Capital Markets and Corporate Control: Empirical Evidence from Hedge Fund Activism in Germany

Since the beginning of this century the German financial system has changed from an extreme universal banking system to a more financial market oriented system in various aspects. Most importantly and most visibly, the corporate governance and corporate control structure underwent substantial changes. In fact, hedge funds and other activist investors are increasingly taking advantage of a control vacuum within the ownership structure of many German firms which resulted from the reallocation of corporate control from universal banks to capital markets. In particular, many German banks have sold off their equity stakes in industrial companies and have stopped voting proxies on behalf of their clients. In addition, they reduced their involvement in supervisory boards. One interesting question is whether this capital market orientation led to an increase in shareholder value. Based on a sample of 324 events in Germany between January 2000 and June 2006, we find empirical evidence that the engagement of activist shareholders such as hedge funds increased shareholder value in the short and in the long run. Moreover, our findings suggest that this effect is more pronounced for small illiquid stocks due to higher information asymmetries. Furthermore, there is also some weak evidence that the initial valuation effects around the announcement date depend on the track record and reputation of the activist investor. Current Version: January 15, 2008