Activist shareholders have been accused of hindering innovation in companies they target. During a 2-3 year activist engagement in a company, activist shareholders focused on pursuing short-term goals may seek to cut costs in the target, maximize profits, then exit quickly, (possibly) with little care for the long-term prospects of the target company. In Hedge Fund Activism and Corporate Innovation (the Paper), He, Qui and Tang (the Authors) argue that is not necessarily the case, and that in fact activist shareholders can and do spur innovation, especially in the technology sector.
Innovation, the Authors explain, is a key marker of economic growth for technology companies, as long term value tends to be derived from the innovative capacity of the company. Continued innovation is therefore vital to the success and survival of individual companies in the technology sector. The conflict between the interests of technology companies and the interests of activist investors lies in the unique features of innovation: innovation requires a prolonged period of commitment of resources that is associated with a high degree of uncertainty and information asymmetry. Activist shareholders are not known to shy away from risk or uncertainty, but are not likely to want to wait for an extended period of time to exit their investment. Therefore, with a short investment timeline, can activist investors spur innovation in the technology sector, or do their actions ultimately end up hindering future prospects for technology companies?
The Paper offers an empirical investigation into the impact activist shareholders have on the innovation activities of the technology companies they target. The Authors tracked innovation progress in technology companies by looking at research and development expenses (innovation input) and the number of patent applications filed (innovation output). The Paper shows that while the presence of an activist shareholder does not have a significant impact on innovation input, activist shareholders were able to significantly increase the levels of innovation output while they were involved in any given target technology company. The increase in innovation output may be explained in part by previous failures on the part of the company’s management to innovate; whether it is due to a lack of skill or lack of efficiency. However, the Authors argue that the more important cause of the increased innovation output is having the activist shareholder monitor the company, and in turn monitor innovation, which may lead to more effective and efficient innovation. In the long-term, the Authors argue that the monitoring activities by activist shareholders could play a crucial role by enhancing innovation within technology companies.
While the findings presented by the Authors are interesting, measuring innovation based on the number of patent applications has some flaws. Behavioral studies suggests that following the introduction of new management (the activist shareholder) it would not be uncommon to see an artificial increase in the number of patent applications filed at the company. Increased pressure to obtain positive results may encourage workers to inflate file patent applications for the sake of overall numbers, and in doing so the quality of the patents filed may suffer. To get a better understanding of the true relationship between innovation and shareholder activism, it would be beneficial to know how many of those patent applications were actually approved. That being said, the current results presented in the Paper do merit further discussion, if not further research, on the ways in which activist shareholders can impact innovation in the technology companies they target.