
to pay capital gain tax instantly after transaction, whereas in a stock offer, capital gain tax can
be deferred until later when stocks received in a transaction are sold. Hence, cash transactions
are more costly for target shareholders with higher capital gain tax. Consequently, bidders have
to pay higher premium to compensate for target shareholders’ tax loss. The empirical evidence
supporting this argument can be found in Carleton et al. (1983), Huang and Walkling (1987),
Eckbo and Langohr (1989), and Brown and Ryngaert (1991). Franks et al. (1988), however,
cast doubt on this view by showing that the premium on cash payment exists both before and
after the introduction of a capital gain tax in the UK.
Another strand of the literature demonstrates that means of payment is part of a broader
financing decision made by a company. Harford et al. (2009) find that acquirers with a leverage
ratio above their optimal one are more likely to use equity to finance the transaction. Uysal
(2011) shows that over-levered companies are less likely to make acquisitions; when they do,
they are less likely to offer cash. The author also finds that managers actively rebalance their
capital structure before making an offer to merge. Ross (1977) posits that company managers
are conscious about the increased bankruptcy costs when using debt to finance an investment.
Faccio and Masulis (2005) find financing constraints weakens a bidder’s ability to pay in cash.
In a recent study, Vladimirov (2015) argues that a stock offer is more costly for a bidder than
a cash offer. By offering lower premiums, bidders pass on the higher financing cost of stock
offers to targets.
Regarding the concern over corporate control rights, Stulz (1988) suggests that bidders with
private benefits of control rights are reluctant to dilute their holdings via a stock offer. The
empirical evidence in Amihud et al. (1990), Martin (1996), Ghosh and Ruland (1998), Chang
(1998), and Faccio and Masulis (2005) supports this view.
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Our paper is also related to a literature showing that merger waves are driven by stock market
valuation. Representative theoretical works include Shleifer and Vishny (2003) and Rhodes-
Kropf and Viswanathan (2004). Shleifer and Vishny (2003) build on the assumption that
bidder managers are value maximising and target managers have shorter investment horizon
than long-term investors. This leads to agency conflicts between short-term target managers
and long-term target shareholders. A target accepts overvalued bidder stock because short-term
managers are eager to cash out, which compromises the value of long-term shareholders. In
Rhodes-Kropf and Viswanathan (2004), both bidder and target managers are value maximising
for long-term shareholders. The target, however, does not know with certainty the bidder’s
stand-alone value and the value of merger synergies. When the bidder makes a higher stock
offer, the target attributes part of this offer to higher synergies and accepts the offer. In the
current paper, we investigate how the short-termism of target hedge fund shareholders impacts
merger payments. Our study, therefore, is more related to the model in Shleifer and Vishny
(2003).
2.2 Hedge funds, financial markets and real economy
The majority of studies on the impact of hedge funds on the real economy focuses on one
type of hedge funds, namely, the activists funds. The research spans the impact of activists
hedge funds on firm performance and productivity (Brav et al., 2008), its bondholders (Xu and
Li, 2010; Klein and Zur, 2011), and other related firms (Aslan and Kumar, 2016; Gantchev
et al., 2016), as well as performance of target firms in M&A deals which are subject to activism
(Boyson et al., 2017). All these papers come to the conclusion that hedge fund activism
enhances shareholder value by monitoring management and improving firm productivity. For
instance, using hand-collected data, Brav et al. (2008) find that the market reacts positively on
an activism announcement, reflecting the expected improvement in operational performance of
firms targeted by activist hedge funds. Although activist hedge fund play an important role in
making real economy firms more efficient, they are not the most common type of hedge funds.
According to the Hedge Fund Research (HFR) industry report5, as of the second quarter of 2015,
the assets under management of the activist hedge funds were about USD 130 billion, whereas
5https://www.hedgefundresearch.com/
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the total estimated size of the hedge fund industry over the same period was approaching USD
3 trillion. Our paper closes this gap in the literature by providing empirical evidence on how
broader classes of hedge funds impact real economy in the context of the market of corporate
control.
Another strand of literature finds evidence that hedge funds may manipulate the financial
market. Ben-David et al. (2013) show that stocks held by hedge funds exhibit positive abnormal
return on the day preceding the day, on which hedge funds are required to report their holdings
to the Securities and Exchange Commission (SEC). The next day, these stocks exhibit price
reversal. This pattern is stronger for more illiquid stocks and for funds with good past total
returns, poorer reporting return quality, history of price manipulation, and during quarters
with low market return. Cao et al. (2017), on the contrary, argue that hedge fund trading
improves the efficiency of stock prices, but not during the times when hedge funds experience
funding liquidity shocks.
Yet another line of research focuses on the predictive power of hedge fund holdings for future
stock returns, which reflects managerial stock picking skills. Using the 13F filings of 306 hedge
fund companies from 1980 to 2004, Griffin and Xu (2009) find only marginal evidence of hedge
fund outperformance relative to mutual funds, casting doubt on the claimed superior skills of
hedge fund managers. More relevant for our current study, they find that hedge funds have
twice as large turnover of their portfolio compared to mutual funds.
The opposite conclusion is drawn by Aragon and Martin (2012) who also use 13F filings of
250 hedge fund companies from 1999 to 2006 augmented with hand-collected option holding
data. They show that hedge fund stock holdings predict future returns and option holdings
predict both future returns and volatilities of the underlying stocks, pointing towards superior
stock picking skills of hedge fund managers.
Related results are obtained by Agarwal et al. (2013). The authors use the confidential
holdings6 from the 13F filings of 106 hedge fund companies from March 1999 to June 2007. They
show that funds are more likely to use confidential holdings if they are large, hold concentrated
6When filing their holdings to the SEC, reporting firms may request confidential treatment for some of theseholdings. They are then omitted from the filed 13F form, and the SEC reviews the request. In case of a requestdenial, the holdings must be reported in an amendment to the original form. In case of an approval, the holdingswill be reported in an amendment after the expiration of the confidentiality period.
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portfolios with high idiosyncratic risk, or follow Event Driven, Multi-Strategy, or Relative Value
Arbitrage strategies. The stocks from the confidential reports are more likely to be associated
with information sensitive events (such as mergers and acquisitions), and they exhibit higher
abnormal returns compared to other holdings reported in 13F filings. In contrast, the authors
do not find any evidence of managerial skill associated with “normal” holdings.
Cao et al. (2016) investigate managerial skills of merger-arbitrage hedge funds by examining
the changes of their holdings around mergers and acquisitions. The authors find that merger-
arbitrage hedge funds do not predict or affect deal outcome, but they have superior skill of
managing downside risk and are able to avoid bad deals. The focus of their study is quite
different from ours. They focus on the ability of merger-arbitrage hedge funds to profit from
M&As, while we are primarily interested in how hedge fund positions are related to essential
terms of a merger bid.
3 Research design and hypotheses development
Hedge funds are typically short-term investors (Griffin and Xu, 2009). This is also true in our
sample, where an average hedge fund rolls over its complete long equity portfolio trice every
year.7 With an exception of activists funds, they normally do not keep any control rights in
a firm over long horizon or intervene in company affairs. Thus, we exclude 1.5% of identified
activist funds from our sample. In a frictionless market with perfectly liquidity, such short-
term hedge fund investors should be indifferent between receiving bidder stock as payment or
the equivalent amount of cash, as they can instantly cash in on the open market. However,
multiple market imperfections, including price uncertainty, transaction costs, and liquidity
risk that leads to a potential price impact, may well induce target hedge fund shareholders to
prefer cash over stock. Specifically, short-termist hedge funds would avoid illiquid bidder stocks
because it is hard to liquidate these stocks without incurring a loss, due to the price impact of
trading (Amihud, 2002). Transaction costs also exacerbate the difficulty of trading (?). As is
show in Keim and Madhavan (1997), trading costs include both the costs due to unfavorable
7We discuss additional results in Section 5.6, which further illustrate short-termistic nature of hedge fundsin our sample.
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price impact and direct costs such as commissions. Such costs are economically significant and
increase with trading difficulties (e.g., when shares are less liquid).
At the same time, bidders also benefit more from a cash offer made to short-termist hedge
fund target shareholders, ceteris paribus. In particular, by catering to the hedge funds’ demand
for cash, bidders improve the chance of deal completion and minimize the associated uncertainty,
costs and risks (e.g., the extra managerial effort required over a prolonged transaction process
or a potential emergence of a competing bidder). A cash offer also preempts the possibility of
diluting the bidder’s control right via introducing a new block holder in a stock offer (Chang,
1998). Further, in case of a stock offer, a large amount of the bidder’s stock is expected to
be sold in the market shortly after deal completion. A cash offer would mitigate a potential
adverse impact on bidder stock. The rational above leads to our first hypothesis:
H1: Hedge fund holdings in a target before an M&A announcement increase the percentage
of cash in the consideration.
To test this hypothesis, we estimate a Tobit regression of the share (in percent) of cash
offered in consideration (pctcash) on the hedge fund holdings in a target (in percent of the
target’ shares outstanding) as of the last quarter prior to deal announcement (HFhold). We
control for an extensive list of variables (Controls), suggested by the the previous literature, as
well as year and industry fixed effects. We use heteroscedasticity and serial correlation robust
standard errors thought all the regressions.
Table 1 defines all the control variables in alphabetic order. Most of the variables are
either directly obtained from the respective databases, or are based on simple calculations.
The measures of bidder and target overvaluaition are more complicated. These variables are
measured as the ratio of the firm’s market value to its fundamental value.
The fundamental value is estimated using a residual income model following Lee et al.
(1999).8 We use a three-year horizon to calculate the terminal value of the firms, obtain the
discount rate for individual companies (re) based on 5 years (minimum 2 years) of prior monthly
returns and the CAPM, and winsorize the values at 1% and 99% before including them into
8The same model is used in Dong et al. (2006), too.
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the regressions.
In particular, we compute the fundamental value (V̂t) of a firm at time t as:
V̂t = Bt +FROEt+1 − re
1 + reBt +
FROEt+2 − re(1 + re)2
Bt+1 +FROEt+3 − re
(1 + re)2reBt+2 (1)
Here, Bt is the book value per share from the latest financial statement of the firm. FROEt+i
is the forecasted return on equity for period t + i, which is a ratio of forecasted earnings per
share (FEPSt+i) over the book value per share during the previous period (Bt+i−1). Bt+i is a
forecasted book value per share. It is estimated recursively as the previous book value per share
(Bt+i−1) plus forecasted earnings per share (FEPSt+i) minus forecasted dividends per share,
which is a κ share of FEPSt+i, with κ being the year t dividend payout ratio. All necessary
data are obtained from the I/B/E/S database.
Our main regression specification is similar to that used in Faccio and Masulis (2005) and
is as follows:
pctcashi =
0 if y∗i < 0
y∗i if 0 ≤ y∗i ≤ 1,
100 if y∗i > 1
(2)
y∗i = c+ γ HFholdi + β Controlsi + ε, (3)
ε ∼ Normal(0, σ2).
Here y∗i is a latent variable driving the observed share of cash offered (pctcashi), with the latter
being truncated by 0 and 1.
We have established hedge funds’ preference for cash payment in our above discussions. Two
alternative channels are possible which translate such preferences to a positive relation between
hedge fund holdings and the proportion of cash payment. Hedge funds may leverage on their
holdings and negotiate for cash payment (the negotiation channel). The alternative channel is
that hedge funds are able to predict the cash payment and take positions in targets accordingly
14
(the prediction channel). If this is the case, than higher hedge funds holdings before the deal
announcement predict cash payment, but do not actually cause it.
Table 1: M&A control variables
The table lists the control variables used in our empirical analysis. Sub-indices a/tof the listed variables throughout the paper indicate Acquiror/Target.
Variable Descriptionbharvw Buy-and-hold abnormal return over a 12-month period
stopping 2 months before announcement, relative to the value weighted nyse/amex/nasdaq indexbm Equity book to market ration, the last fiscal year before announcementlcap Natural logarithm of market capitalization ($mil), the last fiscal year before announcementcollateral Tangible assets over total assetsdfriend A dummy variable for a friendly dealddiv A dummy variable for bidder and target being from different industriesdivyield Dividend yieldfcf Ratio of free cash flow to total assetshhsalesic3 Sales-based Herfindahl-Hirschman index for 3-digit SIC codeinsthold Holdings of institutions other than hedge funds as of the last quarter before deal announcementlevmkt Market-value based leverageoverval Overvaluation measure on the announcement datepe Price earnings ratiopois d A dummy variable that takes a value of one if a target has a poison pill provisionphda Percentage held by acquiror in the target at deal announcementroa Return on assets (i.e., net income over total assets)saleg Sales growth in the past 3 yearsswap Swap dummy taking a value of one if at least 50% of the consideration is paid in bidder’s stocktend Tender offer dummy. 1 for tender offers and 0 otherwisevalpct Deal value in percent of acquiror market capitalization at the end of fiscal year before the deal announcement
In order to disentangle these alternative channels, we include three additional explana-
tory variables to Equation (2). The first one measures the change in hedge funds holdings
over a quarter preceding the last end-of-quarter reporting date before the deal announcement
(∆HFholdi,t−). A positive coefficient on this variable would indicate that hedge funds pre-
dict cash payment prior to deal announcement. The second variable measures the change in
hedge fund holdings over the course of deal negotiation (∆HFholdi,t+). More specifically, it
is computed as the change in hedge fund holdings between the last reporting end-of-quarter
date before the deal announcement and the last reporting end-of-quarter date before the deal
completion. Note, that this variable can be computed only for those deals, that have a report-
ing date within the negotiation period, reducing the sample available for this type of analysis.
A positive and significant coefficient on ∆HFholdi,t− would suggest that hedge funds predict
cash payment before the deal announcement. Whereas a positive and significant landing on
∆HFholdi,t+ would support the deal negotiation channel.
Hedge funds can enhance their influence on cash payment through coordinated voting in
shareholder meetings or through coordinated private communication with bidder and target
15
managers. Such coordination is easier when it involves a lower number of hedge funds, other
things being equal. Not only the cost of coordination among fewer hedge funds is smaller, but
also it its easier to monitor each other’s actions.9
Keeping hedge fund holdings constant, a smaller number of hedge fund shareholders also
further motivates bidders to offer more cash. First, when shares are concentrated in the hands
of a smaller number of target shareholders, the chances are higher that the bidder will have
a new block holder post M&A transaction. Second, a potential adverse price impact on the
bidder’s shares after deal completion can be expected to be stronger, as larger positions are
likely to sold simultaneously by fewer number of shareholders. Hence, higher concentration of
hedge funds holdings makes it easier for hedge funds to push for cash and motivates a bidder
to offer more cash, ceteris paribus. To test this corollary, we include in Equation (2) a dummy
variable that takes a value of one if the number of hedge funds holding the target is below
the sample median or zero otherwise, I(nhf<med). A positive coefficient on this dummy variable
would support the presence of the deal negotiation channel, too.
This leads to our three corollaries, which are tested using Equation (4) below:
Corollary 1 of H1: Higher changes in hedge fund holdings before an M&A announcement
increases the percentage of cash offered in consideration (prediction channel).
Corollary 2 of H1: Higher changes in hedge fund holdings during the negotiation period
increases the percentage of cash offered in consideration (negotiation channel).
Corollary 3 of H1: Smaller number of hedge fund holding a target before a M&A announcement
increases the percentage of cash offered in consideration (negotiation channel).
y∗i = c+ γ HFholdi + γ− ∆HFholdi,t− + γ+ ∆HFholdi,t+ (4)
+θ I(nhf<med) + β Controlsi + ε
Our discussion so far suggests that the key reason for hedge funds to push for cash payment
is their preference for liquidity. This would imply that the less liquid the bidder’s stock is,
9See Stigler (1964) for a similar view in the context of industrial monopolization.
16
the more attractive a cash offer becomes for short-term hedge fund shareholders. Hence, we
formulate the following hypothesis:
H2: The positive relation between pre-acquisition hedge fund holdings in the target firm
and the proportion of cash payment in consideration is more pronounced when the
bidder’s stock is less liquid.
To test this hypothesis, for each bidder we calculate the Amihud illiquidity measure (Amihud,
2002) based on the daily returns in the past 12 months. We then construct a dummy for illiquid
bidders, that takes a value of one if the bidder’s Amihud measure is above the sample median or
zero otherwise, I(Amihuda>med). We include the product of hedge fund holdings in the target and
the illiquid bidder dummy in Equation (4). We also interact the level of institutional holdings
(excluding hedge funds) with this dummy to test if bidder illiquidity has a different impact on
short-term and long-term shareholders’ strategies.
y∗i = c+ γ HFholdi + γ− ∆HFholdi,t− + γ+ ∆HFholdi,t+ (5)
+η HFholdi · I(Amihuda>med) + κ instholdi · I(Amihuda>med)
+θ I(nhf<med) + β0 I(Amihuda>med) + β Controlsi + ε.
Even though hedge funds are typically considered short-term investors, there is still consid-
erable heterogeneity among them in terms of investment horizon. Since the key hedge fund
characteristic relevant for our analysis is their investment horizon, we further isolate a group
of hedge funds with investment horizons shorter than the sample median. These funds can be
expected to have even stronger preference for liquidity and greater desire for cash payment. We
test the following corollary:
Corollary 1 of H2: The positive relation between pre-acquisition hedge fund holdings
in the target firm and the proportion of cash payment in the consideration
is more pronounced when the bidder’s stock is less liquid,
and hedge funds have especially short investment horizons.
17
To measure hedge fund investment horizon, we follow Griffin and Xu (2009) and Agarwal
et al. (2013). For each hedge fund we compute the average portfolio turnover (turn). The
measure captures the frequency with which hedge funds update their portfolio composition.
The higher the turnover, the more often a hedge fund revises its portfolio. Higher portfolio
turnover implies shorter holding periods of constituent stocks, and, hence, a shorter investment
horizon of a hedge fund. For each hedge fund, its turnover in quarter t is measured by averaging
across the previous T quarters the ratio of the minimum of sales and purchases in quarter τ
to the reported portfolio size at the end of the previous quarter PortSizeτ−1. The minimum
of purchases and sales is taken to capture the trading activity of a hedge fund, free from the
impact of flow driven trades.
turn = 1/T
tT∑τ=t1
min(Purchasesτ , Salesτ )
PortSizeτ−1
(6)
To test the corollary, we include holdings of hedge funds with average turnover above the
sample median and their interaction with a bidder illiquidity dummy as additional regressors
in Equation (5).
Some hedge funds, such as the ones following Event Driven, Multi-Strategy, and Relative
Value Arbitrage styles, often follow risk-arbitrage strategies and take advantage of event-specific
private information (Agarwal et al., 2013). These strategies involve taking long positions in
a target firm and simultaneously shorting a bidder’s stocks to cover the long positions in the
target, and are often implemented after a deal announcement. To close the trade and cash
out, such funds will eventually need to purchase the bidder’s stock on the open market. If the
bidder’s stock is less liquid, such purchases may lead to a price increase, partially offsetting
the gains. Thus, such event driven hedge funds would be less concerned about stock payment,
moreover, they are likely to benefit by receiving bidder’s stock as payment in an M&A deal.
They even have incentives to push for a stock payment, which are especially strong when
bidder’s stocks are illiquid. We test the corresponding corollary:
Corollary 2 of H2: The holdings of event driven hedge funds in a target before the
announcement decrease the percentage of cash offered in consideration,
if the bidder’s stocks are less liquid.
18
To tests this corollary, we compute the aggregate holdings of Event Driven, Multi-Strategy,
and Relative Value Arbitrage funds and include them as a separate explanatory variable
(EvDrHold) in Equation (5), together with the interaction term of this variable and the bidder
illiquidity dummy.
Our hypotheses so far suggest that the liquidity preference of short-termist hedge fund
investors leads to higher percentage of cash offered in M&A transactions. Is such higher cash
payment efficient for long-term shareholders? Following the Cadbury deal, concerns were raised
on the possible loss to long-term target shareholders due to hedge fund involvement. Cadbury’s
then second-largest shareholder, Legal&General, stated that the Cadbury’s management gave
in too easily and the final price did not “fully reflect the long-term value of the company”
(Financial Times, 12 March, 2010).
Shleifer and Vishny (2003), in their theoretical model, also highlight a strong conflict of
interests between short-term an long-term stakeholders. In particular, the model posits that
short-term stakeholders in target firms can rationally accept payment of overvalued bidder
stocks at the expense of long-term shareholders. In the context of our analysis, short-termist
hedge funds are less resistant to stock offers than other investors, because their desire to cash in
as soon as possible with a gain. Despite hedge fund preference for liquidity, they are well aware
of the possibility of a deal failure when payment terms cannot be agreed upon. No deal implies
zero gains for hedge funds. Thus, we can expect hedge funds to be more inclined to accept
overvalued stock of a bidder compared to other investors, in cases in which stock offers are
made. Here, hedge funds would trade a higher deal completion probability for inefficient means
of payment from the long-term investors’ point of view, which leads to our next hypothesis:
H3: The positive relation between pre-acquisition hedge fund holdings in the target firm
and the proportion of cash payment in the consideration is weaker, when the bidder
stock is overvalued.
Furthermore, the shorter the investment horizon of hedge funds, the greater the incentives
for hedge funds to cash in soon and the less resistant they are to stock offers. Similarly to
19
Corollary 2 of H2, event driven hedge funds may also prefer accepting overvalued bidder stock
as payment, as opposed to buying it in the open market and potentially inducing adverse price
movements. This leads to our last two corollaries:
Corollary 1 of H3: When bidder stocks are overvalued, the positive relation between
pre-acquisition hedge fund holdings in the target firm and the
proportion of cash payment in the consideration
is further weakened if hedge funds have shorter investment horizon.
Corollary 2 of H3: When bidder stocks are overvalued, the positive relation between
pre-acquisition hedge fund holdings in the target firm and the
proportion of cash payment in the consideration
is further weakened if holdings by event driven hedge funds are higher.
To test the hypotheses H3, we include in Equation (4) an interaction term between hedge
fund holdings and the measure of bidder overvaluation. To asses the potential differences in
the impact of bidder overvaluation on short- and long-term target shareholders, we also include
an interaction term of the institutional holdings and bidder overvaluation. To test the two
corollaries, we further add in the regression an interaction term of holdings of hedge funds with
higher-than-median turnover and bidder overvaluation, and an interaction term of holdings of
event driven hedge funds and bidder overvaluation, in turn.
4 Data
In this paper, we use three sets of data: (1) a sample of hedge funds from several commercial
databases, (2) hedge fund holding data from the 13F filings to the Security and Exchange
Commission (SEC), (3) a sample of M&A transactions with detailed information from the SDC
M&A database.
Our hedge fund sample is from the union of six major databases (Barclayhedge, CISDM,
Eurekahedge, Morningstar, TASS) previously used in Hodder et al. (2014). Large hedge fund
investment companies registered in the U.S. are required to report on a quarterly basis to the
SEC their long equity positions though the 13F form if the size of the investment company
20
exceeds USD 100 million, and its holdings in a US company either exceed 10,000 shares or
USD200,000 in market value. Since the holding data are on the company level, and hedge
fund companies often operate several hedge funds, we aggregate individual hedge funds in the
respective hedge fund companies. We follow Mattes (2011) and obtain the holding information
from the CDA database (Thomson Reuters, 13F filings). We use only those hedge fund com-
panies that do not have a mutual fund business, to make sure that we capture pure hedge fund
holdings in the target firms in our analysis. The sample period matches the one of the acquisi-
tion data set used and is from January 1995 to June 2009. Altogether, we have information on
1,050 hedge fund companies and 8,879,150 data points on holdings (each data point is uniquely
defined by a hedge fund company - quarter - security). 994 of those companies held at least
one of the target firms in our sample.
Table 2 reports the descriptive statistics of hedge fund holdings together with their portfolio
characteristics for those 994 hedge funds. A portfolio of an average fund has a value of over
USD2 billion and contains some 185 individual firms. The average quarterly turnover is 0.44,
implying that an average hedge fund completely changes its portfolio compositions almost twice
a year. Individual firms subject to take over attempts account for about 0.02% of the value of
the total hedge fund portfolio.
Table 2: Descriptive statistics of hedge fund portfolios
The table reports the descriptive statistics of hedge fund portfolios, including theaverage portfolio turnover (turn) and total portfolio size in billion USD (PortSize)based on 994 hedge funds that hold at least one target in our sample.
Mean STD 5% 25% 50% 75% 95%N firms held 185.17 355.57 6.04 36.35 71.98 181.50 759.99turn 0.44 1.73 0.02 0.14 0.26 0.45 0.80PortSize (billion USD) 2.15 9.48 0.01 0.15 0.38 1.13 7.35Target in HF port (%) 0.02 0.05 0.00 0.00 0.01 0.02 0.07
Our initial acquisition sample is from the Security Data Corporation (SDC) mergers and
acquisitions database. These acquisitions are completed or withdrawn between January 1995 to
June 2009. We only include the major types of acquisitions, namely, mergers and acquisitions
of majority interests.10 We require both the bidder and the target to be public firms, as the
10These transactions are defined by the SDC and are commonly used in M&A studies. In a merger, all sharesoutstanding of the target are acquired by the acquirer. In an acquisition of majority interests, the acquirerholds less than 50% of the target shares before the transaction and more than 50% after the transaction.
21
data on hedge fund holdings are available only for public firms. We require deal value to be
at least $1 million to ensure the deal is large enough to have price impact on the bidder. To
mitigate problems associated with recording error, we require the sum of the percentages of
stock, cash, and mixed payments to be between 95% and 105%. We also spoke to Thomson
One to verify that the means of payment reflect the figures of the final offer. We also exclude
targets that have multiple share classes with different voting rights. The initial sample contains
over 4,480 deals. When a target has multiple bids over the sample period, only the first one is
kept in the sample, to assure that the sample contains first time targets only. By this filtering
we lose 355 deals, which is about 7.9% of our sample. We use only those deals for which all the
variables used in our baseline analysis can be computed using the available data from CRSP
and Compustat, which results in a substantial sample reduction to 1,752 deals. We winsorize
all the variables at the 1% and 99% levels.
We use 6-digit CUSIP identifiers to match the firms in our M&A sample with the holdings of
hedge fund companies. As we explicitly focus on non-activists hedge funds, we further exclude
27 deals where the target was subject to an activist attempt from a hedge fund in the five years
preceding the deal. We identify the activist attempts from the 13D reports from the EDGAR
database of hedge fund companies in our sample. The final sample includes around 1,725 deals
and its descriptive statistics are reported in Table 3.
In our final sample, on average, 40% of the deal payment in made in cash and 52% in stock11,
85% of deals are completed, and 18% are executed though tender offer, and the negotiations
last on average 138 days. Hedge funds hold around 9% of the target stocks at the end of the last
quarter prior to deal announcement, and about 1.7% of target stocks is held by event driven
funds. Other institutional investors hold some 28% of the target stocks on average as of the
end of the last quarter prior to announcement.
5 Empirical results
We, first, perform a descriptive univariate analysis and sort all M&A deals into four portfolios
according to hedge fund holdings. We then move to an in depth multivariate analysis and
11Note, that one average another 8% of payment is made via “other” means of payment
22
Table 3: Descriptive statistics of M&A deals
The table reports the descriptive statistics of our final sample of M&A deals pctcashand pctstock are percentage of stock and cash offered in consideration; statcdumis an indicator variable that takes a value of one for successfully completed deals;duratoin is the length of negotiations in days; car2 t and car2 a and target and bid-der cumulative abnormal returns computed from two days before the announcementto two days after. Other variables are defined in Table 1.
Variable Mean Median Std. Dev. Min. Max. Npctcash 0.406 0.193 0.443 0 1 1,725pctstock 0.522 0.595 0.451 0 1 1,725statcdum 0.852 1 0.355 0 1 1,725duration 138.193 118 100.54 0 1,178 1,725car2 a -0.012 -0.010 0.085 -0.276 0.252 1,725car2 t 0.217 0.174 0.227 -0.235 1.023 1,725HFhold 0.092 0.056 0.102 0 0.438 1,725EvDrHold 0.017 0.005 0.027 0 0.135 1,725insthold 0.276 0.233 0.213 0 1.01 1,725fcf a 0.058 0.070 0.113 -0.544 0.266 1,725bm t 0.755 0.545 0.749 0.032 4.582 1,725bm a 0.589 0.414 1.523 0.003 52.554 1,725saleg t 0.222 0.112 0.43 -0.425 2.569 1,725lcap a 0.184 0.124 1.951 -6.293 6.348 1,725lcap t -1.793 -1.969 1.785 -7.018 4.446 1,725levmkt t 0.147 0.103 0.156 0 0.752 1,725tend 0.174 0 0.38 0 1 1,725ddiv 0.303 0 0.46 0 1 1,725dfrend 0.931 1 0.254 0 1 1,725collateral t 0.296 0.236 0.239 0 0.953 1,725valpct 0.462 0.227 0.664 0.012 4.897 1,725phda 1.302 0 6.637 0 88.2 1725overval t 5.926 1.841 6.995 0.025 17.286 1,725overval a 4.239 1.620 7.938 0.015 37.308 1,725
formally test our hypotheses.
5.1 Univariate analysis
Table 4 reports the descriptive statistics of the variables of interest across four groups of M&A
deals sorted in quartiles according to hedge fund holdings as of the last quarter prior to deal
announcement. Q1 contains 25% of deals with the lowest holdings, and Q4 contains the deals
with 25% highest hedge fund holdings. The last two columns report the difference in means
between Q4 and Q1, and the corresponding p-value from a t-test for the significance of the
difference.
23
The descriptive statistics are in line with our main hypotheses. The proportion of cash
payment monotonically increases from Q1 to Q4. The median percentage of cash offered is
44% for Q4, compared to 0% for Q1. The mean differences in the percentage of cash and stock
between Q4 and Q1 are statistically significant at the 1% level.
As for other variables, the deal completion probability increases from Q1 to Q4, but the
differences is not statistically significant. The probability of a tender offer increases from 12%
for deals with low hedge fund holdings (Q1) to 18% for deals with high hedge fund holdings
(Q4). The difference in significant at the 5% level. Deal duration monotonically decreases from
Q1 to Q4. The difference in average deal duration between Q1 and Q4 of is over 30 days and is
highly statistically significant. This finding is consistent with the view that higher hedge fund
holdings (thus a larger short-terminstic shareholder base) facilitate the process to complete an
M&A transaction sooner.
A notable pattern is apparent with respect to target overvaluation. It monotonically de-
creases from Q1 to Q4 (with the difference between Q1 and Q4 being significant at the 1%
level), suggesting that hedge funds tend to avoid overvalued targets. Such firms are less likely
to become takeover targets ex ante and offer less scope of gains for investors ex post. This
observation can also indicate that hedge funds possess stock picking skills and are less likely to
invest in overpriced stocks.
Abnormal returns for bidder and target do not seem to exhibit any pattern across the
quartiles, suggesting that the value implication of hedge fund involvement in M&As are unde-
termined on average.
24
Table 4: M&A deal characteristics sorted by HF holdings
The table reports the descriptive statistics of the key M&A variables together withthe measures of bidder and target overvaluation (overvala/t) for deals sorted intoquartiles based on the hedge fund holding as at the end of the last quarter priorto deal announcement (HFhold). Q1 contains deals with the lowest hedge fundholdings, Q4 contains deals with the highest hedge fund holdings. The last twocolumns report the mean difference and the corresponding p-value for two-samplet-tests for difference in means.
Q1 Q2 Q3 Q4 Q4-Q1Mean Median Mean Median Mean Median Mean Median Mean diff p-value
HFhold 0.00 0.00 0.03 0.03 0.10 0.10 0.24 0.22 0.24 0.00pctcash 0.37 0.00 0.38 0.00 0.40 0.21 0.48 0.44 0.11 0.00pctstock 0.55 0.67 0.55 0.72 0.52 0.58 0.47 0.45 -0.08 0.01statcdum 0.83 1.00 0.88 1.00 0.84 1.00 0.86 1.00 0.03 0.19tend 0.12 0.00 0.19 0.00 0.20 0.00 0.18 0.00 0.05 0.03duration 150.80 140.00 141.59 125.00 139.90 112.00 120.46 99.00 -30.34 0.00overval a 4.23 1.62 4.73 1.88 4.59 1.87 3.41 1.18 -0.82 0.11overval t 10.12 17.29 6.06 1.97 4.30 1.64 3.22 1.20 -6.90 0.00car2 a -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 0.00 0.89car2 t 0.22 0.17 0.21 0.17 0.21 0.17 0.22 0.18 0.00 0.77
25
5.2 Hedge fund holdings and the percentage of cash offered
Column (1) of Table 5 reports the estimation results of our baseline Tobit model specified
in Equation (2). The effects of the control variables are in line with the predictions of the
previous literature. In particular, large bidders, smaller targets, tender offers, and hostile deals
are associated with higher percentage of cash offered (see Faccio and Masulis, 2005, among
others).
Our main variable of interest (HFhold) is positively related to the percentage of cash offered,
with a coefficient of 1.06 (significant at the 5% level). For the deals in our sample, when hedge
fund holdings in a target increase by one standard deviation, the percentage of cash payment
in the consideration increases on average by three percentage points. This finding supports
our hypothesis H1, that larger hedge fund holdings in a target before the deal announcement
are linked to higher cash payments. Holdings of other institutional investors are also positively
associate with the percentage of cash. The magnitude of the coefficient is, however, smaller at
0.54. The marginal impact of an increase in hedge fund holdings is, thus, almost two times
larger than that of an increase in holdings of other institutions.12
The change in hedge fund holdings over a quarter preceding the last reporting date before
deal announcement (Column (2) of Table 5) has no material impact on the means of payment.
The coefficient on ∆HFholdt− is not statistically significant. This suggests that hedge funds
cannot predict merger payment or do not trade on their predictions before deal announcement.
The change in hedge fund holdings over the negotiation period (Column (3) of Table 5) has
positive and highly significant coefficient (1.69 with a t-statistics of 2.36). These results pro-
vide support to the notion that hedge fund target shareholders facilitate cash payments, if
not proactively seek ones. Including both changes in holdings simultaneously in Column (4)
confirms the results.
To test the corollary 3 of hypothesis H1, we report in Column (5) of Table 5 the estimation
12As a robustness check, we repeat the analysis including estimated probabilities of a positive share of cashoffered in consideration, share of cash over 50%, and all cash deals. The loadings on these probabilities arepositive and statistically significant, but our key result of the positive effect of hedge fund holdings on the shareof cash offered remains qualitatively the same. We also use a Heckman two-step procedure and estimate theprobability of non-zero hedge fund holdings in a target, and include this probability as an additional regressor.The estimated coefficient for this probability is not statistically significant, and our key regression results barelychange. These robustness checks alleviate any potential concerns of possible selection bias in our results.
26
results where a dummy variable is included, which takes a value of 1 if the number of hedge funds
holding the target is less than 6, the sample median. In Column (6) the results are reported
for the full specification. The loading on this dummy variable is positive and significant at the
5% level in the full model specification (0.24, t-statistics of 2.04). It supports our intuition
that a smaller number of hedge funds holding the target facilitates coordinated actions among
the funds, what places them at a stronger stance when negotiating for more cash payment.
This is consistent with the presence of the influencing channel. In other words, the hedge
funds concerted negotiation effort contributes to the positive relation between the hedge fund
holdings in a target and the proportion of cash payment.13
13As a robustness check, we include the average hedge fund holding in target before the deal announcementand also find a highly significant positive relation. This further confirms that highly concentrated hedge fundholdings increase the proportion of cash payment. The average holdings hide, however, the separate impact ofthe level of total holdings and the lower number of funds.
27
Table 5: Percentage of cash and hedge fund holdings
The table reports the estimation results of Tobit regressions of the percentage ofcash offered in consideration. HFhold stands for hedge fund holdings in a target asof the last reporting quarter before deal announcement. ∆HFholdt− is the changein the hedge fund holdings during the preceding quarter. ∆HFholdt+ is the changein the hedge fund holdings over the course of deal negotiation. Inhf<med is a dummyvariable taking a value of one if the number of hedge funds holding the target isbelow the sample median. ***, **, * indicate significance at the 1, 5, and 10% levelrespectively. Robust standard errors are in parentheses.
(1) (2) (3) (4) (5) (6)HFhold 1.06** 1.14*** 1.52*** 1.60*** 1.27*** 1.98***
(2.57) (2.67) (3.28) (3.41) (2.84) (3.91)insthold 0.54** 0.53** 0.37 0.36 0.57** 0.40
(2.31) (2.28) (1.48) (1.44) (2.39) (1.57)∆HFholdt− -0.59 -0.75 -0.75
(-0.51) (-0.60) (-0.60)∆HFholdt+ 1.69** 1.66** 1.76**
(2.36) (2.32) (2.44)Inhf<med 0.14 0.24**
(1.26) (2.04)fcf a -0.28 -0.28 -0.25 -0.25 -0.27 -0.24
(-0.83) (-0.84) (-0.71) (-0.73) (-0.81) (-0.70)bm t -0.10* -0.10* -0.11** -0.12** -0.09* -0.11*
(-1.79) (-1.81) (-1.98) (-2.00) (-1.72) (-1.87)bm a 0.04* 0.04* 0.03 0.03 0.04 0.03
(1.68) (1.67) (1.44) (1.43) (1.64) (1.37)saleg t 0.02 0.02 0.06 0.06 0.02 0.06
(0.24) (0.25) (0.61) (0.62) (0.24) (0.62)lcap a 0.19*** 0.19*** 0.17*** 0.17*** 0.19*** 0.16***
(5.17) (5.16) (4.22) (4.21) (5.17) (4.15)lcap t -0.35*** -0.35*** -0.33*** -0.33*** -0.33*** -0.30***
(-7.47) (-7.47) (-6.72) (-6.72) (-6.89) (-5.88)levmkt t -0.19 -0.19 -0.06 -0.06 -0.18 -0.07
(-0.67) (-0.67) (-0.21) (-0.21) (-0.66) (-0.23)tend 1.78*** 1.78*** 1.67*** 1.67*** 1.78*** 1.67***
(14.60) (14.60) (12.43) (12.42) (14.61) (12.45)ddiv -0.04 -0.04 -0.06 -0.06 -0.04 -0.06
(-0.40) (-0.40) (-0.63) (-0.63) (-0.40) (-0.63)dfrend -0.86*** -0.86*** -0.91*** -0.91*** -0.87*** -0.92***
(-5.15) (-5.15) (-5.48) (-5.49) (-5.15) (-5.49)collateral t -0.03 -0.03 -0.14 -0.14 -0.03 -0.14
(-0.12) (-0.13) (-0.60) (-0.60) (-0.12) (-0.59)valpct 0.21*** 0.21*** 0.15* 0.15* 0.21*** 0.15*
(2.83) (2.82) (1.88) (1.86) (2.85) (1.84)phda 0.00 0.00 0.00 0.00 0.00 0.00
(0.29) (0.26) (0.45) (0.41) (0.25) (0.34)overval t 0.00 0.00 -0.00 -0.00 -0.00 -0.00
(0.01) (0.02) (-0.03) (-0.00) (-0.02) (-0.07)overval a -0.01*** -0.01*** -0.01** -0.01** -0.01*** -0.01**
(-2.67) (-2.65) (-2.48) (-2.46) (-2.62) (-2.35)Constant -0.18 -0.19 -0.40 -0.41 -0.23 -0.51
(-0.49) (-0.53) (-1.09) (-1.12) (-0.64) (-1.37)(22.11) (22.11) (21.40) (21.40) (22.12) (21.41)
Year and industry FE yes yes yes yes yes yesPseudo R-sq 0.27 0.27 0.25 0.25 0.27 0.25Nobs 1725 1725 1558 1558 1725 1558
28
5.3 Bidder illiquidity
We now move to test Hypothesis 2 and its corollaries related to illiquid bidders. As is discussed
earlier, illiquidity makes bidder shares less attractive to short-termist hedge fund shareholders,
strengthening their preference for cash payment. The estimation results are reported in Table
6. We still use the full set of control variables, but since their estimated coefficients remain
qualitatively unchanged, we do not report them for the sake of brevity.
Supporting our intuition that illiquid bidder stocks are less attractive to hedge fund investors,
and bidders with illiquid stock should be more inclined to offer cash, we find that the positive
effect of hedge fund holdings on the proportion of cash payment is stronger when bidder stocks
are less liquid. The coefficient on the interaction term between hedge fund holdings and the
dummy for illiquid bidder stocks is positive (2.79) and significantly at the 1% level (Column
1). The coefficient on hedge fund holdings themselves (capturing the effect when bidder’s stock
is liquid) in this setting is no longer significant, indicating that hedge funds’ desire for cash is
much relieved when the bidder’s stock is liquid.14 Moreover, the loading on the product of other
institutional holdings and bidder illiquidity dummy is negative and significant. Longer-term
shareholders do not seem to be eager to give up control in the joint firm. In case of a cash
offer, they would need to purchase the shares of the bidder in the open market, which turns
to be costly for illiquid bidders. Thus, in such a case, longer-term institutional investors prefer
stock exchange as opposed to cash payments, revealing a conflict of interest between long- and
short-term shareholders.15
Event driven hedge funds are less concerned about stock offers and may even prefer stock
offer due to the arbitrage strategy they are following, as we discussed earlier. They can use
bidder’s stock received in payment to close out short positions established according to their
strategy. Such approach is more beneficial when bidder’s stock is less liquid, since event driven
hedge funds incur high trading cost when purchasing illiquid bidder shares from the open market
to close their positions. Column (6) of Table 6 reports a negative coefficient (–6.93, significant
14In unreported results, we also interacted changes in hedge fund holdings and the bidder illiquidity dummy,but neither of these interaction terms is statistically significant.
15Non-hedge-fund institutional investors are themselves heterogeneous with respect to their investment hori-zon and goals in M&As. Our results suggest that on average they are still longer-term investors, as comparedto hedge funds.
29
at the 10% level) on the interaction term between the holdings by event driven hedge funds
and the bidder illiquidity dummy. Thus, although in bidder illiquidity typically induces hedge
fund target shareholders to demand more cash, event driven hedge funds push for higher stock
proportion facing higher bidder illiquidity.
Columns 3 and 4 of Table 6 report the results for hedge funds with especially short investment
horizons – hedge funds with the average portfolio turnover above the sample median. Although
the coefficient on the product of the holdings of high-turnover hedge funds and the bidder
illiquidity dummy is large and positive (2.27 and 3.17), consistent with our intuition, it does
not have enough statistical support. It could be because the average portfolio turnover of hedge
funds with relatively lower turnover is still sufficiently high, given the average deal duration in
our sample of about 4 months.
30
Table 6: Percentage of Cash and HF Holdings for Illiquid Bidders
The table reports the estimation results of a Tobit regression for the percentageof cash offered. HFhold stands for hedge fund holdings in a target as of the lastreporting quarter before the deal announcement. ∆HFholdt− is the change in thehedge fund holdings during the preceding quarter. ∆HFholdt+ is the change inthe HF holdings over the course of deal negotiation. HighTurnHold captures theholdings of hedge funds with higher than the sample median turnover. EvDrHoldare holdings of event driven hedge funds. I(nhf<median) is a dummy variable taking avalue of one if the number of HFs holding the target is below median. I(Amihuda>med)captures those acquiring firms with stock illiquidity above the median. ***, **, *indicate significance at the 1, 5, and 10% level respectively. Robust standard errorsare in parentheses.
(1) (2) (3) (4) (5) (6)HFhold -0.22 0.41 -0.33 0.38 -0.57 -0.05
(-0.42) (0.67) (-0.42) (0.44) (-0.77) (-0.06)insthold 0.92*** 0.89*** 0.91*** 0.85** 0.93*** 0.89***
(3.06) (2.66) (2.99) (2.54) (3.07) (2.66)HFhold · IAmihuda>med 2.79*** 3.27*** 2.12** 2.31** 3.54*** 4.55***
(3.59) (4.07) (1.98) (2.06) (3.35) (4.20)insthold · IAmihuda>med -0.84** -1.04** -0.82** -1.02** -0.86** -1.08***
(-2.17) (-2.55) (-2.13) (-2.49) (-2.22) (-2.62)IAmihud a>med -0.06 -0.03 -0.06 -0.03 -0.06 -0.03
(-0.46) (-0.22) (-0.50) (-0.26) (-0.46) (-0.20)∆HFholdt− -0.73 -0.79 -0.88
(-0.64) (-0.67) (-0.79)∆HFholdt+ 1.63** 1.74** 1.66**
(2.27) (2.43) (2.32)Inhf<med 0.23* 0.24** 0.22*
(1.96) (2.09) (1.94)HighTurnHold 0.27 0.19
(0.17) (0.11)HighTurnHold · IAmihuda>med 2.27 3.17
(1.01) (1.35)EvDrHold 1.82 2.62
(0.73) (0.98)EvDrHold · IAmihuda>med -3.99 -6.93*
(-1.13) (-1.90)(22.16) (21.40) (22.12) (21.36) (22.15) (21.41)
Year and industry FE yes yes yes yes yes yesControls yes yes yes yes yes yesPseudo R-sq 0.27 0.26 0.27 0.26 0.27 0.26Nobs 1725 1558 1725 1558 1725 1558
5.4 Bidder overvaluation
Next, we test if, as suggested by Shleifer and Vishny (2003), hedge fund target shareholder
are less opposed to accepting overvalued bidder stock as payment. The results are reported in
Table 7, suppressing the coefficients of the control variables for the sake of space. We find a
negative and highly significant coefficient on the interaction term between bidder overvaluation
and hedge fund holdings. When acquisitions are motivated by bidders’ overvalued equity, the
31
tension between the bidder’s attempt to pay stock and the hedge funds demand for liquidity
increases. Shleifer and Vishny (2003) maintain that short-term managers eager to cash out
may compromise long-term shareholders’ value by accepting overvalue equity. In the same
spirit, our results show that short-termist hedge fund shareholders are more prepared to accept
bidder’s overvalued equity. This compromises long-term shareholders’ value, pointing towards
inefficiency of hedge fund involvement in M&A transactions. This is also in line with the view of
Gaspar et al. (2005) that firms with short-term investors have a weaker bargaining position. The
product of other institutional holdings and bidder overvaluation is not statistically significant,
pointing again to the existence of a conflict of interest between shareholders with different
investment horizons. These results support the theoretical model and indicate that indeed it
is short-term shareholders that are less opposed to overvalued bidder stock, and not long-term
shareholders.
Further looking into what types of hedge funds are more likely to accept overvalued bidder
stock, we see in Columns (5) and (6) a negative coefficient on the interaction term between the
holdings of the event driven funds and the measure of bidder overvaluation. Event driven funds
are more open to stock offers due to their short positions in bidders’ equity. Further, they are
less concerned about overvaluation, because they are likely to hold short positions in bidders’
shares.
Columns (3) and (4) of Table 7 provide further evidence of the importance of the invest-
ment horizon for determining means of payment. Offering overvalued stock would meet less
opposition from target shareholders, if those shareholders are hedge funds with shorter than
the median investment horizon. The coefficients of the corresponding intersection term are
negative of –0.11 and –0.34 (less cash is demanded) and significant at the 10% level for the full
specification in Column (4).16
16The absence of statistical support in Column (3) can be due to the fact that it is based on all deals, some ofthem took very short time to resolve, which was fast enough for hedge funds with an average turnover. Column(4), however, is based on deals with longer negotiation process. In this case the incremental impact of shorterinvestment horizon of some hedge funds becomes detectable.
32
Table 7: Percentage of Cash and Hedge Fund Holdings for Overvalued Bidders
The table reports the estimation results of a Tobit regression for the percentage ofcash offered. HFhold stands for HF holdings in a target as of the last reportingquarter before the deal announcement. HighTurnHold captures the holdings ofhedge funds with higher than the sample median turnover. EvDrHold are holdingsof event driven hedge funds. ∆HFholdt− is the change in the hedge fund holdingsduring the preceding quarter. ∆HFholdt+ is the change in the HF holdings over thecourse of deal negotiation. I(nhf<median) is a dummy variable taking a value of oneif the number of HFs holding the target is below median. overvala is the measureof bidder overvaluation, computed as a ration of the market value to the estimatedfundamental value following Lee et al. (1999) and Dong et al. (2006). ***, **, *indicate significance at the 1, 5, and 10% level respectively. Robust standard errorsare in parentheses.
(1) (2) (3) (4) (5) (6)HFhold 1.52*** 2.40*** 0.99 1.57** 1.31** 2.41***
(3.31) (4.40) (1.58) (2.29) (2.18) (3.50)insthold 0.48* 0.34 0.48* 0.33 0.46* 0.31
(1.90) (1.23) (1.93) (1.22) (1.84) (1.14)HFhold · overval a -0.12 -0.14* -0.09 -0.03 -0.05 -0.08
(-1.55) (-1.81) (-0.76) (-0.35) (-0.69) (-0.97)insthold · overval a 0.01 0.01 0.01 0.01 0.02 0.02
(0.47) (0.52) (0.39) (0.46) (0.95) (0.78)∆HFholdt− 0.18 -0.05 0.02
(0.14) (-0.04) (0.02)∆HFholdt+ 1.82** 1.93*** 1.83**
(2.51) (2.64) (2.53)Inhf<med 0.23** 0.23** 0.22*
(1.97) (2.01) (1.91)HighTurnHold 1.57 2.65**
(1.23) (1.98)HighTurnHold · overval a -0.11 -0.34*
(-0.57) (-1.82)EvDrHold 1.70 0.42
(0.85) (0.20)EvDrHold · overval a -0.68** -0.54*
(-2.55) (-1.88)Year and industry FE yes yes yes yes yes yesControls yes yes yes yes yes yesPseudo R-sq 0.27 0.26 0.27 0.26 0.27 0.26Nobs 1725 1558 1725 1558 1725 1558
In a nutshell, the actual composition of the payment in an M&A deal is influenced not only
by the usually discussed factors, for example, related to the expected synergies, but also by
the investment horizon and trading strategies of the target shareholders. Generally, liquidity
concerns of hedge funds holding a target induce these short-term investors to push for a higher
cash proportion, especially if the bidder’s stock is illiquid. At the same time, they are less
opposed to accepting overvalued bidder stock than long-term investors, and even more so if
their investment horizon is particularly short. A notable exception are event driven hedge
funds. Due to their particular arbitrage strategies that involve holding long positions in target
33
shares and shorting bidder shares, they push for a higher stock proportion if the bidder is
illiquid or overvalued.
5.5 Cumulative abnormal returns and the premium
As suggested by the literature discussed in Section 2, a higher percentage of cash is often
associated with a higher premium and a higher cumulative abnormal return (CAR) for the
target. Our results discussed so far indicate that hedge fund holdings in a target increase the
percentage of cash payment. However, from a hedge fund’s point of view, there is a clear trade-
off between the speed of deal completion and the price received. Negotiating a higher price
leads to a higher target CAR. Pushing for a faster deal completion, however, has the opposite
effect. The net effect may well be zero, as is found in our univariate analysis in Table 4.
Table 8 reports the estimation results for the regressions of bidder and target CARs over the
+/– 2 days around deal announcement, CARs over 30 days after the announcement, as well as
a premium paid.17 The premium is computed as a ratio of the deal value over the target market
value six weeks before deal announcement. We do not find any significant effect of hedge fund
holdings or their changes on the target CARs.18 At the same time, there is some marginal
evidence showing that higher hedge fund holdings and larger increase in hedge fund holdings
during deal negotiations lead to lower announcement returns of a bidder, and a smaller number
of hedge funds holding the target results in a higher premium paid.
The means of payment are often determined simultaneously with the premium, thus, as a
robustness check, we jointly estimate the proportion of cash in consideration and the premium
in a seemingly unrelated regression (SUR) framework following de La Bruslerie (2013). We find
very similar results with hedge fund holdings leading to a higher proportion of cash, but not
affecting the premium, which we do not tabulate for the sake of space.
17Note that the number of observations in these regressions is smaller as compared to our main specification,as CAR regressions require several additional control variables, which are not always available for M&A deals.
18We also re-estimate the regressions for the CARs and the premium for all-stock deals and all-cash dealsseparately, and do not find any significant results.
34
Table 8: Hedge Fund Holdings, CARs and Premium
The table reports the estimation results of OLS regressions for cumulative abnormalreturns for bidder and target +/– 2 days around deal announcement (car2 a andcar2 t), over 30 days after deal announcement (car5 a and car5 t), and a premiumpaid (prem). HFhold stands for hedge fund holdings in a target as of the lastreporting quarter before the deal announcement. ***, **, * indicate significance atthe 1, 5, and 10% level respectively. Robust standard errors are in parentheses.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)car2 a car2 a car5 a car5 a car2 t car2 t car5 t car5 t prem prem
HFhold -0.02 -0.08** -0.00 -0.05 0.06 0.06 0.01 -0.04 -25.03 -11.09(-0.88) (-1.98) (-0.09) (-0.66) (0.74) (0.59) (0.13) (-0.53) (-1.05) (-0.32)
insthold -0.00 0.02 0.01 0.03 -0.02 -0.01 0.01 0.01 -7.80 1.75(-0.06) (0.89) (0.55) (0.88) (-0.42) (-0.26) (0.29) (0.34) (-0.59) (0.11)
∆HFhold t− -0.05 -0.24 -0.26 -0.12 -1.94(-0.52) (-1.58) (-1.20) (-0.79) (-0.03)
∆HFhold t+ -0.19*** -0.15 -0.14 -0.06 -18.77(-3.36) (-1.61) (-1.00) (-0.66) (-0.40)
Inhf<med -0.01 -0.02 0.03 -0.02 14.65**(-0.91) (-1.26) (1.27) (-1.23) (2.03)
fcf a 0.02 0.02 0.19*** 0.20*** 0.13* 0.18** 0.11* 0.10 -35.91 -25.86(0.54) (0.50) (3.31) (3.05) (1.81) (2.37) (1.93) (1.64) (-1.21) (-1.26)
fcf t -0.05 -0.06* -0.05 -0.07 -0.05 -0.07 -0.10* -0.11* -44.58 -53.68**(-1.43) (-1.66) (-1.04) (-1.19) (-0.66) (-0.79) (-1.76) (-1.89) (-1.61) (-2.06)
bm t 0.00 0.00 -0.01 -0.01* -0.01 -0.01 -0.02** -0.02** 13.85*** 14.29***(0.13) (0.30) (-1.15) (-1.67) (-0.91) (-1.10) (-2.46) (-2.13) (4.85) (3.90)
bm a 0.00 0.00 0.00 0.00 -0.00 -0.00 0.00 0.00 -0.94 -0.98(0.85) (0.66) (0.16) (0.01) (-0.80) (-0.44) (0.09) (0.20) (-1.56) (-0.70)
saleg t -0.00 -0.00 0.01 0.01 -0.03* -0.03 0.02 0.03** -7.33 -9.72*(-0.30) (-0.01) (0.63) (0.68) (-1.74) (-1.64) (1.35) (1.97) (-1.63) (-1.74)
lcap a -0.00 -0.00 -0.01* -0.01 -0.00 -0.00 0.00 -0.00 -0.30 -0.07(-1.06) (-1.12) (-1.92) (-1.53) (-0.09) (-0.33) (0.37) (-0.07) (-0.17) (-0.03)
lcap t 0.01 0.00 0.01 0.00 -0.00 0.00 -0.00 -0.00 23.23*** 26.29***(1.58) (0.92) (1.48) (0.59) (-0.29) (0.42) (-0.19) (-0.39) (6.25) (8.59)
levmkt t 0.01 0.01 -0.07** -0.08** 0.02 -0.00 0.01 0.01 34.38 42.50**(0.45) (0.34) (-2.05) (-2.26) (0.28) (-0.04) (0.16) (0.26) (1.47) (2.20)
pe t 0.00 0.00 0.00 0.00 -0.00 0.00 0.00* 0.00* -0.03 -0.03(0.79) (1.07) (1.61) (1.55) (-0.33) (0.02) (1.78) (1.70) (-1.11) (-0.66)
roa t -0.03 -0.03 0.04 0.05 -0.01 -0.02 0.07* 0.09* -25.01 -25.67(-1.15) (-0.96) (1.00) (1.04) (-0.09) (-0.32) (1.69) (1.96) (-1.23) (-1.29)
divyield t -0.00* -0.00 0.01*** 0.01*** -0.01 -0.00 0.01* 0.01** -2.35*** -2.41*(-1.77) (-1.10) (2.94) (2.91) (-1.43) (-1.16) (1.96) (2.30) (-2.89) (-1.72)
bharvw a -0.02*** -0.02*** -0.06*** -0.06*** 0.00 0.00 -0.02 -0.02 -2.45 -2.93(-3.93) (-3.59) (-7.20) (-7.05) (0.27) (0.06) (-1.59) (-1.64) (-0.74) (-0.73)
ddiv 0.01 0.01 0.01 0.01 -0.01 -0.01 -0.02* -0.02 -0.62 -0.81(0.85) (1.12) (0.76) (0.77) (-0.39) (-0.33) (-1.77) (-1.28) (-0.13) (-0.14)
dfrend 0.00 -0.00 0.03 0.03 -0.00 -0.00 -0.03 -0.03 17.58** 20.24**(0.04) (-0.01) (1.25) (1.36) (-0.11) (-0.12) (-1.38) (-1.31) (2.56) (2.20)
collateral t 0.02 0.02 0.02 0.02 0.01 0.02 0.06* 0.08** -18.27 -28.17(0.85) (1.04) (0.73) (0.74) (0.22) (0.45) (1.69) (2.07) (-1.14) (-1.57)
valpct -0.01* -0.01* -0.02* -0.01 -0.00 -0.01 0.01 -0.00 5.95 6.84(-1.81) (-1.84) (-1.84) (-1.37) (-0.19) (-0.56) (0.56) (-0.01) (0.99) (1.33)
phda 0.00 0.00 0.00 0.00 -0.00*** -0.00*** 0.00 0.00 0.43 0.40(0.97) (1.03) (0.31) (0.48) (-2.68) (-2.84) (0.24) (0.58) (1.02) (0.98)
hhsalesic3 a -0.08* -0.08* 0.05 0.04 0.01 0.01 0.10** 0.10** 18.06 15.62(-1.95) (-1.76) (0.77) (0.58) (0.15) (0.23) (2.47) (2.19) (1.03) (0.71)
lm12 a 0.00* 0.00* 0.00 0.00 -0.00** -0.00** 0.00 0.00 0.79*** 0.78***(1.69) (1.77) (1.37) (1.19) (-2.31) (-2.20) (0.91) (0.74) (3.24) (4.32)
overval t -0.00 0.00 0.00 0.00 -0.00 -0.00 0.00 0.00 0.33 0.40(-0.23) (0.15) (0.70) (0.63) (-0.01) (-0.32) (1.10) (1.31) (1.43) (1.01)
overval a 0.00 0.00 -0.00 -0.00 -0.00 -0.00 -0.00 -0.00 0.11 0.17(0.39) (0.17) (-0.44) (-0.30) (-0.24) (-0.45) (-0.30) (-0.47) (0.60) (0.58)
pois d -0.00 -0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00(-0.22) (-1.21) (1.25) (0.62) (0.11) (0.69) (1.54) (1.36) (0.28) (0.22)
Constant 0.01 0.01 -0.02 0.00 0.20*** 0.22*** -0.01 0.02 46.18** 44.12(0.38) (0.37) (-0.47) (0.04) (3.40) (2.99) (-0.29) (0.33) (2.22) (1.60)
Year and industry FE yes yes yes yes yes yes yes yes yes yesR-sq 0.23 0.24 0.24 0.25 0.22 0.25 0.18 0.19 0.37 0.39Nobs 1456 1322 1456 1322 1455 1321 1455 1321 1455 1321
35
5.6 Extended analysis of hedge fund short-termism
In this section we report some further results, which are not directly related to the means
of payment, but rather highlight the short-term nature of hedge fund target shareholders.
In particular, we examine the relation between hedge fund holding and the deal completion
probability, the probability of a tender offer, and deal duration.
If hedge funds are indeed short-term investors, interested in speedy money recovery, they
prefer to resolve the deal faster and facilitate the negotiations, resulting in a higher deal com-
pletion probability and shorter deal duration. As hedge fund holdings in targets are observed
before the announcement, they may affect the strategy of the bidder. Knowing that hedge
funds are eager to exit faster and do not wish to participate in the governance of the joint
firm, a bidder expects them to be willing to sell the target shares in response to a tender offer.
Thus, the probability of a tender offer should increase with hedge fund holdings. The univariate
results reported in Table 4 support this intuition.
We estimate logit models for the probabilities of deal completion and tender offer, and
OLS regressions (with heteroscedasticity and serial correlation robust standard errors) for deal
duration.
The results reported in Table 9 show that hedge fund holdings increase the probability of
a tender offer. The coefficient varies from 3.42 to 4.21 depending on the specification and is
statistically significant at least at the 5% level. Hedge fund holdings also reduce deal duration,
with the coefficient varying from of −123.29 to −97.88 being significant at least at the 5% level.
Increasing hedge fund holdings by one standard deviation decreases deal duration by over 12
days. Hedge fund holdings do not affect the deal completion probability or announcement
returns, which is consistent with the findings in Cao et al. (2016) for merger-arbitrage funds.
36
Table 9: Hedge Fund Holdings and M&A Deal Characteristics
The table reports the estimation results of a Logit model of the probability of dealcompletion (Column (1)), a Logit model for the probability of a tender offer (Column(2)), and OLS regressions for deal duration (Column (3)). HFhold stands for HFholdings in a target as of the last reporting quarter before the deal announcement.∆HFholdt− is the change in the hedge fund holdings during the preceding quarter.***, **, * indicate significance at the 1, 5, and 10% level respectively. Robuststandard errors are in parentheses.
(1) (2) (3) (4) (5) (6)statcdum tend duration
HFhold -2.21 -3.83** 3.42*** 4.21** -123.29*** -97.88**(-1.55) (-2.24) (3.03) (2.39) (-4.14) (-2.37)
insthold 0.97 0.74 2.61*** 1.44* -64.34*** -46.46**(1.41) (1.07) (4.50) (1.85) (-3.80) (-2.36)
∆HFholdt− -1.02 -3.64 154.79*(-0.27) (-1.03) (1.93)
∆HFholdt+ -4.16** -3.65 57.14(-2.09) (-1.53) (1.11)
Inhf<med -0.10 0.01 25.44***(-0.31) (0.02) (2.75)
fcf a -0.29 -0.02 1.66* 1.95* -55.65 -49.29(-0.29) (-0.02) (1.86) (1.93) (-1.55) (-1.29)
fcf t -0.85 -0.39 -0.67 0.14 -9.64 -22.46(-0.71) (-0.31) (-0.74) (0.10) (-0.28) (-0.62)
bm t -0.37** -0.38** -0.06 -0.06 14.65** 16.48***(-2.16) (-1.97) (-0.44) (-0.41) (2.53) (2.66)
bm a 0.31 0.36 -0.06 -0.03 1.13 1.07(0.86) (0.87) (-1.01) (-0.80) (1.22) (1.04)
saleg t -0.37* -0.38 0.33* 0.32 -13.19* -12.53*(-1.73) (-1.54) (1.73) (1.31) (-1.95) (-1.66)
lcap a 0.46*** 0.55*** 0.34*** 0.42*** -7.04*** -6.65**(3.12) (3.26) (4.05) (3.76) (-2.61) (-2.22)
lcap t -0.39** -0.50*** -0.58*** -0.68*** 22.25*** 24.99***(-2.52) (-2.62) (-5.65) (-4.73) (5.99) (5.85)
levmkt t 0.02 0.67 -0.53 -0.84 40.69 49.59(0.03) (0.78) (-0.67) (-0.88) (1.35) (1.60)
pe t -0.00 0.00 -0.00** -0.00** -0.08 -0.06(-0.00) (0.20) (-1.98) (-2.31) (-1.47) (-1.03)
roa t 0.40 0.07 0.49 0.24 8.18 12.26(0.43) (0.07) (0.73) (0.23) (0.35) (0.50)
divyield t 0.11 0.08 0.10** 0.05 -3.97*** -3.77***(1.27) (0.82) (2.10) (0.95) (-3.19) (-2.86)
bharvw a 0.17 0.26 -0.36** -0.38* -0.12 -0.88(0.78) (1.09) (-2.11) (-1.85) (-0.02) (-0.16)
ddiv -0.51* -0.33 -0.09 0.22 -4.54 -6.81(-1.90) (-1.16) (-0.40) (0.84) (-0.68) (-0.97)
dfrend 3.25*** 3.21*** -0.87*** -1.32*** 14.39 22.36(9.32) (9.06) (-2.76) (-3.53) (0.96) (1.42)
collateral t 1.49* 1.33 -0.92 -0.40 -23.88 -33.18(1.68) (1.38) (-1.17) (-0.39) (-1.14) (-1.49)
valpct -0.25 -0.03 0.49*** 0.68*** -12.10* -11.99*(-1.06) (-0.12) (2.90) (3.12) (-1.91) (-1.74)
phda -0.02* -0.02 0.00 0.02* 0.93 0.58(-1.68) (-1.51) (0.20) (1.71) (1.26) (0.89)
hhsalesic3 a 0.45 0.18 -0.26 0.30 16.31 8.49(0.47) (0.17) (-0.29) (0.29) (0.62) (0.31)
lm12 a 0.00 0.00 -0.02 -0.02 0.46 0.48(0.19) (0.02) (-1.39) (-1.17) (1.42) (1.46)
overval t 0.01 0.00 -0.01 -0.03 0.72 0.67(0.38) (0.06) (-0.61) (-1.29) (1.27) (1.13)
overval a 0.02 0.02 -0.01 -0.00 0.07 0.13(1.30) (1.28) (-0.52) (-0.12) (0.20) (0.35)
Constant -1.43 -2.44* -0.82 -1.79 142.62*** 123.09***(-1.06) (-1.67) (-0.68) (-1.29) (4.46) (3.00)
Year and industry FE yes yes yes yes yes yesPseudo R-sq 0.32 0.32 0.20 0.24R-sq 0.27 0.30Nobs 1136 1000 1166 965 1456 1322
37
6 Conclusion
The involvement of hedge funds – intrinsically short-term investors – in the market for corporate
control has led to heated discussions in press. Yet little has been done in academia to examine
their impact in a systemic manner. In this paper, we study how hedge fund holdings in target
firms affect the means of payment – an essential transaction term that has serious consequences
for corporate control, tax, financing and cash flows to the bidder and target.
We find the proportion of cash payment increases in hedge fund holdings before the deal
announcement. The relation is particularly pronounced when bidder’s stock is illiquid, suggest-
ing that hedge funds’ short-termism results in strong preference for liquidity. We further find
that hedge funds facilitate cash payments, rather than predict them. The percentage of cash
offered increases if hedge funds accumulate more target shares during the negotiation process.
It is also higher, if hedge fund shareholders can coordinate their actions more easily. Keeping
the level of holdings unchanged, a smaller number of hedge funds involved in a target leads to
a higher percentage of cash offered.
One particular group of hedge funds – event driven funds – is, however, very distinct. These
funds often implement arbitrage strategies involving long positions in targets and simultaneous
short positions in bidders. To close such a trade, these funds need to eventually acquire the
bidder’s stock. This gives them less incentives to push for cash payment in an M&A deal,
especially if they can expect a strong price impact on the bidder’s stock in the future, when
repurchasing it. We show that holdings of event driven funds are negatively related to the
proportion of cash offered by illiquid bidders.
Further evidence point to the inefficiency of hedge fund involvement. Hedge funds in general,
and high-turnover and event driven hedge funds in particular, are more prepared to accept
bidders overvalued equity as payment, supporting the theoretical predictions by Shleifer and
Vishny (2003). Moreover, we find that, although higher hedge fund holdings increase the
proportion of cash payment, they do not improve target announcement returns or premiums,
contrasting with the expectations that cash payment increases merger premium (Gilson et al.,
1988; Betton et al., 2008; Vladimirov, 2015). This indicates that hedge funds are willing to
trade in higher premium for more liquidity. Both of the above observations suggest that hedge
38
fund involvement may compromise the value of long-term shareholders.
Overall, this study enhances our understanding of the impact of hedge funds on the real
economy in the context of the market for corporate control. We conclude that hedge fund
involvement significantly affects merger payment in a way that is inefficient to long-term share-
holders of the target company.
39
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