(Reuters) – U.S. companies that spend more on social and environmental causes, such as sustainability or charitable donation programs, are more likely to attract hedge funds that challenge their strategy and board, according to a new academic study.
The study’s findings underscore the pressure on companies to balance the interests of Wall Street and Main Street as management fields calls to protect companies’ share price while doing more to tackle social inequality. This tension has intensified in the wake of the COVID-19 pandemic and U.S. protests over racism and policing after the death of a Black man, George Floyd, in police custody.
U.S. companies have about a 3% chance on average of being targeted by an activist hedge fund, but the probability nearly doubles for those who are top spenders on corporate and social responsibility (CSR) programs, according to the study, which analyzed 506 instances of shareholder activism between 2000 and 2016.
“CSR spending can be an indicator (to hedge funds) that there might be some wasteful spending at companies and that maybe top management isn’t focused on the short-term returns,” one of the study’s authors, Pennsylvania State University professor Mark DesJardine, said in an interview.
The research, conducted by DesJardine along with Emilio Marti of Rotterdam School of Management and Rodolphe Durand of HEC-Paris, will be published in the Academy of Management Journal later this year.
While hedge funds are rarely explicit in their demands to companies about doing away with CSR spending, their focus on cost-cutting often results in the scaling back of these programs, according to the study. As a result, the targeted companies become reluctant to invest in CSR, even after the hedge funds have cashed out on their stock.
“We see CSR flatline for up to five years” after an activist exerts pressure to boost short-term profitability, DesJardine said.
For example, Motorola Solutions Inc (N:MSI), which was spun out of telecommunications firm Motorola in 2011 under pressure from activist investor Carl Icahn, cut CSR spending by 50% over the following three years, according to data provider KLD Global Socrates.
Icahn and Motorola Solutions did not respond to requests for comment.
CSR investing has become important for many younger investors and has been backed by pension funds who have also fueled investments in hedge funds over the years.
One of the world’s most prominent activist shareholders, Jeffrey Ubben, said on Tuesday he was stepping down from the hedge fund he founded in 2000, ValueAct Capital, because he believes his focus on social and environmental investments can no longer “peacefully co-exist” with traditional shareholder activism. He is launching a new firm focused on CSR investments.
DesJardine said that the economic uncertainty fueled by the pandemic will pit the need of many companies to protect profits by cutting costs against calls by their customers, vendors and others to demonstrate a strong social conscience.
“This will increase the tension companies face when deciding how to balance social spending and short-term profitability pressures,” DesJardine said.