Private Equity and Corporate Governance: Retrospect and Prospect

• Date: 01 May 2009
• Published date: 01 May 2009
• Author: Mike Wright,Sourafel Girma,Charlie Weir,Kevin Amess
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00744.x

Private Equity and Corporate Governance:

Retrospect and Prospect

Mike Wright*, Kevin Amess, Charlie Weir and Sourafel Girma

ABSTRACT

Manuscript Type: Review

Research Question/Issue: We assess the corporate governance role and the impact of private equity.

Research Findings/Results: Private equity f‌irms are heterogeneous in their characteristics and activities. Nevertheless, a

corporate governance structure with private equity involvement provides incentives to reduce agency and free cash f‌low

problems. Additionally, private equity enhances the eff‌icacy of the market for corporate control. Private equity investment

is associated with performance gains, with such gains not simply being a result of transfers from other stakeholders. In the

short term, the benef‌its appear clear to outgoing owners and to the new owners and management while in the longer term

the benef‌its are less clear. While non-f‌inancial stakeholders argue that other stakeholders suffer in the short and long term,

the evidence to support this view is at best mixed.

Theoretical Implications: By reviewing a comprehensive selection of theoretical and empirical papers published in

refereed academic journals in f‌inance, economics, entrepreneurship, and management as well as publicly available working

papers and private equity industry studies, we develop a more complete understanding of private equity investment.

Agency theory has shortcomings when applied to the broad sweep of private equity-backed buyout types, as in some cases

pre-ownership change agency problems were likely low (e.g., family f‌irms), in some cases the exploitation of growth

opportunities owes more to the entrepreneurial behavior of managers than to improved incentives, and in some institu-

tional contexts outside Anglo-Saxon countries traditional agency issues are different and stakeholder interests are more

important. There is a need for further theorizing on the heterogeneity of buyout and private equity types and the contexts

in which they occur. Particularly useful perspectives seem to be entrepreneurial perspectives (e.g., entrepreneurial cogni-

tion, strategic entrepreneurship), stewardship theory, and institutional theory. Stakeholder governance theory (e.g., relating

to employee ownership and participation) may also be useful for explaining wider distribution of gains.

Practical Implications: Private equity investment is a positive feature of the corporate restructuring landscape. There is a

need for managers and their advisors to be aware of the heterogeneity of the opportunities to create value and the expertise

of different private equity f‌irms. Policymakers designing mechanisms to regulate private equity need to be aware of the

systematic evidence that shows a more positive impact of private equity than some have claimed, but also that there are

heterogeneous effects relating to different types of buyouts and private equity f‌irms that need to be taken into account.

Keywords: Corporate Governance, Institutional Shareholders, Mergers and Acquisition, Financial Performance, Busi-

ness Outcomes

INTRODUCTION

It is well documented that the separation of ownership

from control and the dispersed ownership structure of

the public corporation create agency costs that reduce share-

holder wealth (Jensen and Meckling, 1976; Famaand Jensen,

1983; Hart, 1995). In his seminal paper, Jensen (1989) argues

that the publicly held corporation has been eclipsed by a

relatively new organizational structure in which equity is

privately held with peak tier management having a signif‌i-

cant equity stake, that the f‌irm is highly leveraged, and that

there is an “active investor” in the form of private equity

(PE) institutions. These features of this organizational struc-

ture combine to create the necessary incentive and monitor-

ing mechanisms to induce wealth maximization.

Private equity and buyout transactions have become

an increasingly important governance mechanism to

rapidly and radically restructure organizations worldwide

(Wright, Robbie, Chiplin and Albrighton 2000b; Cumming,

Siegel and Wright, 2007; Wright, Burrows, Ball, Scholes,

*Address for correspondence: Mike Wright,Center for Management Buyout Research,

Nottingham University Business School, and Rotterdam School of Management,

Erasmus University Rotterdam. Tel: +44 (0)115 951 5257; E-mail: mike.wright@

nottingham.ac.uk

353

Corporate Governance: An International Review, 2009, 17(3): 353–375

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00744.x

Meuleman and Amess 2007b). The US buyout market

emerged in the early 1980s and has since diffused world-

wide (Table 1).

The period since 2000 saw a notable surge in deal activity

internationally (Wright et al., 2007b). For example, in addi-

tion to rapid growth in the US, the Western European

market grew by more than 50 per cent in 2005 and rose

further in 2006 to reach €160bn and the UK PE market rose

some 70 per cent in value in 2007 (Table 1). Public to private

(PTP) transactions were a particular feature of this explo-

sion, with the PE-backed buyout of Alliance Boots in 2007

the f‌irst such deal involving a FTSE100 company and

buyouts of listed corporations occurring in many European

countries as well as in Japan for the f‌irst time (Wright et al.,

2007b).1

Growth in PE and the buyout market has been accompa-

nied by increased media attention and criticism from,

among others, trade unions and members of the European

Parliament (PSE Group of the European Parliament, 2007).

For example, John Monks, General Secretary of the Euro-

pean Trade Union Confederation, claims that “established

companies (with consensualindustrial relations systems) are

destroyed” by PE f‌irms who take them over (Monks, 2006).

While industry studies have promoted the contribution of

PE to economic and f‌inancial performance, PE f‌irms have

been accused of: (1) asset stripping and prof‌iting from the

reselling of assets within short periods of time (asset f‌lip-

ping); (2) instigating restructuring within f‌irms that nega-

tively impacts employment and employee remuneration;

and (3) using leverage and off-shore holding companies to

reduce tax charges and it is these that account for, or signif‌i-

cantly contribute to, investment performance (PSE Group of

the European Parliament, 2007).

Increased scrutiny of the industry in many countries has

been accompanied by proposalsto increase regulation of the

industry (Treasury Select Committee, 2007; Unquote, 2008).

Much of the criticism has been based on selective evidence

and/or anecdotes (e.g., PSE Group of the European Parlia-

ment, 2007) and has generally ignored the large body of

systematic research reaching back over two decades. Watt

(2008) does, however, provide a recent exception from the

trade union perspective.

There is therefore a strong need for a review of the role of

PE in theory and of the available evidence on its impact. The

outcome of such a review provides the basis for an assess-

ment of the contribution of PE that has important implica-

tions for policymakers considering regulatory changes to

the industry. Our review also leads us to identify a future

research agenda thatwill enable further insights into the role

of PE f‌irms to be obtained.

Previous reviews have either focused on f‌inance-related

evidence from the f‌irst wave of PE and buyouts from the

1980s (e.g., Palepu, 1990; Jensen, 1993; Thompson and

Wright, 1995) or, while dealing with the later period, sacri-

f‌iced depth of focus on governance issues for breadth

(Cumming et al., 2007). We undertook a comprehensive

selection of papers published in refereed academic journals

in f‌inance, economics, entrepreneurship, and management

TABLE 1

Value of Buyouts/Buy-ins (€m)

Country Name 1998 1999 2000 2001 2002 2003 2004 2005 2006

US 16633 20590 32308 18462 31538 72308 105385 152308 179231

Austria 95 680 734 47 154 303 110 287 41

Belgium 820 2595 342 1744 517 1448 2270 4257 588

Denmark 267 2520 1313 500 1391 848 260 7089 13369

Finland 560 1085 675 1047 480 1039 977 2163 881

France 6153 8387 6502 6387 15568 8767 11520 21623 23282

Germany 5230 4642 14879 7229 8252 11974 17915 12928 20622

Ireland 243 1475 259 5021 4930 747 977 773 1004

Italy 670 2997 2560 1107 3428 7773 2940 17527 6392

Netherlands 3397 2906 1856 4433 1899 4958 7614 10338 25782

Norway 22 225 1004 1370 142 308 431 470 1581

Portugal 84 206 83 2 26 54 8 76 94

Spain 854 1715 941 1532 2069 934 2279 9391 4100

Sweden 928 2686 3169 3005 1116 2226 1701 4702 5435

Switzerland 1347 1013 1772 715 2766 865 1584 1081 924

UK 23270 26869 38419 31346 24851 23574 30155 35411 38261

Australia 1293 3433 168 1315 553 478 752 1147 3911

Canada 598 30 2365 228 1979 916 2279 1704 2404

Japan 24 956 1074 1473 711 5121 4745 2734 24

S. Korea 769 491 673 1093

Source: CMBOR/Barclays Private Equity/Thomson Financial

354 CORPORATE GOVERNANCE

Volume 17 Number 3 May 2009 © 2009 Blackwell Publishing Ltd