CFGT-3: Blockholders and Investor Activism: Theory
Large Shareholders and Financial Distress
The Wharton School, University of Pennsylvania, United States of America
I examine large shareholders' externalities on other claim holders when firms are financially distressed. I develop a tractable dynamic model of the interplay between these blockholders and regular equity holders. Blockholders' information acquisition and investment decisions play a pivotal role in distressed firms’ access to finance, affecting both total firm value and its distribution across claims. The impact on distress costs is non-monotone; whereas blockholders' information exacerbates debt overhang for intermediate levels of distress, it increases firms' survival chances in deep distress. These findings reveal that frictions delaying block acquisitions to "last minute" rescue interventions can in fact be efficiency-enhancing.
Dark Knights: The Rise in Firm Intervention by CDS Investors
1Scheller College of Business, Georgia Institute of Technology; 2Warwick Business School, University of Warwick
We document an increase in cases where credit default swap (CDS) investors intervene in the restructuring of a distressed firm. In our theoretical analysis, we focus on the case of intervention by protection sellers and show that—contrary to popular belief—it is not reducing firm value. Allowing a protection seller to intervene, while ex post costly to the protection buyer, also reduces the probability of costly liquidation. As a result, ex ante borrowing costs go down, and investment and firm value both increase. Under certain assumptions, investment reaches first-best. One counter-intuitive result is that even though the probabil- ity of liquidation is zero, the lender buys CDS protection and the CDS spread is positive. Asymmetric information between protection buyers and sellers can de- stroy this beneficial equilibrium, and we argue that improved transparency in the CDS market can restore it. Our results suggest that the empty creditor problem could be partially solved by protection seller-intervention.
Blockholder Disclosure Threshold and Hedge Fund Activism
1University of Bristol, United Kingdom; 2University of Illinois; 3University of Warwick
Hedge fund activists discipline corporate management in exchange for trading profits obtained by secretly acquiring shares in target companies prior to intervention. We show how blockholder disclosure thresholds regulate market transparency and hence the extent of activism. We characterize how disclosure thresholds structure the complex interactions between (a) initial investors in a firm---who value the value-enhancing disciplining effects of activism on management, but incur costs trading with activists who know their own value-enhancing potential; (b) activists---who value higher thresholds when establishing equity stakes, but incur costs if high thresholds reduce real investment or discourage managerial misbehavior; and (c) firm managers---who weigh private benefits of value-reducing actions against potential punishment if activists intervene. When managerial behavior is sufficiently unresponsive to threats of activism, initial investors and society value tighter disclosure thresholds than activists whenever the costs of activism tend to be low, making the probability of activism insensitive to the level of activist trading profits. In contrast, activists value tighter thresholds when managerial behavior is responsive to potential activism.