Hedge funds more like guardian angels than vultures: research

May 08, 2012

(Phys.org) -- New University of British Columbia research shows that – contrary to popular opinion – hedge funds have a positive influence when investing in U.S. companies filing for Chapter 11 bankruptcy.

The study, co-authored by Sauder School of Business finance Prof. Kai Li, reveals that when a hedge fund invests in a distressed , other creditors in the transaction fare better and there is a greater chance a company will emerge from bankruptcy.

“It’s a common view in the media and popular opinion that hedge funds are ‘vulture investors’ who dismantle companies to maximize profits in the shortest time-frame possible,” says Li, who co-wrote the study for the April edition of the Journal of Finance with professors from Columbia and Queens Universities.

“We found the opposite is true. Our data show that hedge funds strategically invest in troubled companies with the intention of becoming major shareholders after they emerge from bankruptcy. They are motivated to strengthen firms, not tear them apart.”

Unlike mutual funds and pension funds, which have very stringent requirements on the types of companies they invest in, hedge funds are free to take on the risk of investing in companies in Chapter 11.

Li and her co-authors conclude that this flexibility allows them to make strategic investments in failing companies that exhibit the potential for recovery. They also argue that hedge funds are much more likely to wait while companies successfully restructure under new management than other private investors.

The researchers analyzed 474 Chapter 11 filings in the United States between 1996 and 2007. Looking at firms with assets worth more than $100 million, the researchers examined bankruptcy filings from a wide variety of angles, including the presence of hedge fund investment, CEO turnover, key employee retention, asset liquidation, debt recovery and emergence.

They found that 87 per cent of these bankruptcies had observable hedge fund involvement. The data shows such companies had improved chances of surviving the bankruptcy process. The results also reveal that the presence of hedge funds increased the likelihood of failed CEOs being fired and reduced the liquidation pressure from other stakeholders clamouring for a payout.

“We find that hedge funds are more like mediators than predators,” says Li. “They use the power of a controlling stake to negotiate between the desires of top executives fighting to preserve their high salaries, and the company’s lenders who may want to cut their losses by dismantling the company and selling off the pieces.”

The researchers also found that the presence of hedge funds as the largest unsecured creditors had a favourable effect on stock price, and positive influence on the overall debt recovery for other lenders. Finally, where hedge funds were involved, companies had a reduction in leveraged debt one year after emergence from bankruptcy.

“Until now, have been wrongly classified,” says Li.  “Instead of vultures, circling overhead above a dying prey, it is better to see them as guardian angels of distressed companies, overseeing their transition into healthier entities.”

Explore further: Narcissistic CEOs and financial performance

add to favorites email to friend print save as pdf

Related Stories

Yahoo shareholder pushes for its board nominees

Mar 21, 2012

(AP) -- One of Yahoo's major investors is urging shareholders to vote its four nominees on to the Internet company's board, launching a potentially nasty fight to transform the Internet company's board.

Recommended for you

Local education politics 'far from dead'

18 hours ago

Teach for America, known for recruiting teachers, is also setting its sights on capturing school board seats across the nation. Surprisingly, however, political candidates from the program aren't just pushing ...

First grade reading suffers in segregated schools

18 hours ago

A groundbreaking study from the Frank Porter Graham Child Development Institute (FPG) has found that African-American students in first grade experience smaller gains in reading when they attend segregated schools—but the ...

Violent aftermath for the warriors at Alken Enge

19 hours ago

Denmark attracted international attention in 2012 when archaeological excavations revealed the bones of an entire army, whose warriors had been thrown into the bogs near the Alken Enge wetlands in East Jutland ...

Why aren't consumers buying remanufactured products?

21 hours ago

Firms looking to increase market share of remanufactured consumer products will have to overcome a big barrier to do so, according to a recent study from the Penn State Smeal College of Business. Findings from faculty members ...

Expecting to teach enhances learning, recall

21 hours ago

People learn better and recall more when given the impression that they will soon have to teach newly acquired material to someone else, suggests new research from Washington University in St. Louis.

User comments : 1

Adjust slider to filter visible comments by rank

Display comments: newest first

rwinners
not rated yet May 08, 2012
What type of bankruptcy filings?