Political influence in hedge fund activism: Causal evidence from U.S. gubernatorial election

Abstract This study examines the causal impacts of political influence on hedge fund activism in an exogenous setting of U.S. gubernatorial election. Local incumbent politicians have incentives to protect local inefficient firms from being targeted by activists because activism could lead to divestment and local worker layoffs. And such incentives can become weaker in election years because political competition increases the incumbent politician’s accountability to broader groups of stakeholders. Consistent with this prediction, the likelihood of local firms being targeted by activists is shown to be significantly higher during election years. Moreover, the firm’s political connections mitigate the effects of election, suggesting that politicians still maintain protection to connected firms. Further cross-sectional tests show that the effects of election are stronger (1) for firms with lower labor intensity, severer problem of free cash flow and lower efficiency, and (2) when the political competition is fiercer. Additional tests reveal that hedge fund activism enhances the target firm’s operating performance and creates larger value for investors when it faces weaker political influence. To sum up, our findings suggest that political influence affects hedge fund activism and the activists strategically adjust the timing of initiating campaigns according to the changes of such influence.