Ep.281 - Jacob Fisher on Shareholder Activism in Banks

Speaker A: Welcome to the Business Scholarship Podcast, a place for interdisciplinary conversations in the broad world of business research. My name is Andrew Jennings, and it's my pleasure to be your host. If you like what you hear today, please subscribe to the podcast on Apple, Spotify, or wherever you get your podcast, plus leave a rating and let other people know about the show, too. And if you have ideas for the show, please let me know. My email address is andrewdrewkginnings.com and I look forward to hearing from you. All right, time for the episode.

Speaker B: Our guest today is Jacob Fisher, a recent PhD graduate in finance from Cornell University. We'll be discussing his new paper, the Impact of Shareholder Activism on the Banking Industry, which I'll add a link to in the show notes for the episode. Jacob, welcome to the Business Scholarship Podcast.

Speaker C: Thank you, Andrew. I'm very happy to be here and I appreciate you having me. I just finished my PhD program, and anytime somebody wants to actually hear about my research, it makes me giddy. So I'm honored to be here.

Speaker B: Well, I'll confess that I am, um, interested in both shareholder activism and shareholder activism as it might take place in the banking space, particularly maybe community banks. So this paper was catnip for me when I saw it on the SSRN Digest, and I hope it's of interest to listeners and readers as well. Before we dig into this paper, I wanted to maybe give you a chance to introduce yourself to some of the listeners. Not every listener of the show is a lawyer or law professor, but there are a lot of them out there. You, in addition to being, uh, a recent PhD finance graduate, you're also a lawyer, and I understand that you'll be going on to the law teaching market this fall. So I wanted to just give you an opportunity to perhaps introduce yourself as a candidate on the law teaching market. What's your background? What are your interests? What are your teaching and research interest? And kind of how do you see yourself as maybe being a, uh, future law professor out there?

Speaker C: Well, thank you. Yes, I graduated from Stanford Law School last year, and then I just finished my PhD in finance at Cornell two weeks ago, just graduated, and I'm looking forward to putting my application in the far. The goal is to be a law professor and has been for many years. My research focuses mainly on financial institutions. I'm just fascinated about what the definition of a financial institution is. How they innovate, how they behave, how their behavior is driven by market forces and by the rules of corporate governance and also by government regulation. And some of my research that I'm most into right now is in ways that those rules of corporate governance and that government regulation are in tension with each other. And there's some of that in the paper that I'm going to be discussing here today. So that's my basic research agenda. Financial institutions, corporate governance. And I'm going to be on the job market soon.

Speaker B: All right, so listeners out there who might be on, uh, appointments committees or might have the ear of those who are, keep an eye out for Jacob and his far form when those go out. Turning to your paper now, Jacob, I wanted to start with just some background questions for the benefit of some, maybe some level setting. Could you explain what shareholder activism is? And within that world of shareholder activism, what is an activist hedge fund? What is the nature of this player in the financial markets? And what does it do when it targets a particular company for activism?

Speaker C: So an activist hedge fund you can think of as an investment company that has a pile of cash. And its investment thesis with that cash is it's going to look for publicly traded companies that are not doing very well. For example, their stock price might be low, they could be badly managed. It buys up a small stake in that company, you know, 5 or 10% of all the stock, and that, uh, it will pressure the company to make changes. And if those changes are successful and the stock price goes up, then that hedge fund can exit at a profit. The changes they push for might be operational efficiencies, it might be changing management or the board, and they often want mergers and acquisitions activity. They acquire this small stake. Well, it's a large stake in comparison to scattered shareholders, but it's still a minority stake. So they obtain this minority stake in a company, 5 or 10%, which is just enough to apply some real pressure to management, and they try to make things change.

Speaker B: Turning to shareholder activism in the banking context, what motivated this paper? What motivated you to study activism at banks specifically, which are kind of interesting and distinct corporate institutions in many ways? And why is bank governance different from the governance of non bank firms?

Speaker C: So, like I said earlier, I'm very fascinated by financial institutions, just as my personal greatest interest. But there are some deeper reasons why the banking context has some interesting twists that make it important in the activism literature. If you read activism papers, all the empirical literature for the last 15 years gives you the same general lament, which is that we can collect lots of statistics about activism and we can run lots of interesting studies, but there's no real natural experiments or empirical settings where you can make really plausible Causal inference. And all the empirical papers in the activist hedge fund literature give the same lament. And I focused on banking because I thought that banking could be a setting where we might be actually break through that and actually have a setting with plausibly causal inference because banks are so highly regulated. And anytime those regulations change, that could create a natural experience for us. And you asked why bank governance is so different from governance at non bank firms. The most obvious reason is, like I said earlier, banks are highly regulated. There's thick layers of regulation by different entities at the state and the federal level. And that's going to exercise a lot of control over banks, independent from corporate law and market forces. And they're also interesting because they're highly leveraged. And sometimes this drives a conflict of interest between the creditor side of the balance sheet and the shareholder side of the balance sheet, especially in terms of risk preferences. And so it's well known in the literature that shareholders at a bank are going to be much more risk friendly than providers of capital on the debt side.

Speaker B: There's been this challenge in the activism literature around causal identification, a lack of natural experiments, and certainly there aren't lab experiments that could be used. And you identified banking as an area where there could be more fruitful instances of natural experiments to Till, could you tell us a little bit about the empirical design that you adopted in this paper? Were there some natural experiments that arose that you could exploit? And after you did that, tell us a little bit about the design. But after you conducted the research, what did your data look like at the end?

Speaker C: I focus most specifically on one regulatory change from 2020. That IRU serves as reasonable natural experiment for the effect of activism on these banks. The natural experiment was a Federal Reserve rule change. The Bank Holding Company act gives the Federal Reserve authority and power to regulate anyone who controls a bank. And in 2020, they updated the framework that they use to think about what is a controller of a bank who controls a bank, who falls under this regulatory perimeter with this rule specifically. And so in 2020, they changed this rule. And they make it much looser for people to hold large stakes in banks without falling under Federal reserve scrutiny. Before 2020, anyone who accumulated a large stock position in a bank, anyone who had board representation in the bank or was otherwise exercising some kind of influence, was in danger of falling under this Federal Reserve regulation that nobody wanted if they could avoid it. And the rules were not very clear about when you would or wouldn't have all these regulatory duties and responsibilities and this scrutiny. So in 2020, the, uh, federal Reserve updated their framework and they gave a very transparent, very clear framework for when they would and would not consider shareholders in a bank to be controlling it under the bank, uh, Holding Company Act. And so starting in 2020, this field opens up for activist shareholders. You now know exactly what to expect. You know how much stock you can hold, how many board seats you can have without triggering this Federal Reserve scrutiny on you as an investor. And so commentators at the time said, now that the rule has been updated, changed and clarified, we're going to see a big increase in shareholder activism, um, at banks. So that's the natural experiment that I start with. And for causal identification, I separate these banks into a treatment and control group based on their shareholder structure before the rule change occurs. And banks that have a lot of insider ownership, I, uh, consider them my control group. Because if your bank is owned by a lot of insiders, you have a lot of insulation against outside activist pressure. The obvious example is if the majority of shares are owned by insiders who all like each other, it's going to be very hard for an outside activist to get any traction at all because you can outvote them every time. Whereas a bank with very low inside ownership has a lot more vulnerability because this activist that, uh, obtains a 9% stake in the bank is suddenly one of the largest shareholders and all your public shareholders could turn against you. So I divide banks based on their shareholder structure, really closely owned banks to

Speaker B: be the control group.

Speaker C: I say they're still insulated against activist campaigns, notwithstanding the rule change. But then the treatment group is these banks with less insider ownership, where now that the Federal Reserve has changed its rules, this regulatory insulation against activist campaigns is going to disappear and you're suddenly going to be much more vulnerable to these active ass campaigns than you were before. And so I had to do, uh, a simple difference in differences approach to say whether the behavior of the control group versus this treatment group changes after their exposure to activist campaigns changes due to this rule change. So that's the basic empirical design. I collected data. Most of my activist campaigns are from public 13D filings. I also used LSCG data to supplement that a little bit. And as far as what my data looked like, I found what would seem to be an encouraging thing, which is if you take my treatment group and my control group and put various of their metrics on graphs next to each other, their behavior runs in parallel up to the year that this rule changes. If you look at capitalization levels, for instance, these treatment and Control groups, their lines, they run very close to each other, and they always move the same direction up or down the same year. But then once this policy takes place, you get a change, and that is the treatment group. These, these banks that are more exposed, their capitalization levels dive, and the control group, which is the unexposed banks, their capitalization levels actually increase. And I found the similar pattern with several other measures. And so you have the idea that these treatment and control groups, with respect to the measures I'm interested in, they looked and behaved very similarly until this rule took effect. And then suddenly they go opposite directions. And if you look at the data on, um, activist hedge fund activity as well, you find that it had been declining for about a decade before this rule change took effect and was never very common. A lot of activist hedge funds tended to avoid banks because, among other reasons, they didn't want to deal with the regulatory scrutiny. It's a very difficult environment to work in if you don't know how to deal with all these regulators. And so most activist hedge funds avoided banks. So these campaigns were not common. They were declining, and they were only really engaged in by a small handful of funds that kind of specialized in dealing with all the unique problems of dealing with banks. But then after the rule change takes effect, you suddenly have a sharp increase in the frequency of these campaigns. You have an increase in the aggressiveness of these campaigns. For example, you have. These hedge funds are fighting harder for board seats. They're running proxy battles among shareholders at the banks. And so these campaigns that become more common, they become more aggressive. And also you see an increase in hedge funds that previously had avoided the banking sector entirely. Suddenly, they're trying the waters, and they're, they're, they're trying out, uh, campaigns at these community banks that before this rule change, they never wanted to touch. And so if you look at the data, what I'm seeing is that this rule change really did increase the Runway that shareholder activists have for running aggressive campaigns at banks. And then banks responded.

Speaker B: So for a long time before this change, activists didn't really want to get involved with the banking sector. They focused on others. What, uh, are we talking about in terms of how common activism became after this rule change, both in comparative or maybe absolute terms? And were there distinctions that you saw in which banks got targeted by activists and which didn't get targeted as much?

Speaker C: Uh, before 2020, we were to a world where you could count the number of campaigns on one hand every year. And this, despite there being hundreds of publicly traded banks including small community banks that are the usual targets for this activism. And so it was very, very rare, like between 1 or 2% of banks targeted for a campaign per year. And then those numbers triple or quadruple after the rule change. And we have yet to see the full extent of that. For example, 2025 was the, the busiest year they've had since the rule change. And so the full effect of this change is probably still happening. And we don't, we don't know how far it will go, but that, that frequency has definitely increased very dramatically. As far as which banks get targeted, it tends to be, and this is consistent with the literature on activism. Very generally it's banks that are doing very poorly. I focus specifically on a couple measures like Tobin's Q. They have very low market value compared to the book value of their assets or total shareholder return over the last three years is very bad. So these are, these are banks where the stock price has been tanking for a couple of years, where the dividends have been decreasing, and uh, where, where the market just says this bank is doing very badly. And especially if, if you can identify a management driven reason why this would be the case rather than general market conditions, then that bank is likely to be an activist target. And again, that's consistent with the literature on activism in all industries generally. It's usually these companies that are performing very badly in terms of their returns to shareholders. That's, that's who activists are going to target.

Speaker B: Let's zero in a little bit on, on the activists. There are different flavors of activist hedge funds out there. What did you find about the funds that decided to run these campaigns? Is there anything distinctive about them compared to the universe of activist hedge funds? And were there any distinctive tactics that you identified that they employed compared to their competitors or their fellow activists?

Speaker C: Well, one, one factor that I alluded to a little bit earlier is that almost all the activist activity in banks is done by a small set of funds. It's four or five funds that specialize in targeting banks. If you have an activist hedge fund that deals with other types of companies, you know, energy companies, manufacturers, tech companies and so forth, those hedge funds are not going after banks. And then you have these four or five hedge funds and I name each of them in the paper, that all they do is go after banks. They avoid the manufacturers, they avoid the energy companies, they just go after bank after bank after bank. And they've specialized in just this sector. They're kind of one trick ponies and they're repeat players. In the community banking sector and that degree of specialization, it's a banking unique thing. There is no other sector in which you see a bunch of hedge funds that only attack this sector. But it is what you do see in banking. Although that's starting to loosen because again, after this Federal Reserve change, there's some hedge funds that are starting to venture into the banking space because they feel like it might be easier than before. As for distinctive tactics or characteristics of these hedge, uh, funds, you see a pretty similar general toolbox for this activism. You buy up similar sized stakes, you ramp up public pressure, the proxy fights different settlement offers that will give you a seat or two on the board of directors. Very similar activist toolbox in the banking industry compared to elsewhere. But the end goals of these activists tend to be distinct in that the scope is narrower. For example, in the activist literature more generally, you will see a lot of campaigns aiming to change the CEO or to drive various strategic shifts, maybe spin off a division, maybe drive operational efficiencies. That's not common in banking. In hedge fund activism, um, in the banking industry specifically, it's almost always either increasing distributions to shareholders like dividends and buybacks, or driving M and A. They're trying to get the target bank to sell itself to an acquirer. And that's common in the general activism as well. But in banks it's always one of those two things, with almost no exceptions.

Speaker B: That's some helpful background in what's happening on the bank activism front. But I want to talk a little bit about the effects of activism, or the threat of activism, rather on how banks are behaving following this change. What do you see changing in bank behavior and what might have happened?

Speaker C: So I mentioned earlier a, uh, graph that I have in the paper where you take a couple of metrics, for example, capital ratios at, uh, these banks, and they're behaving very similarly before this Federal Reserve policy change. And then they diverge pretty sharply after the Federal Reserve policy takes effect. And there's a few ways in which that happened. The first, and this is one of the highlight effects of the core of the paper, is that when banks suddenly become more exposed to the threat of activism, they reduce capital ratios. So instead of being cautious and hoarding up capital on their balance sheets, they're paying it out more, or they're refusing to raise equity when they otherwise would. So their capital ratios go down when they're more exposed to the threat of activism. To some extent, that's a measure of riskiness because a bank with a Thinner capital buffer is closer to insolvency. And so one, uh, way you could say it is, these banks are becoming riskier due to this activist threat. But then there's a nuance to it, because I also find evidence that these same banks that are affected by this increase in exposure to campaigns by activist hedge funds, their own earnings volatility goes down. That's a measure of riskiness as well. And the net effect of these two different directional changes is that I don't find an increase in the risk of failure at these banks. You can measure that by a Z score, for instance, and you find that that doesn't change. So you have these banks where on the one hand capital ratios are going down, uh, capital versus your credit risk that you're taking is going down. So you might think these banks are getting riskier as a result of this greater shareholder pressure that they're exposed to. But on the other hand, you might say maybe they're being better managed because their earnings volatility has decreased. Maybe there's more consistency or hard work on the part of management. Because now management knows if I don't work hard, if I don't do a good job, I'm going to be the target of an activist campaign, and I don't want that. So it's a balance of two effects where on the one hand, shareholders like risk, and so these banks get riskier when they're more exposed to shareholder pressure. But on the other hand, shareholders want their managers to be disciplined and hardworking and to do a good job. And you perhaps see some evidence of that as well. These effects sort of balance each other out. And so you don't get any visible change in failure risk. You don't get any measurable change in systemic risk contributions by these different banks. So it's a bit of a nuanced, um, story, but I think one of the most startling little pieces of data in the paper is that you don't see banks that are failing after activists push them. I write in the paper, and I have to update this because the version on SSRN actually has an assertion that more recently is incorrect because it happened. But what I say in the paper is that I can't find any banks that were previous activist targets that then failed. And so if you think that these activists are pushing banks on the brink of failure, you'd think you'd see some failures, but there's just none in my sample. What I found out is there's actually been one more. Recently there was, uh, a bank that was an activist target, and it did fail. It's worth doing an autopsy to find out the role of the shareholder activist in that failure, because it was arguably on life support before the activists stepped in. But the point is, there's no rash of failures after activists step in at these banks. And so, from a regulatory perspective, if you're concerned that these activists are going to drive a lot of risk and bring down capitalization, that's a valid concern. But you can't see in the data this rash of banks that fell after activists come after them.

Speaker B: Your paper, I think, sets up banks as having two identities for us to think about. One identity is that they are investable assets. They're participants in the capital markets that folks can invest in, and corporate governance and the quality management and all that good stuff comes to bear there. That's the activism story that's typical of any publicly traded company. But then there's the identity of these are highly regulated financial institutions that are filling a public purpose and that are closely monitored by regulators to serve safely that public purpose. Keeping those two identities in mind, could you maybe walk us through some of the implications of this study?

Speaker C: One key audience for this paper would be people involved in the regulatory scene. I mean, one way to read this paper is it's a commentary on this regulatory change. It's almost a policy analysis of after the Federal Reserve changed this policy, how did things change in the banking industry? Did they get worse or better? Because, as you say, banks have this very regulated public role of keeping the financial system running nicely. And we want to know if regulation is helping or hindering that goal. And so there's a lot of implications for regulators here on how they evaluate this policy specifically and more generally, thinking about the role of activist shareholders in bankings. And the implication would be that shareholder activism, um, in the banking industry is worth keeping an eye on. These activists, they definitely like to shake things up. And the results that I have on capital ratios at targeted banks should draw your attention. We know that capitalization is one of the key measures that we have for how safe a bank is and how safe the banking industry as a whole is. And if exposure to these hedge fund activists is measurably reducing capital buffers, then that's worth looking at. You should be aware of it. On the other hand, my other results show that there's not a reason for instant panic. It's more nuanced than that. These activists also have a very positive disciplinary effect on target banks, and not even the banks that they don't target. It's just the banks that know that they could be targeted if they perform badly, that's a strong motivation to perform really well. And so there's a positive effect as well. So from a regulatory perspective, the implication of this paper would be, watch this field closely, but don't squelch it. Don't try to stop the activists who writ large because they have a very positive effect. And so just to kind of, not to put a fine point on it, but it's worth watching. But it's not an obvious source of undue risk that you should be trying really hard to stop. And then I think the second set of implications would be for a scholarly audience, especially those who are interested in the activist literature, that there's a lot of literature already existing on shareholder activism and these hedge funds. But the big takeaway for them is that you really can find experimental settings if you look in the right place. And my argument is that the right place to look, at least one right place to look, is highly regulated industries where, despite regulation, these activists are allowed to exist and the regulations change. My big argument is you can find these quasi experimental settings. They do provide an opportunity for plausibly causal inference. That's something that the literature has lacked as long as it exists, and it often talks about how much it lacks it. And I bring this paper up to say we actually can find these experimental settings that give us causal inference where we can say something more than correlational about the actual effects of these. Those would be the two big takeaways. And then, of course, a third audience would be community bankers themselves in the way that they think about their own exposure to a potential hedge fund campaign, how they can best respond, and how they can deal with regulators. When regulators want to talk about the interplay between this banker and a, uh, hedge fund that has a stake in the bank, those conversations are likely to happen. And, uh, I hope that my paper sheds some light on the economics behind how these campaigns work at banks so you know how to have those conversations. So those, I would say, would be the audiences for whom there are real takeaways for this paper.

Speaker B: Our guest today has been Jacob Fisher, a recent PhD graduate in finance at Cornell University. We've discussed his new paper, the Impact of Shareholder Activism on the Banking Industry, which I'll, uh, link to in the show notes for the episode. Jacob, thank you for joining the Business Scholarship Podcast.

Speaker C: Thank you, Andrew. Again, it's been a pleasure.

Speaker A: Thank you for listening to another episode of the Business Scholarship Podcast. If you like what you heard today, be sure to subscribe the podcast on Apple, Spotify, or wherever you get your podcast. Rate the show and let other people know about it too. If you have ideas for future future

Speaker B: episodes, let me know.

Speaker A: My email address is andrewdrewkginnings.com and I look forward to hearing from you. Until the next time. I'm your host, Andrew Jennings.

Speaker C: Mhm, Mhm. It.