September 1, 2009

Volume 2, Issue 8

Empirical Finance Newsletter

Turning academic insight into investment performance

Editor’s Note:
The Empirical Finance, LLC team has been synthesizing, cataloguing, and writing empirical fi-
nance research for many years. Our investment programs integrate many of the research insights
highlighted in the Empirical Finance Research Newsletter, but not all of them. This newsletter is
meant to highlight ideas we look for and consider when developing our investment technologies.

Hedge Fund Activism, Corporate

Governance, and Firm Performance
Alon Brav, Wei Jiang, Randall Thomas and Frank Partnoy
Journal of Finance Vol. 63 No. 4. August 2008
Abstract:
Using a large hand-collected dataset of hedge fund activism in the U.S. over the period
2001 through 2005, we find that activist hedge funds act both as value investors and
shareholder advocates. They target undervalued firms, and propose an array of strategic,
operational, and financial remedies. Most tactics are non-confrontational, and attain
success or partial success in two-thirds of the cases. However, hedge funds seldom seek
control of target companies. The market reacts favorably to hedge fund activism, as the
abnormal return upon announcement of potential activism is in the range of 5-7 percent,
with no apparent reversal in the subsequent year. We show that this positive market
reaction does not reflect anticipated wealth transfers from creditors to shareholders, but
instead reflects anticipated improvement in performance. Indeed, target firms see moderate
improvement in operational performance and considerably higher CEO turnover after
activism. Our analysis provides important new evidence on the mechanisms and effects of
informed shareholder monitoring.

Data Sources: Discussion:

Empirical Finance, LLC The authors examine a sample of all SEC
16192 Coastal Hwy.
Schedule 13-D filings between 2001 and 2006.
In total they analyze 11,602 filings and then
Lewes, DE 19958
systematically find those filings associated with
T: +1.773.230.4727 bona fide hedge funds via internet searches,
F: +1.888.517.5529 phone calls, etc. In the end, after various filters,
http://empiricalfinancellc.com the authors create a database of 236 hedge funds
who file 13-D filings at some point between
2001 and 2006 on regular corporations. The
total number of events analyzed is 1,032.
Hedge fund managers (as opposed to mutual
fund managers, fund of funds, etc) have the
greatest incentive to create shareholder value
through shareholder activism. Hedge fund
managers' pay is strongly tied to good
performance, they can lock money down for
longer periods (1+ year lock-ups), and they do
not have to deal with many of the regulations
the rest of the money management industry
must endure (Investment Company Act of 1940,
SEC more generally, state regulators, etc).

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 Hedge Fund Activism, Corporate Governance
and Firm Performance
The sample examined in the paper includes both
hostile and friendly activism, and the authors
find that friendly activism is far more common
than hostile action. They go on to conjecture
that the reason for CEO opposition to hedge
fund activism is possibly due to the likely
impact it will have on CEO pay.
Figure 1 displays a column chart of the returns
for the period of twenty days prior to the 13-D
filing through 20 days after the filing.
Abnormal returns are positive 3.2% in the
twenty days before the filing (consistent with
the activist establishing a position) but are also
positive after the filing. The day of and the day
after the filing combine for a 2.0% abnormal
return and by day 20 the cumulative abnormal
return reaches 7.2%. This indicates that simply
buying on the second day after a 13-D filing can
produce a 2% abnormal return over four weeks.
Buying even earlier after an announcement can
make this return even larger.
After decomposing the sample, the authors
further find that announcements of activism that
focus on liquidation or sales of business
segments result in the highest abnormal
returns—more than 8% over the post-13-D four
week period on average. This indicates hedge
funds can indeed create value when they
identify inefficiency with regards to the
allocation of the firm’s resources
The authors also point out that the average
holding period in their sample is about one year,
contradicting the notion that activist hedge
funds are short-term traders trying to quickly
extract value from existing shareholders.
Empirical Finance, LLC
16192 Coastal Hwy.
Finally the authors confirm that the abnormal
Lewes, DE 19958 returns around announcements are not simply
T: +1.773.230.4727 representative of a wealth transfer from
F: +1.888.517.5529 creditors to shareholders. In fact, those target
firms without debt actually experience larger
http://empiricalfinancellc.com
abnormal returns than those with debt.
Investment Strategy:
1. Focus on small companies.
2. Watch for activists who are entering
companies at the same time mutual funds are
dumping (watch for 13-Gs filed concurrently
with 13-Ds). This way you can buy at cheap
prices while the mutual funds are putting
pressure on the stock. Eventually, the selling
pressure is gone and you have an activist
presence to ensure the ship is sailing straight
ahead.
3. Call the company in question and assess how
―open‖ they are. Sometimes even the best
activist campaign can't beat an overly
entrenched and crooked management.
4. Call the activist and get a feel for what they
want to do with the company. In my experience,
activist investors are usually class-act capitalists
and may give you hints as to the direction they
want to take a company.
5. Do your own due diligence and determine
where the hidden value is located. If you have
an assessment of exactly what the activist is
after, you may be able to determine how
successful they will be in their attempts to
unlock this value.
Conclusions:
The contribution of this paper is to show that
activist hedge funds are good for corporations,
shareholders and the economy generally: They
are not short term traders, they encourage the
efficient allocation of capital, they generate
higher returns for shareholders and do not harm
creditors in the process.
In light of this evidence, it is difficult to
understand the enmity shown by politicians and
the media towards the activist hedge fund
industry. Of course, it is less difficult to
understand why an entrenched CEO who has
successfully extracted wealth from the
corporation at the expense of other stakeholders
might show such enmity. And therein lies a
possible explanation as to why activist hedge
funds often get such a bad rap.
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 Empirical Finance LLC
Current Stock Screens

Empirical Screen #1
Piotroski F-Score and signaling factors
This table highlights all companies that have the highest score possible on the Piotroski F-Score
fundamental analysis screen (slightly augmented). We screen for small-cap companies that have
book/price ratios in the top 20% of all companies traded on the NYSE/AMEX/NASDAQ. We add
information on CEO ownership to signify ―skin in the game.‖ Finally, we highlight any open
market repurchase activity that has taken place in the last 6 months (signals that shares are cheap).
Ideas generated in this screen are not meant to be short-term trades, but represent long-term
opportunities that, on average, have outperformed the general market by great margins. (Screened
on August 31, 2009).

Company Name, Mkt. Cap. Book/ Recent CEO %

Exchange, Ticker ($mm) Price Buybacks ownership
Comfort Systems USA Inc.
(NYSE:FIX) 428.7 0.65 - 1.03
MYR Group, Inc.
(NasdaqGM:MYRG) 399.9 0.40 - 0.827
Pike Electric Corporation
(NYSE:PIKE) 369.5 0.68 - 5.72
M&F Worldwide Corp.
(NYSE:MFW) 363.5 1.24 - 0.026
Apogee Enterprises Inc.
(NasdaqGS:APOG) 354.7 0.87 - 1.45
Advance America, Cash Advance
Centers Inc. (NYSE:AEA) 342.2 0.53 - 0.785
Republic Airways Holdings Inc.
(NasdaqGS:RJET) 297.3 1.56 - 0.574
Matrix Service Co. 02/04/2009
(NasdaqGS:MTRX) 273.2 0.59 Buyback 0.46
DHT Maritime, Inc.
(NYSE:DHT) 245.2 0.71 - 0.129
Asset Acceptance Capital Corp.
(NasdaqGS:AACC) 216.5 0.65 - 0.375
International Shipholding Corp.
(NYSE:ISH) 205.7 1.01 - 6.19
Preformed Line Products Co.
(NasdaqGS:PLPC) 194.0 0.75 - 15.14
Young Innovations Inc. 07/20/2009
(NasdaqGS:YDNT) 179.0 0.61 Buyback 1.41
Spartan Motors Inc. 07/24/2009
(NasdaqGS:SPAR) 168.7 1.01 Buyback 2.14
Frisch's Restaurants Inc.
(AMEX:FRS) 140.9 0.79 - 6.33
Spectrum Control Inc.
(NasdaqGS:SPEC) 114.0 0.93 - 1.22
Empirical Finance, LLC
Screening Criteria: ►Market Value between $100mm and $500mm ►Book Value /
16192 Coastal Hwy.
Market Value less than 3 ►LTM Net Income greater than 0 ►LTM Cash from Operations
Lewes, DE 19958 (CFO) greater than 0►LTM Return on Assets % greater than 5% ►LTM CFO greater than
T: +1.773.230.4727 LTM Net Income ►LTM LT Debt / Capital greater than LTM-1 LT Debt/Capital ►LTM
F: +1.888.517.5529
Current Ratio greater than LTM-1 Current Ratio ►LTM Shares Outstanding less than LTM
–1 Shares Outstanding ►LTM Gross Margin greater than LTM-1 Gross Margin ►LTM
http://empiricalfinancellc.com Asset Turnover greater than LTM-1 Asset Turnover.

*Please Note: This newsletter is published by Empirical Finance, LLC, which serves as the general partner for various investment vehicles. Empirical
Finance, LLC may purchase or sell securities and financial instruments discussed in this newsletter on behalf of its clients. Empirical Finance, LLC is
not an investment, legal, or tax advisor, and none of the information available through the newsletter is intended to provide tax, legal or investment
advice. Nothing provided through this report constitutes a solicitation by Empirical Finance, LLC for the purchase or sale of securities.

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 Empirical Finance LLC
Current Stock Screens

Empirical Screen #2
Top 10 Long/Short Net Operating Asset companies
These tables highlight the companies with the lowest net operating assets and the highest net
operating assets. We screen for small-cap companies having 8+ years of operating performance.
Low NOA ideas generated in this screen are not meant to be short-term trades, but represent long-
term opportunities that, on average, have outperformed the general market by great margins. High
NOA companies are good short-sell candidates. (Screened on August 31, 2009).
Long:
Company Name, Mkt. Cap. CEO %
Exchange, Ticker ($mm) NOA Ownership
Zion Oil & Gas Inc.
(AMEX:ZN) 167.8 -3.17 2.27
Insmed Incorporated
(NasdaqCM:INSM) 108.7 -2.99 -
Energy Recovery, Inc.
(NasdaqGM:ERII) 254.3 -2.36 1.04
Hemispherx Biopharma, Inc.
(AMEX:HEB) 265.1 -2.33 0.36
ATA, Inc.
(NasdaqGM:ATAI) 159.9 -2.15 0.10
China Mass Media Corp.
(NYSE:CMM) 104.1 -1.59 -
BioSpecifics Technologies Corp.
(NasdaqGM:BSTC) 156.7 -1.56 23.45
Agria Corporation
(NYSE:GRO) 115.7 -1.53 -
Maxygen, Inc.
(NasdaqGM:MAXY) 272.5 -1.21 1.51
China Distance Education Holdings
Limited (NYSE:DL) 253.6 -1.10 -

Short:
Company Name, Mkt. Cap. CEO %
Exchange, Ticker ($mm) NOA Ownership
Domino’s Pizza, Inc.
(NYSE:DPZ) 451.6 3.43 0.79
JMP Group Inc.
(NYSE:JMP) 199.2 1.83 14.97
NPS Pharmaceuticals, Inc.
(NasdaqGM:NPSP) 197.8 1.61 0.26
Crown Media Holdings Inc.
(NasdaqGM:CRWN) 171.9 1.59 -
KapStone Paper and Packaging Corp
(NasdaqGM:KPPC) 188.1 1.48 9.30
Empirical Finance, LLC Valence Technology Inc.
16192 Coastal Hwy. (NasdaqCM:VLNC) 191.6 1.43 0.00
Revlon, Inc.
Lewes, DE 19958 (NYSE:REV) 224.3 1.42 0.05
T: +1.773.230.4727 Raser Technologies, Inc.
(NYSE:RZ) 145.9 1.28 0.00
F: +1.888.517.5529 Dynex Capital Inc.
http://empiricalfinancellc.com (NYSE:DX) 112.3 1.24 4.68
Cheniere Energy, Inc.
(AMEX:LNG) 145.8 1.03 0.76
Screening Criteria: ►Market Value between $100mm and $500mm ►NOA=[(Total Assets
-Cash and Equivalents)-(Total Assets—Total Debt)]/Total Assets year prior)
*Please Note: This newsletter is published by Empirical Finance, LLC, which serves as the general partner for various investment vehicles. Empirical
Finance, LLC may purchase or sell securities and financial instruments discussed in this newsletter on behalf of its clients. Empirical Finance, LLC is
not an investment, legal, or tax advisor, and none of the information available through the newsletter is intended to provide tax, legal or investment
advice. Nothing provided through this report constitutes a solicitation by Empirical Finance, LLC for the purchase or sale of securities.

Page 4