Short Campaigns by Hedge Funds

Compared to the substantial literature on long equity positions, there is not much published on short campaigns conducted by hedge funds. By way of explanation, the authors appeal to the significant costs and negative press that plague short campaigns. Recall the “fun” the short sellers of GameStop experienced in 2021: beset by violent threats, called to testify before Congress, the costly dealing with anti-shorting actions taken by the firm although they are not obliged to disclose their positions. Most of that is changing as high-profile short campaigns increase in number. Hedge funds now wage short campaigns by announcing them at investor conferences and go on to provide a rationale, all negative of course–insufficient reserves, poor accounting controls, etc. Those events and actions are picked up and publicized by the press and media outlets and followed unsurprisingly by a drop in the share price of the target short.

This paper has initiated the first comprehensive examination of these types of campaigns.

Short Campaigns by Hedge Funds

• Ian Appel and Vyacheslav Fos
• The Review of Financial Studies
• A version of this paper can be found here
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What are the research questions?

1. What are the characteristics of hedge funds that initiate and run short campaigns?
2. Are the market reactions to short campaigns economically substantial?
3. What is the nature of the relationship between market reactions and the allegations made?
4. Do short campaigns convey information accurately?

What are the Academic Insights?

1. Activist hedge funds represent close to 25% of all hedge funds, however they represent almost 80% of funds that initiate short campaigns.  The dominance of activists among short campaigns is a surprise. What is their secret? There is no apparent link between AUM which suggests that limits to arbitrage for the target firms is not the driving force.  The link between activist funds and short campaigns appears to be non-monetary and usually include allegations of mismanagement by the target, proxy fights and other hostile tactics.
2. YES.  The economic impact for short campaigns is substantial. Cumulative abnormal returns (CARs) are -7%, on average, for the +/-20-day window pre-and post-announcement period of the short campaign.  That value falls to -10% when the post-announcement period is increased to 100 days. The effect is robust, at least up until the extra 80 days to the post announcement period. The decrease in market value observed on short campaigns is of a similar magnitude to the increase in value associated with long campaigns. Analysis of the magnitude of CARs for long and short campaigns conducted by activist funds produce near zero CARs. The results also trounce the returns surrounding substantial changes in short interest. There is an asymmetry that partially drives these results, at least partially. Note the chart below. Short campaigns that are announced at investor conferences more than double the result.
3. As to the nature of the allegations, they are classified in this study as general (e.g., “the market price is undervalued”) or specific (e.g., “the firm has defective products”). Long activist campaigns tend to use general allegations (about 52%) however, the absolute value of excess returns are range betweenf 4% to 5% whether the allegation is general or specific in nature. Comparisons to short activist campaigns produced notable differences. The short campaigns utilize specific allegations, and the type of allegation affects the level of excess returns. On the short side, 73% of allegations are specific and produce excess returns of -8% on average. The remaining 27% use general allegations and produce excess returns of -3%! The specificity of allegations are key drivers of success for short campaigns.
4. YES. The success rate is 34%.  Accuracy of the information promoted by short campaigns was indicated by various outcomes including as examples: allegations are confirmed by a regulator, an increase in forced CEO turnover or other types of litigations against the target firm.

Why does it matter?

The analysis presented in this paper is a first in that it documents the impact activist hedge funds can and have made using short campaigns.  The analysis is comprehensive and challenges the current literature that understates the overall impact of activist investors.  Short and long activist campaigns have differential operating tactics and differential influence on the market value of target firms.  This finding is robust, in spite of the fact that short campaigns are less frequent and target larger firms than long campaigns. 

The authors maintain: “our findings are consistent with short campaigns promoting price discovery and economic efficiency. Thus, efforts to impose uniform restrictions on short campaigns may not be welfare enhancing.”

The most important chart from the paper

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained.  Indexes are unmanaged and do not reflect management or trading fees, and one cannot invest directly in an index

Abstract

The number of short campaigns by hedge funds has dramatically increased over the last two decades. Nearly 80% of campaigns are undertaken by activist hedge funds, particularly those that employ hostile tactics in their long campaigns. Short campaigns are associated with negative abnormal returns of -7%, with aggregate valuation effects similar in magnitude to the gains from long activism campaigns. In contrast to long campaigns, public communication is a critical component of short campaigns. We do not find evidence that such communication is manipulative. Overall, our analysis highlights the importance of short campaigns for understanding the economic impact of activist hedge funds.