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.

4

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.

11

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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