Can someone explain to me how hedge funds bankrupt companies?
In: Economics
They don’t. At least not directly. And of course, “hedge fund” is too wide a term – there are many types of hedge funds all with different ways of investing.
But to take what is the more common idea. There are companies that do poorly in their business area. There could be a variety of reasons for this (not relevant). Some hedge funds are very good at finding these companies and what the hedge fund will do is to “short” that company’s shares. In effect the hedge fund is saying “this company isn’t doing well and their share prices will fall soon”.
Of course, the hedge funds are not always right. But what some people believe is that the actions of the hedge fund “causes” the fall in the share price.
Shareholders of a company the hedge fund bets against are, of course, angered. Their argument might be “the company has a recovery plan”, “the company needs time”, “this is just an unusual situation” etc etc. These shareholders don’t want the market to know how badly the company is performing because they want to preserve their assets. And, to an extent, they might have a point – perhaps hedge funds force management to be short term focused. Another argument is that hedge funds might cause “self fulfilling prophecies” – by betting against a company, other investors panic and rush to sell thereby causing the share prices to fall.
Hedge fund supporters argue that the hedge funds provide useful information to the market (ie in effect telling everyone about problem companies). And, of course, hedge funds are investing their money – so they are not simply pundits. The argument is that they make share values align to company performance quicker.
If a company share price falls (a lot), then it becomes vulnerable to takeovers and to be broken up for assets. It might also become harder to borrow money. Since top executives are also paid in shares – this also causes their top executives to resign/retire and/or look for new jobs – thus making a difficult situation even worse.
Latest Answers