Remember the scene from Woody Allen's 1973 movie Sleeper when the main character wakes up from hibernation 200 years into the future? He asks for wheat germ for breakfast, making a doctor incredulous. Back in the 20th century, the physician recalls to a colleague, deep fat, steak, cream pies, and hot fudge “were thought to be unhealthy, precisely the opposite of what we now know to be true.”

Hard to believe, yes, but how nice if it was accurate. A new academic paper from a trio of well-respected academicians may elicit a similar response.  

If there has been an accepted mantra in the markets in recent years, it is that short-termism is stripping American corporations of their capacity to invest for the long term. According to conventional wisdom, hedge fund investments from the likes of Bill Ackman and Daniel Loeb are the capital equivalent of high-fructose corn syrup—maybe good for a brief surge but hazardous to a company's health over time. But in the paper, The Long-Term Effects of Hedge Fund Activism, the professors take a jackhammer to that assumption with newly generated empirical evidence.

Harvard Law School's Lucian Bebchuk, Fuqua Business School's Alon Brav, and Columbia Business School's Wei Jiang test the charge that hedge funds, in pursuit of short-term stock price pops at the public companies they target, routinely inflict long-term damage on these firms. (In the interest of full disclosure, Stephen Davis is associate director of Bebchuk's Program on Corporate Governance at Harvard Law School.)

The trio finds the claim that activist hedge funds are damaging to the companies they invest in to be without merit. In fact, study data, embracing 2,000 hedge fund events, show the opposite: “activist interventions are followed by improved operating performance during the five-year period following these interventions.” The paper may have come out in the dead of summer, but expect it to become an academic milestone in research on short-termism.

The observed bump in operating performance is an important distinction. It isn't news, for instance, that hedge funds can spur value. Professors Brav, Jiang, and two others published findings making that claim in 2007. The New York Times said at the time that “the evidence shows that for the most part, buy-and-hold investors ought to cheer when hedge funds jump aggressively into a stock.”

We have no illusions that the Bebchuk-Brav-Jiang evidence will suddenly reverse received wisdom, given the history of past research.

What? Hedge funds are good for you? Whatever academics may say, the idea flies in the face of long-held beliefs circulated within the business world. Within 24 hours of the publishing of an op-ed the professors authored about their findings for the Wall Street Journal, long-time hedge fund foe and frequent Bebchuk sparring partner Marty Lipton—a partner at law firm Wachtell, Lipton, Rosen & Katz—along with colleagues Steven Rosenblum and Sabastian Niles, attacked the idea that activist hedge fund investments could be a positive event for companies in a response to clients.

Hedge funds, they charged, not only injure companies by pressing for “short-term results at the expense of long-term value,” but pose “significant implications for the broader economy and our nation's competitiveness.” They even branded hedge funds as “major contributors to unemployment and slow growth of GDP.” The three concluded: “We believe that the statistics Professor Bebchuk uses do not establish the validity of his claims that activist attacks are beneficial nor justify his uncritical embrace of activists.”

The Lipton letter was unsettlingly free of real evidence to contradict the claims of Bebchuk and his co-authors. A second letter two weeks later took a deeper dive, criticizing the scholars' methodological judgments. But Lipton and directors and executives have more often founded their views on a trove of experiential rather than academic evidence. This is understandable: Executives and directors are unlikely to enjoy sitting in the crosshairs of activists. And their war stories help shape business opinion.

Credible bodies have, in response, initiated inquiries into the challenge of short-termism. For example, both the Brookings Institution and Aspen Institute have projects looking at the purpose of the corporation. Aspen's Overcoming Short-Termism report asserted that hedge funds “can harm the interests of shareholders seeking long-term growth and sustainable earnings if managers and boards pursue strategies simply to satisfy those short-term investors. This, in turn, may put a corporation's future at risk.”

In other words, the confidence, passion, and experience that fuel agreement about the destructive impact of hedge funds long ago solidified into hardcore conviction. So no matter how powerful the findings of Bebchuk, Brav, and Jiang, as well as earlier evidence debunking the myth of hedge fund short-termism, it all runs counter to the overwhelming market narrative.

What's Next?

So what should we expect to happen, based on this new evidence? For one, don't count on the new Bebchuk-Brav-Jiang analysis to be readily debunked. The paper may not yet have been published in a peer-reviewed journal, but it is being exposed to scholars for comment. So far, no one has punched any fatal holes in it.

Indeed, the paper's most potent contribution may have been in pinpointing an insight hidden in plain sight. Hedge funds need exit strategies. They have to sell their stakes to buyers who themselves believe that the stock will rise after they acquire it. If hedge funds really did gut companies for short-term price pops, buyers would detect that and stay clear. The market is, after all, a future cash flow discounting machine. So it turns out that to make short-term money, hedge funds have to promote mid- to long-term value in assets they own.

We have no illusions that the Bebchuk-Brav-Jiang evidence will suddenly reverse received wisdom, given the history of past research. But the study does offer evidence to validate why activism has proven a popular hedge fund strategy. It likely will drive even higher allocations to activist strategies from pension funds and other institutional investors.

Also, looking to next year's proxy season debates, it seems obvious that the paper will form a large part of the intellectual backdrop against which individual corporate battles will play out. The analysis may even help shape decisions at the Securities and Exchange Commission and in the Delaware courts.

Finally, directors at corporations that have attracted or could attract activist attention can draw their own insights from the research, too. Of course, no board will want to lure activists onto the share register just because Bebchuk et al claim they are good for business. And no one is saying that every activist campaign is destined to yield outsized returns. On the other hand, it may be time for boards to take hedge fund perspectives seriously rather than dismissing all of them as a gang of hold-up artists.

Find out preemptively what hedge funds look for, how they think, and conduct game theory exercises to figure out if your firm is vulnerable to their attention. If it is, consider steps hedge funds might advocate—but before they do it for you, and you lose control.

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