John Coffee reports that:
[A] recent study suggests that there may be real, but long-term, costs from hedge fund activism for the economy as a whole. These researchers took the stocks included in the Wall Street Journal’s and FactSet’s Activism Scorecard and trimmed this sample down to just those campaigns launched by activist hedge funds. Then, they followed those firms that successfully avoided a takeover. They found that these firms, even though they survived the activists’ engagement intact, were forced to curtail their investments in research and development by more than half over the next four years. Specifically, R&D expenses in this sample fell from 18% of sales to 8.12% of sales over that period.[16] Nor was this a general secular trend, because in a random sample of firms not engaged by activists, they found that research and development expenditures rose modestly as a percentage of sales over the same period.[17]
Although still a preliminary study, this finding should not surprise, because it confirms what activists say they are doing. Trian Fund made clear that it wanted to reduce DuPont’s expenditures on R&D. Similarly, when Pershing Square Capital and Valeant Pharmaceuticals made a bid for Allergan last year, Valeant announced that, if successful, it would cut R&D at the combined firm by 69%.[18] Although most pharmaceutical companies typically spend about 20% of their revenues on R&D, Valeant spent only 2.7% of its revenues on R&D.[19] Its business model was to milk acquired companies like cash cows for their cash flow.
This pattern of cutting R&D expenditures (even at companies like DuPont that have historically profited from R&D) may make sense for investors who will be long gone within a year or so.
[16] See Allaire and Dauphin, supra note 1, (finding an average decline in R&D expenditures as a percentage of sales from 17.34% in 2009 to 8.12% of sales in 2013). [Full cite: Yvon Allaire and Francois Dauphin, “Hedge Fund Activism: Preliminary Results and Some New Empirical Evidence” (Institute for governance of public and private corporations, April 1, 2015).]
[17] Id (finding a modest increase in R&D expenditures from 6.54% of sales in 2009 to 7.65% of sales in 2013).
[18] See Joseph Walker and Liz Hoffman, “Allergan’s Defense: Be Like Valeant,” The Wall Street Journal, July 22, 2014 at B-1.
[19] See Joseph Walker, “Botox Itself Aims Not to Age,” The Wall Street Journal, May 19, 2014 at B-1.
But it sucks for the rest of us.
I await a reply from the activists' academic apologists.
