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Validation capital

Publication ,  Journal Article
Brav, A; Lund, D; Rock, E
Published in: Texas Law Review
July 1, 2021

Although it is well understood that activist shareholders challenge management, they can also serve as a shield. This Article describes “validation capital,” which occurs when a bloc holder’s—and generally an activist hedge fund’s—presence protects management from shareholder interference and allows management’s pre-existing strategy to proceed uninterrupted. When a sophisticated bloc holder with a large investment and the ability to threaten management’s control chooses to vouch for management’s strategy after vetting it, this support can send a credible signal to the market that protects management from disruption. By protecting a value-creating management strategy that might otherwise be misjudged, providers of validation capital benefit all shareholders, including themselves. However, validation capital may also have a dark side: it could be used to entrench under-performing management from outside interference that would benefit the company and its shareholders. In this scenario, the bloc holder acts as a hired “bodyguard” who receives a side payment in exchange for the promise to ward off other investors. We argue that legal and market forces do much to constrain the corrupt form of validation capital, and our empirical study of hedge fund activism events from 2015 offers evidence in support of our theory. We find that although side payments from corporate management to hedge funds are relatively common, they tend to be small and not of the magnitude necessary to induce corruption of the sophisticated funds capable of generating a persuasive signal.

Duke Scholars

Published In

Texas Law Review

ISSN

0040-4411

Publication Date

July 1, 2021

Volume

99

Issue

7

Start / End Page

1247 / 1273

Related Subject Headings

  • Law
  • 48 Law and legal studies
  • 1801 Law
 

Citation

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Brav, A., Lund, D., & Rock, E. (2021). Validation capital. Texas Law Review, 99(7), 1247–1273.
Brav, A., D. Lund, and E. Rock. “Validation capital.” Texas Law Review 99, no. 7 (July 1, 2021): 1247–73.
Brav A, Lund D, Rock E. Validation capital. Texas Law Review. 2021 Jul 1;99(7):1247–73.
Brav, A., et al. “Validation capital.” Texas Law Review, vol. 99, no. 7, July 2021, pp. 1247–73.
Brav A, Lund D, Rock E. Validation capital. Texas Law Review. 2021 Jul 1;99(7):1247–1273.

Published In

Texas Law Review

ISSN

0040-4411

Publication Date

July 1, 2021

Volume

99

Issue

7

Start / End Page

1247 / 1273

Related Subject Headings

  • Law
  • 48 Law and legal studies
  • 1801 Law