Why board diversity makes a company a target for activist hedge funds

Diversity on a company board is a good thing but it can attract activist hedge funds that might push for a restructuring or a change of strategy, reveals new research from Rotterdam School of Management, Erasmus University (RSM).

The researchers, Dr Mark R. DesJardine of Tuck School of Business, Prof. Wei Shi of the University of Miami, and Dr Emilio Marti, Assistant Professor at RSM, studied hedge fund campaigns in the U.S. over a period of nine years, focusing on companies with poor governance and poor performance because activist hedge funds are particularly likely to target these.

Their research reveals that demographic diversity in board members makes it much more likely that activist hedge funds target firms with governance or performance problems. For firms with governance problems, the likelihood of targeting increases from 1.7% for boards with low demographic diversity to 5% when the board is highly diverse. For firms with performance problems, the likelihood of targeting increases from 1.3% to 5.1%.

Dr Emilio Marti says: “While demographically diverse boards are more effective under normal circumstances, diverse boards mean that decision-making is slower and that unity may be lower. Both benefit activist hedge funds. Slow decision-making means that activist hedge funds get a head start in mobilizing other shareholders. And less unity makes it more likely that activist hedge funds can make alliances with some board members. These benefits make companies with demographically diverse boards attractive targets for activist hedge funds.”

The study has important implications for (1) asset owners and (2) policy makers who want to safeguard the advantages of having boards with demographic diversity: boards like this bring different perspectives, tend to develop more innovative strategies, spot more promising opportunities, and monitor management more effectively compared to less diverse boards.

(1)Lots of people and organisations invest in activist hedge funds through their regular pension funds and endowments. The insights of the study suggest that asset owners who see the benefits of board demographic diversity may need to rethink where they invest their money.
(2)The implication for policy makers is to give boards additional time to respond to activist hedge funds if they want to encourage greater demographic diversity in company boards. In 2021, the Netherlands adopted such an approach by allowing boards to initiate a “cooling off period” of up to 250 days in confrontations with activist shareholders.

Their research paper, The Corporate Opportunity Structure for Shareholder Activism: How Activist Hedge Funds Exploit Board Demographic Diversity, is to be published in Organization Science and is available open access.

/ENDS

For more information, a copy of the research paper, or to speak with the researchers, contact Kate Mowbray at BlueSky PR on Kate@bluesky-pr.com or call +44 710022871