PRIVATE EQUITY

Private Equity

Private Equity

Introduction

Perhaps the best indicator of the systemic failure in governance is the dramatic rise of hedge funds and private equity firms - the second category that can be termed "investor governance" in the sense that they act more as owners of companies instead of just holders of their securities. The jury may be out on the claims that they are a force for moral or social good, but there is little question that they are a positive economic force. They act like "good" bacteria in attacking inefficiencies with a superior governance model and bridging the agency gap. Their rise has not been an accident. Poor governance has left the door open for them. Private equity is a highly illiquid asset, its holder may not be well diversified, and selling it involves high search costs. In addition, for large investments it may simply be impossible to find a private equity investor to finance the entire expenditure. Dynamic capital structure models yield several predictions that hinge on the existence and characteristics of the transaction costs that firms may face when issuing debt and equity.

Discussion

Private equity funds invest in a small number of companies and the general partners are far more 'hands on' than even a large institutional investor will be in respect of a public company. In addition, private equity will typically 'own' a company for several years before selling it on, whereas the average length of ownership of shares is now under a year I think (although this doesn't actually tell you as much as many people make out). So, clearly, private equity as an ownership structure has some theoretical advantages over public companies (Titman, S., Fan, J., & Twite, G. 2003).

But, and this is a big but, governance structures only get you so far. What matters much more is how people behave within those structures. As many have said before, good governance structures don't create good managers, and this is as true for private equity as it is for public companies. Cases like the AA demonstrate that actually private equity owners can be pretty clueless. And flip it around, are we really to believe that all those managers in public companies are performing sub-optimally, simply because the ownership structure is different? What sounds good at a theoretical level, sounds odd when you think about it in the real world (Robb, 2002).

Private equity has come a long way since the 18th century, when entrepreneurs would approach wealthy individuals, usually aristocrats, and beg them to bankroll their projects; or even since the 1980s, when they were seen as the heartless “Barbarians at the Gate”. These days, private equity is a huge and eminently respectable industry, employing one out of five of those who work in the British private sector and dominated by some of the world's most professional companies, such as KKR, Blackstone, Goldman Sachs, Bain Capital, Cinven, 3i, Carlyle, CVC Capital Partners, BC Partners, Texas Pacific Group and Permira (Pinegar, ...