Private equity firms and "activist" hedge funds can help strengthen corporate governance by prodding other investors to become more informed about their rights, according to a new study.

The report was issued July 23 by the Steering Group on Corporate Governance of the Organisation for Economic Co-Operation and Development (OECD), a Paris-based economic think tank. The group studied not only the effects of reform-minded hedge funds on public company governance, but also how private equity firms have recruited other institutional investors for reform campaigns and turned around failing public firms with buyouts.

As opposed to many institutional investors, the report says, hedge funds often consult with other investors and make public announcements regarding proposed governance changes, instead of dealing quietly with company management. This approach, the OECD says, pushes other investors to become more knowledgeable about company strategy.

For instance, the report cites the example of German exchange Deutsche Börse’s proposed acquisition of the London Stock Exchange. Several hedge funds, including U.K.-based The Children’s Investment Fund, as well as U.S. funds Atticus Capital and Jana Partners, publicly opposed the transaction, preferring a proposed takeover of Euronext instead. Though neither deal occurred, Deutsche Börse withdrew its bid for the London exchange after the hedge funds’ combative, very public campaigns caused several of its institutional investors to sign on in opposition to the bid.

The report also addresses a number of issuer concerns with activist funds, including "short-termism" and proxy battles. The OECD committee suggests that hedge funds looking at a company’s long-term prospects can foster better market performance by the company even if the fund will only keep a short-term stake in the firm. The report posits that the lack of long-term strategies at certain companies is a major reason why activist funds target those issuers for reform in the first place.

Hedge fund activism has led to greater numbers of close votes, according to the report, especially in board elections and proxy contests. The OECD says that the numbers of close votes are unlikely to abate as hedge funds continue to push for reform. In fact, the report suggests that the only way companies can work to prevent proxy contests and other challenges is to remove barriers to shareholder participation so as to pre-empt activist funds.

Studies cited in the report show that failing companies that are bought out, not only by activist funds but by private equity of any stripe, tend to exhibit better short-term returns and perform better than their peers after the purchased company returns to trading with another public offering.

The conclusions reached by the OECD committee are preliminary, though, and the report calls for additional study of hedge funds in the markets in which they are predominant--the United Kingdom and the U.S. The report also calls for further examination of whether activism is catching on at hedge funds based in emerging markets.

Anxiety over the growing role of hedge funds has grown over the past few years, especially among European issuers, regulators, and lawmakers. In late May, the United Kingdom’s Financial Services Authority (FSA) released a report warning that hedge funds acquiring shares for the sole purpose of effecting corporate change may be tantamount to market abuse. A German Socialist politician has described hedge funds as “locusts,” while other leftist lawmakers in Europe argue that the funds overemphasize short-term gains.

Despite these complaints, Internal Markets chief Charlie McCreevy announced that the European Commission would not seek to regulate hedge funds. In July, the U.S. Securities and Exchange Commission adopted a rule that seeks to protect hedge fund investors from fraud, but the agency has not moved to curtail fund activism.

Meanwhile, a few European governments have tightened shareholding disclosure requirements in an effort to better monitor hedge funds. In June, the Dutch government proposed to lower the threshold for public disclosure of shareholdings in any company from 5 percent to 3 percent. Swiss legislators have voted to lower disclosure thresholds and to mandate greater disclosure of conversion rights, disposal rights, swap arrangements, and other derivatives.

The OECD, in spite of the anxieties caused by hedge funds and private equity firms, said that it believes the informational benefits to investors outweigh the possible risks.