The Returns to Hedge Fund Activism in Germany

Date01 January 2015
Published date01 January 2015
DOIhttp://doi.org/10.1111/eufm.12004
European Financial Management, Vol. 21, No. 1, 2015, 106–147
doi: 10.1111/eufm.12004
The Returns to Hedge Fund Activism
in Germany
Wolfgang Bessler
Center for Finance and Banking, Justus-Liebig-University Giessen, LicherStrasse 74,
35394 Giessen, Germany
E-mail: Wolfgang.Bessler@wirtschaft.uni-giessen.de
Wolfgang Drobetz
Institute of Finance, University of Hamburg, Von-Melle-Park 5, 20146 Hamburg,Germany
E-mail: Wolfgang.Drobetz@wiso.uni-hamburg.de
Julian Holler
Center for Finance and Banking, Justus-Liebig-University Giessen, LicherStrasse 74,
35394 Giessen, Germany
E-mail: Julian.Holler@wirtschaft.uni-giessen.de
Abstract
Recent regulatory changes in the German financial system shifted corporate
control activities from universal banks to other capital market participants.
Particularly hedge funds took advantage of the resulting control vacuum by
acquiring stakes in weakly governed and less prof itable firms. We document
that, on average, hedge funds increased shareholder value in the short- and
long-run. However, more aggressive hedge funds generated only initially higher
returns and their outperformance quickly reversed, whereas non-aggressive hedge
funds ultimately outperformed their aggressive peers. These findings suggest that
aggressive hedge funds attempt to expropriate the target firm’s shareholders by
exiting at temporarily increased share prices.
Keywords: Corporate governance,hedge funds,event studies,long-run perfor-
mance
JEL Classification: G14, G30, G23
We are grateful to two anonymous referees, John Doukas (the editor), G ¨
unter Franke, Vijay
Jog and Ike Mathur as wellas participants at the European Financial Management Conference
in Athens 2008, the INFINITI Conference on International Finance in Dublin 2008, the
Portuguese Finance NetworkConference in Coimbra 2008, the Norther n FinanceAssociation
Meeting in Kananaskis Village 2008, the Annual Meeting of the Verein f ¨
ur Socialpolitik
in Graz 2008, the Financial Management Association Meeting in Forth Worth 2008, the
Symposium on Finance, Banking, and Insurance in Karlsruhe 2008, the International Tor
Vergata, Conference on Banking and Finance in Rome 2008, the Conference of the Swiss
Society for Financial Market Research in Geneva2009, and the Midwest Finance Association
Conference in Chicago 2009 for helpful comments and suggestions.
C
2013 Blackwell Publishing Ltd
© 2013 John Wiley & Sons Ltd
The Returns to Hedge Fund Investments in Germany 107
© 2013 John Wiley & Sons Ltd
1. Introduction
The German corporate governance system has traditionally been regarded as the
archetype of a universal banking system and as a prime example of what Franks
and Mayer (2001) describe as an insider-controlled and stakeholder-oriented system.
Until recently, banks have been part of the corporate governance coalition together
with family investors and a firm’s labour force. In addition to their role as long-term
lenders, banks owned large equity stakes in German firms, and financial analysts were
usually bank-employed. Moreover, universal banks exercised substantial influence over
German firms by being members of supervisory boards as a result of their equity stakes
but also by acting on behalf of investors through voting proxies. It was not unusual
for banks to represent the majority of votes in shareholder meetings (Baums and von
Randow, 1995), and as such, the German financial system has also been viewed as a
bank-based financial system (Allen and Gale, 2000), in which universal banks had a
long-term oriented influence on corporate control. This consensus-based approach is in
sharp contrast to the US market-based financial system with its history of shareholder
activism (Holderness and Sheehan, 1985; Gillan and Starks, 2007).
The German corporate governance system has been characterised for decades by a
consistent and efficient structure, in the sense that it was composed of complementary
elements which accommodated each other and helped to create a stable environment
(Schmidt, 2004). The role of banks and their influence on corporate Germany, however,
havechanged dramatically during the last decade for a number of reasons. First, Germany
has experienced substantial growth of its capital markets. In particular, the introduction
of the Euro has integrated the German capital market into the European and global
financial markets (Pagano and von Thadden, 2004), and in response most large German
banks have started to expand their investment banking activities. Second, the German
government has provided banks and other corporations owninglarge blockholdings with
substantial tax incentives for reducing their equity stakes in German firms. After a new
company tax law was enacted on January 1, 2002, the significant reductions in direct
shareholdings and cross-ownership bybanks and other cor porations haveled to an inflow
of foreign capital with the result that foreign ownership now exceeds 50% in more than
half of the German firms included in the blue-chip index DAX (Weber, 2009). Finally,
shareholdings have become widely dispersed. The median free-float among DAXf irms,
for example, increased from 75% to more than 90% between 2000 and 2006, and only
a few DAX firms are left with major blockholders (e.g., Deutsche Telekom, Deutsche
Postbank, Volkswagen, Metro, and BMW).
One negative consequence of the increased ownership dispersion is the dramatic
decrease in shareholder participation in annual shareholder meetings over the last decade.
The average attendance rate for German blue-chip firms has declined to around 50%
(as measured by the number of shares).1This trend implies that a single shareholder or
a group of small shareholders ‘acting in concert’ can influence, determine, or enforce
corporate decisions. Another consequence is that activist shareholders have increasingly
1The German government discussed measures to reverse this trend of declining attendance
rates, e.g., by paying higher dividends to shareholders that participate in the annual general
meeting (B¨
orsenzeitung, 9 June 2005, p. 7, ‘Berlin scheut vor Beschr¨
ankungen von Hedge
Funds zur¨
uck’). Although none of these measures were actually implemented, there has
nevertheless been a significant reversal in the attendance rates most recently.
Wolfgang Bessler, Wolfgang Drobetz and Julian Holler
108
© 2013 John Wiley & Sons Ltd
advanced to control and govern corporate Germany. The divestment of blockholdings
by banks and other blockholders has been facilitated by the abolition of capital gains
taxes for corporations selling their shareholdings. Ironically, one political intention of
this change in the tax law was to reduce the power of banks and their influence on the
German industry, and to break up ‘Germany Inc.’ (B¨
orsenzeitung, 24 October 1998).
However, one could argue that this strategy has backfired because it allowed activist
shareholders, such as hedge funds and private equity funds, to acquire stakes and voice
their concerns without much opposition in the corporate governance of German firms.
Given the historical development of the German corporate governance system, one
could hypothesise that the impact of the changes in corporate control and shareholder
activism on firm performance should be more pronounced in Germany than in most other
countries. Because the old governing coalition was not always focused on increasing
shareholder value and often pursued its own interests, significant conflicts of interest
with outside shareholders were created. In our analysis, we therefore emphasise the
role of hedge funds as investors and examine the performance of German firms that
were targeted by hedge funds. We focus on the performance impact of hedge funds
in the post-reform environment, which allows us to infer whether they constitute an
effective mechanism for exercising corporate control in Germany.
Many German firms have become targets of hedge funds with varying degree of
success as measured by their share price performance (e.g., Deutsche B¨
orse, TUI, Cewe
Color, Freenet,Balda, Techem, M¨
unchener R¨
uck, and Heidelberger Druck). These events
have sparked an intense debate about corporate control and, in particular, about the
activities of hedge funds in Germany.Politicians, unions, and many corporate managers
uniformly argue that investors with limited stakes should not be allowed to control or
even influence key strategic and financial decisions. Based on the assumption that these
investors focus on short-term profits to the detriment of the long-term success of their
target firms, the German government tried to persuade other countries to take action.2
While new global regulatory rules may still be under development in response to the
current financial crisis, some legal reforms have already been initiated in Germany. For
example, the Risk Limitation Act (‘Risikobegrenzungsgesetz’), which became effective
in February 2007, requires more disclosure, thus making it more difficult for active
shareholders to ‘act in concert’ and to exercise pressure on corporate management.3
Proponents of a capital market-oriented corporate governance system usually discard
the arguments against corporate governance activities of hedge funds. First, theyassume
that hedge funds cannot use their relatively small stakes to effectively impose their will
upon target firms, unless they gain support from other shareholders by gathering the
majority of votes. Second, in efficient capital markets, hedge funds should not be able
to create shareholder value in the short-term if their actions fail to improve the target
firms’ long-term perfor mance. If hedge funds can exercise their influence with small
shareholdings, a major question is whether their activities have a positive or a negative
impact on firm value in the short- and long-run.
Based on a sample of 231 events in Germany during the period between January
2000 and December 2006, we document that hedge funds tend to acquire stakes in firms
2B¨
orsenzeitung, 16 May 2007, p. 3., ‘Hedgefonds-Initiative stockt’.
3Forexample, investors must reveal the purpose of an investment as soon as their accumulated
stakes exceed 10% of voting rights, bringing German reporting rules closer to US regulation.

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