Private Equity, LBOs, and Corporate Governance: International Evidence By Donald Siegel, Mike Wright* & Igor Filatotchev * Address for correspondence: Center for Management Buyout Research, Nottingham University Business School, Nottingham, NG8 1BB, UK Tel: +44(0) 115.951.5257. E-mail:
[email protected]
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Electronic copy available at: http://ssrn.com/abstract=1737462
INTRODUCTION
Private equity is risk capital used in a wide variety of situations, ranging from finance provided to business start-ups to the purchase of family firms, as well as divisions of corporations and even entire mature publicly-traded companies (Gilligan & Wright, 2010). The focus of this special issue is on leveraged buyouts of existing businesses in which private equity investors and a management team pool their own money, usually together with borrowed money to buy a business from its current owners. In recent years, there has been a resurgence of these leveraged buyouts and private equity investment in many nations (Wright, Amess, Weir & Girma, 2009a; Stromberg, 2008), culminating in a peak worldwide in 2007. The onset of the financial crisis from 2008 resulted in a massive fall in deal value worldwide in 2009 as debt markets closed and private equity firms set about restructuring troubled and over-leveraged portfolio companies. Nevertheless, it is clear that private equity was not just a transitory phenomenon and that private equity firms have adapted to begin to build a new future (Wright, Jackson & Frobisher, 2010). At the time of writing worldwide private equity shows signs of recovery, as the third quarter of 2010 provided the strongest showing of the market since the financial crisis at an aggregate value of $66.7 billion (Preqin, 2010). These trends have vital global implications for corporate governance and performance. Disclosure and other governance requirements associated with the SarbanesOxley Act have substantially increased regulatory compliance costs for listed corporations (Yoshikawa and Rasheed, 2009).. The costs associated with a stock market listing, including the costs of scrutiny by security analysts, have important implications regarding the attractiveness of the stock market for firms. As a result, companies of modest size with growth potential may have great difficulty securing funding. Larger firms may find the regulatory burden and additional scrutiny too severe. An overemphasis on accountability 2
Electronic copy available at: http://ssrn.com/abstract=1737462
could stifle the ability of firms to realize entrepreneurial opportunities. Under these circumstances, private equity investors can provide funding to realize growth opportunities, as well as active, specialist governance. Pension funds and other institutional investors, including sovereign wealth funds have also been attracted to the private equity market by superior returns. The end result is that private equity funds have become larger, raising the likelihood of additional acquisitions of large corporations. The rise of the private equity market poses critical research questions regarding how these transactions increase private and social value. As evidence by the papers in this special issue, the “performance” effects of these transactions have important implications for corporate governance practices.
For instance, private equity firms may need to adopt
strategies to secure attractive deals without engaging in public auctions, which have become prevalent. A recent review of the literature in this Journal (Wright et al., 2009a) reported that private equity transactions have resulted in significant gains in “real” performance or productivity (Lichtenberg & Siegel, 1990; Harris, Siegel & Wright, 2005). However, there may need to be a stronger emphasis on entrepreneurial activity to realize the upside potential of these firms (Wright, Hoskisson, Busenitz & Dial, 2000). Changes in the stock market and the market for corporate control also raise issues concerning the ability of private equity firms to realize the gains from their investments, especially for modest sized deals in mature sectors, while at the same time meeting investors’ expectations of significant returns within a particular time period. The returns from private equity transactions have attracted new types of entrants seeking to reap such returns. In particular, hedge funds have actively entered this market, which raises several concerns, given their transaction-oriented nature and a sense that their ability to add real value (in a managerial sense) to enterprises may be limited. Private equity is also increasingly becoming an international phenomenon. Leveraged and management buy-out activity is on the rise in Europe, Japan, and other Asian nations, as
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these countries come under increasing pressure to restructure their economies (Wright et al., 2007). Public to private leveraged buyouts (LBOs) have been occurring in significant volumes in these countries over the past five years where they were previously absent. The development of these types of organization, in contexts where they were previously absent, adds to the growing interest in the influence of contextual, institutional factors in finance and governance. The actions of multinational private equity firms internationalizing into these markets and the controversy this has generated (especially in Europe) in relation to employment and employee relations also heightens the importance of examining international evidence on this phenomenon. The advent of the international financial crisis from 2008 and its implications for highly leveraged private equity deals has further fuelled interest in the corporate governance implications of private equity. In sum, these developments have salient managerial and policy implications for corporate governance. The papers presented in this special issue address these challenges. Although different in style and research methods used, they have one common element: a strong focus on the governance roles of private equity firms in different contexts. This unique focus makes this special issue an important step towards a better understanding of corporate governance around the world. These papers also help to identify a number of important avenues for future research on the governance implications of private equity investments.
PAPERS IN THE SPECIAL ISSUE Following a general call for papers, we received 19 submissions. Based on the first round of reviews, we invited 10 papers for presentation at a conference held at the University of Albany, State University of New York in June 2010. We then invited authors of the papers presented at the conference to revise their papers and resubmit them for further review. We selected the 5 best papers that met the standards of the CGIR review process for publication
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in this special issue. Table 1 contains a summary of these articles. For each paper, Table 1 lists the authors, key research questions, the data and analytical methods, and the key findings relating to corporate governance. INSERT TABLE 1 NEAR HERE Private equity and other acquirers There is substantial evidence of significant announcement effects of public to private transactions (henceforth, P2Ps, see e.g. Renneboog, Simons & Wright, 2007). These significant increases in stock prices have been found in different institutional contexts, including the US, UK, continental Europe and Australia (Cumming, Siegel & Wright, 2007). However, the announcement effects seem to be less in Europe (Andres, Betzer & Weir, 2007) and Asia (Lee, 2009) than in the U.S. or U.K. (Renneboog et al., 2007). Explanations of P2P transactions in the U.S. may not hold in Europe and Asia. First, there is heterogeneity between the three continents in terms of capital market development and regulation, legal and corporate governance frameworks, tax benefits, the use of debt in funding LBOs. Second, the ownership structure of listed corporations differs, with many continental European corporations, in contrast to the U.K. and the U.S., having dominant family shareholders (Geranio & Zanotti, 2010), which is also the case in several Asian countries including Japan (Wright, Kitamura & Hoskisson, 2003). This also affects the functioning of the market for corporate control is less active. Third, although there has been some development of corporate governance codes, protection of minority shareholders is generally weaker in continental Europe and Asia. These differences suggest that P2Ps in continental Europe and Asia may have different determinants which impact the wealth gains that are observed. We return to this point in the next section in the context of PE firms’ rationales and actions in investing in P2Ps.
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Evidence suggests that, as in more traditional acquisitions, pre-buyout shareholders obtain a higher price for their stock if outside acquirers compete for control with the proposed MBO (Easterwood, Singer, Seth & Lang, 1994). Growing attention has, however, been paid to alternatives to the public takeover process, including the roles of private bargaining (Boone & Mulherin, 2007) and irrevocable commitments (Wright et al., 2007). With respect to the latter, acquirers can enhance their chances of success in negotiating a takeover of a listed corporation by seeking irrevocable commitments from significant shareholders to accept their bid before it is made public. Cumming and Li (this issue) add to this literature by examining whether there is evidence of insider trading in public and private acquisitions, including private-equity backed acquisitions. Using international data they find evidence that is consistent with insider trading of acquirer’s stock. These findings have important implications for corporate governance research since they point out that insider trading is not associated only with transactions in public market equity and it represents a more general phenomenon that requires further research.
Private equity firm actions PE firms select firms for investment where they perceive that they are under-performing and that their actions can reverse this trend. Various studies of P2Ps have examined the relative importance of different antecedents to the buyout and find, inter alia, that undervaluation is an important factor (Renneboog et al, 2007). However, in continental Europe while undervaluation is important, deals promoted by family owners register higher abnormal returns (Geranio & Zanotti, 2010). Achleitner,
Betzerb, Goergen and Hinterramskogler
(2010) also find for continental Europe that since corporate control and ownership in continental Europe tend to be highly concentrated, the incentives of incumbent large
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shareholders to monitor management and the private benefits of control the latter may derive from the firm affect the likelihood of the firm being taken over by a private equity investor. There is some debate about the role of financial distress as an indicator of the attractiveness of a target corporation for PE firms, with Opler and Titman (1993) in the US arguing that PE firms are deterred from taking companies private that show signs of distress because firm failure is more likely following a buyout, due to the higher debt burden associated with the transaction. Sudarsanam, Wright and Huang (this issue) challenge this view and extend the argument that private equity can contribute to the general corporate governance literature by extending the market for corporate control beyond traditional acquisitions of companies at risk of bankruptcy. Using a sample of UK P2Ps they find that these firms have significantly higher default probability than non-acquired firms that remain public. This suggests that PE firms are not deterred by the risk of financial distress but consider it a value creating opportunity due to their specialist governance skills. However, they also caution that this view may need to be tempered, given that limited access to information before the deal may mean that serious underlying performance problems are not revealed before the deal is completed. Sudarsanam et al. extend the existing literature on P2Ps, which has tended to cast doubt upon the efficacy or pre-buyout governance mechanisms, by arguing that better governance of the target pre-P2P is associated with lower bankruptcy risk since where the PE investor inherits a strong governance structure, as manifested by the presence of independent boards. These findings, however, raise questions about the ability of private equity governance structures to turnaround troubled former stock market listed corporations. There is growing awareness, particularly in an international context, of the heterogeneity of PE equity and hedge funds. Further, studies have also shown that the effects
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of PE and hedge funds on the performance of their portfolio companies is closely associated with funds’ specialist sector expertise and prior deal experience. Numerous authors have considered the role of traditional takeovers in removing under-performing managers. Most of these papers have reported a higher rate of managerial turnover in the aftermath of a takeover, especially in the case of hostile bids (see e.g. O’Sullivan & Wong 2005 for a review). The emerging PE literature points to the greater role of PE firms in changing management compared to boards in listed corporations (Cornelli & Karakas, 2008; Acharya, Kehoe & Reyner, 2009). Gong and Wu (this issue) add to evidence on the role of PE firms in removing incumbent managers. Using a sample of U.S. LBOs, they find that over half of CEOs are changed within two years of LBO. Boards are more likely to replace CEOs in companies with high agency costs and if pre-LBO performance is low. Interestingly, they find that in contrast to boards of directors in public companies, boards in post-LBO companies are likely to replace entrenched CEOs. Again, this finding is very important for corporate governance research in general since it indicates that the types of investors may have a direct impact on other governance factors, such as CEO replacement.
Portfolio companies As noted earlier, a recent review in this journal (Wright et al., 2009a) identified extensive evidence stretching back to the first wave of private equity backed buyouts in the 1980s of significant performance improvements in portfolio companies, which were associated with improved governance and incentive mechanisms. The effects of private equity backed buyouts on employment in portfolio companies has proven to be a much more controversial issue. Evidence relating to the governance effects on employment resulting from traditional takeovers, has identified substantial reductions (Conyon, Girma, Thompson & Wright, 2002).
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The emergence of private equity backed buyouts serves to emphasize the need to recognize the heterogeneity of acquirers and acquirees and their implications for employment. Research has examined the impact of private equity backed LBOs on employment and in portfolio companies (Amess & Wright, 2007, 2010; Davis et al., 2008). The available evidence suggests that the negative effects on employment are less for PE deals than for traditional acquisitions (Amess & Wright, 2010). Although the impact of alternative investors such as private equity and hedge funds has attractive considerable policy debate, a growing body of evidence suggests that a more nuanced approach is required that reflects the heterogeneity of the circumstances under which the deal takes place, including whether the deal is an insider driven management buyout or an outsider driven LBO or management buy-in (MBI) (see Wright, Bacon & Amess. 2009b for a review). While Amess and Wright (2010) focus upon the broad spread of outsider driven MBIs from a range of vendor sources including family firms and divisional sales, Goergen, O’Sullivan and Wood (this issue) extend recognition of the heterogeneity of acquiree types and their different employment effects to the case of Investor-Led Buyouts (IBOs) of listed corporations. They find that IBOs are accompanied by falls in employment without there being a corresponding increase in productivity and profitability. These findings echo those in Weir, Jones and Wright (2008) who examine the full scope of public to private buyout transactions.
Individuals and employees There is an extensive literature concerning the effects of traditional acquisitions on employee relations (see e.g. Vinten, 1993 for a review). Goergen, Brewster and Wood (2006) suggest that the cross-country effects of traditional acquisitions are not simply due to simple path dependent institutional differences between countries, but rather to industry and firm
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specific factors. Attention is also beginning to be given to the link between institutional context and the effects of private equity on employee relations, including the involvement of employees in firm governance, in recognition of the governance impact resulting from the heterogeneity of acquirer types. A first approach to examining this heterogeneity was undertaken by Bacon et al. (2010b) who, examining a pan-European sample of private equity backed buyouts, find that with respect to the PE firms’ country of origin, buy-outs backed by Anglo-Saxon PE firms are as likely to introduce new high performance work practices (HPWP), and are specifically more likely to extend performance-related pay schemes, as those backed by non-AngloSaxon PE firms, suggesting some adaptation to the local host country contexts of buy-outs. Interestingly, this study also suggests that the overall impact of PE on (HPWP) is affected more by length of the investment relationship than the countries where PE is going to or is coming from; PE investment results in the increased use of HPWP in buy-outs the longer the anticipated time to exit.
Gospel, Pendleton, Vitols & Wilke (this issue) extend this analysis of heterogeneous acquirers by encompassing private equity firms, hedge funds and sovereign wealth funds, each with distinctive corporate governance mechanisms. They find substantial effects of these different forms of alternative acquirer on employees using case studies from three European countries. They note that the effects are heterogeneous. Some consequences such as employment reduction appear to be negative for labour but there are also some benefits in terms of work organisation and employee voice. Their findings that national systems of labour regulation do not seem to impact substantially on the scope for employment reductions but they do affect the extent to which worker representatives receive information after (though not during) the acquisition reinforces the wider evidence from traditional acquisitions. 10
Private equity firms and national institutions The recent review by Wright et al. (2009a) noted that the evidence on the effects of private equity in different institutional contexts is somewhat fragmented. Further, there has been little attempt to theorize and make empirical comparisons across countries or to analyze the cross-border activities of private equity firms. This has especially been the case for multicountry studies in the finance area, yet evidence from single country studies from countries such as the US, UK, France, Netherlands suggests that there may be important differences. Several of the papers in this special issue provide evidence that adds to insights regarding the implications of national institutional differences for the effects of private equity. Sudarsanam et al. provide theoretical argumentation and empirical evidence relating to the UK which stands in contrast to earlier US evidence on the effect of distress costs on the completion of private equity deals. In contrast, the US evidence from Gong and Wu on the extent of CEO replacement is consistent with recent UK studies. With respect to multi-country studies, Cumming and Li examine differences in insider trading in private equity and non-private equity deals in 31 countries, while Gospel et al. provide a specific comparison of the employment effects of different forms of alternative investors in different country contexts.
AN AGENDA FOR FURTHER RESEARCH In this section, we identify areas for further research into the international dimensions of the governance aspects of private equity at five levels of analysis: private equity firms compared to other acquirers, private equity firm actions, portfolio company behavior, individual and employee involvement in governance, and private equity and national institutions. In Table 2, we summarize the key research questions at each unit of analysis. INSERT TABLE 2 NEAR HERE
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Private equity and other acquirers Market developments have seen the emergence of new forms of acquirers who complement traditional players in the market for corporate control which were the focus of previous corporate governance research. At present, however, we know relatively little about the behavioral actions of these related players and the extent to which they may be substitutes for or complements to traditional PE firms. In the environment of the financial crisis, distress funds have emerged to take advantage of turnaround opportunities. We know little about whether turnaround is achieved solely through cost cutting or whether growth strategies (e.g. the provision of funding to enable the roll out further store openings in retail cases) are also implemented to prepare the firms for exit. Such cases blur the distinction with traditional PE firms. The listing of some large PE firms has attracted attention for several reasons, not least of which is the potential impact on their behaviour regarding the selection and governance of portfolio companies. However, listed PE firms form a long-standing and well-established sector. For example, in Europe, there are about 80 investable listed private equity companies (http://www.lpeq.com/listed-private-equity/lpe.html). Unlike traditional private PE funds, listed private equity companies have no fixed lifespan. Proceeds from the sale of assets are generally retained for reinvestment, rather than being distributed to investors. As such, the investment time horizons of listed private equity may be longer. At the same time, listed PE firms are quite heterogeneous. While some are experienced active investors, others may know little about PE and regard it as ‘just another stock’. There is a need for examination of the governance roles of listed PE firms compared to traditional PE firms. This represents an important field for future corporate governance research since it blurs boundaries between public and private market investments traditionally considered as separate areas by governance researchers.
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Two further related sets of investors are firstly secondary buyout funds, who acquire and manage PE portfolios from existing PE firms. How these firms create value from their portfolios is little understood. Second, funds of funds invest in several PE funds and raise research issues concerning their governance role in the PE funds in which they invest. How funds of funds adapt the composition of their portfolio of funds is also an area worthy of further research. An important dimension of the comparison between PE firms and other acquirers concerns their ability to outbid other would-be purchasers of target firms. At present, there is limited evidence directly comparing
PE bidders with traditional corporate acquirers,
although there are some indications of outbidding by PE firms (see Hege, Lovo, Slovin & Sushka, 2010). This somewhat surprising result requires further investigation, particularly in relation to the rationales for outbidding but also for the outturn of these bids once completed. It may be, for example, that where PE firms bid for divested subsidiaries of larger groups they are able to engender more entrepreneurial actions that had previously been frustrated than is possible for a corporate acquirer (Wright et al., 2000). A challenge for studies in this area concerns the ability to obtain information once a firm is bought by a corporate acquirer.
Private equity firm actions One of the conceptual weaknesses of corporate governance research is a relative dearth of studies on the behavior of investors and its impact on portfolio companies. For example, a number of studies have attempted to examine the impact on post-deal performance of PE firm experience. However, there is little direct evidence of the role of other managerial factors such as the experience and expertise of portfolio company executives or that of the investment executives involved in monitoring the portfolio firm. The market has also been marked by an increase in both build –up deals that require multiple rounds of funding and of
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secondary buyouts. The managerial and governance processes in generating gains in these kinds of deals appear to introduce major challenges compared to traditional LBOs that involve one-off investments. The impact of the global financial crisis of 2008 onwards raises important challenges for how the traditional PE model will adapt. Poor performance of portfolios introduces the problems relating to how both executives in PE firms and management in portfolio companies are going to be incentivized if equity investments are under water with little if any prospect of a significant return. For example, to what extent are equity resets and exit bonuses being introduced and what are their implications for how firms are governed and how their strategies are changed? The lack of availability of debt has implications for the ability of PE firms to rely on leverage to generate returns. The advent of all-equity deals is in marked contrast to the traditional PE model. How is value to be generated in such contexts? PE firms may need to adopt longer time horizons to exit in order to allow value to be built. This, in turn, has implications for the governance role of PE firms in portfolio companies. It also has implications for traditional PE limited life fund structures since these may be too constraining. There has also been little attention paid to the cross-border activities of PE firms (Meuleman & Wright, 2010). PE firms that enter foreign markets may do so by investing with syndicate partners who have expertise and knowledge relating to the local environment. We know little about how PE firms select cross-border syndication partners and the implications for the governance of these syndicates. This selection decision is critical since the choice of partner determines the skills, knowledge and resources that a PE firm has access to. The trust required to develop these links may be based on prior experience but where the PE firm is entering new markets, experienced based trust may be absent and a reliance on initial trust may be needed. Initial trust is derived from the institutional cues that enable one actor to trust another without firsthand knowledge (McKnight, Harrison, Cummings &
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Chervany, 1998) and comprise the legal, political and social systems that support the monitoring and sanctioning of social behavior. Research is needed to examine these issues and their implication for the governance mechanisms put in place to manage syndicate arrangements. Another interesting avenue of research would be to analyze the propensity of PE firms to be “socially responsible.” That is, while there have been numerous studies of the effects of PE activity on financial and economic performance (see Cumming et al, 2007 for a review of these studies), more generally, there are few studies which assess the impact of PE transactions on corporate social performance or corporate social responsibility. It would also be useful to explore the role of corporate governance as a mediating factor in this relationship.
Portfolio companies There is now extensive analysis of the financial effects of PE backed LBOs. However, examination of the real effects remains limited (Harris et al., 2005). Additional research on the effects of PE backed LBOs on total factor productivity is warranted. This research should take account of several aspects of the deals and the individuals involved in these transactions, such as PE experience and skills, whether deals are insider driven MBOs or outsider driven MBIs and LBOs; the influence of managerial equity and management turnover, and the extent to which strategies involve cost restructuring or growth. Research on the impact of private equity backed LBOs on employment and employee relations principally relates to samples of deals conducted prior to the financial crisis post-2007. Further research is needed that examines the extent to which PE firms cut more than non-PE firms during recession or whether pre-emptive actions taken by PE firms provide for greater resilience during periods of economic downturn.
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There is relatively little recent analysis of the changes to managerial practices following a PE backed buyout. Bloom et al. (2008) provide a simply examination of types of managerial practices where PE-backed firms were included as a small part of a much larger global project. Critiques of the behavior of PE firms that focus upon their alleged negative effects upon the social and longer term prospects of the firms in which they invest raise the question of whether and to what extent firms pay attention to their corporate social responsibility strategies (McWilliams & Siegel, 2011). What are the changes to CSR behavior by PE firms and their portfolio companies? In which contexts is this particularly prevalent? For example, do foreign PE firms need to pay particular attention to stressing CSR behavior when they enter markets that are more sceptical about the benefits of PE? Majority ownership of portfolio companies by PE firms, or powers for PE firms to fire executives, raises the important issue of the interaction of the management team and the PE firm’s strategy for the business. Some PE firms take the stance that “ the plan always trumps the team” on the grounds that replacement management can always be found to fulfil the strategy that the PE firm has identified. Therefore, an important area for future research is to examine the balance between collaboration and confrontation in addressing issues related to the “professionalization” of portfolio companies.
Individuals and employees Traditionally, the governance literature is focused on the impact of private equity investors on the financial performance of firms. What remains less researched is the relationship between private equity investors and the main stakeholders, such as employees. There has been relatively little analysis of the structure and processes involving buyout teams, even though there is a large literature relating to the dynamics and conflicts within top management teams
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in general (see Wright & Vanaelst, 2009 for a review). Teams may be able to subsume latent conflicts during the initial period post buyout as efforts focus in establishing the business as an independent private entity. But conflicts and divisions may develop as different exit opportunities emerge which have implications for the continuing independence of the firm. Further, particular problems may arise in dealing with the challenges of turnaround. For example, some members may seek to ‘jump ship’ if they can find better alternatives elsewhere. Some members, especially the CEO, may be closer to the PE firm than other members of the team and be perceived to be manoeuvring solutions that are in their own singular interests rather than of the team as a whole. The CFO may have a broader relationship with financial backers, including the banks, and need to act in the interests of all. Or, the CEO and CFO may be closely involved in dealing with the financial problems of the firm, creating a cleavage between them and the rest of the team. These problems may be exacerbated where the team has been constructed by the PE firm at the time of the deal, rather than having worked together before. These interactions may have major implications for the governance of the portfolio company and the ability of the executive team to turnaround the business. Recent studies have examined employee relations aspects of PE deals (see e.g. Gospel et al. this issue; Bacon, Wright, Scholes & Meuleman, 2010a; Bacon, Wright, Meuleman & Scholes, 2010b). However, there is relatively little recent research on employee ownership, even though some larger deals (even controversial ones like the Automobile Association (AA)) involve some employee ownership. A number of new research avenues arise in this context. First, to what extent do employees and their representatives become involved directly with PE providers in the management of portfolio companies? For example, are there regular meetings with PE providers? What form do these meetings take? Second, to what extent do employees as owners exert a governance effect in relation to PE investors? Third,
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what mechanisms are adopted to extend ownership to employees and in which cases are they used? Fourth, in the case of public to private buyouts where there may have been employee ownership schemes when the company was listed, what replaces these schemes when they are abolished when the firm is taken private?
Private equity and national institutions As we indicated in the Introduction, private equity is also increasingly becoming an international phenomenon. Therefore, the impact of different institutional contexts on the governance roles of private equity firms becomes a particularly important research area, yet although we note some evidence on institutional differences in papers in this special issue, this aspect has so far been largely neglected. Bruton, Filatotchev, Chahine and Wright (2010) point out that private equity investments represent an interesting example of a mediated market. In mediated markets, the social capital of a broker can significantly shape market outcomes. Private equity syndicates typically possess higher amounts of social capital related to their informal networks that include various stakeholders, such as financiers, political actors, advisors, and industry partners. Network embeddedness provides a structural and/or relational safeguard against opportunistic behavior, because of the effects a negative reputation can have on future relations (e.g., Gulati, Nohria & Zaheer, 2000). Institutional analysis has indicated that the closeness and trust existing between actors serves as a social lubricant for ongoing interactions such that critical transaction-specific informational resources can be of acceptable availability and quality (Nahapiet & Ghoshal, 1998). Therefore, the way private equity firms provide informal monitoring and its effectiveness may depend on specific formal and informal institutions in a particular country that define formal contracts and informal relationships among investors and investees. For
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example, compared to the U.K./U.S., network-based capitalism in European countries and Japan should increase the positive impact of the investor syndicate by utilizing non-legal sanctions, including trust, mutual dependence, and reputation as governance mechanisms within a syndicate. Makela and Maula (2005) argue that VC syndicates are embedded within broader international and institutional networks. They found that commitment by a VC firm is contingent upon the degree to which the firm is embedded in a social network of relationships with the focal market and these embedded firms take on longer-term decision bases than purely financial ones. Although PE syndication is common in various national capital markets there are considerable differences in the extent of agency conflicts associated with syndication between the markets. As indicated above, syndication is a means by which PEs can share risk through portfolio diversification since for a given fund size, it enables the spreading of capital across a greater number of investments. However, syndication itself may create another agency problem relating to the behavior of the syndicate members. Each syndicate usually contains lead and non-lead firms, with an individual venture capital firm playing both roles over time depending on the particular deal (Wright & Lockett, 2003). Each syndicate is temporary in nature with the financing structure constructed specifically for that transaction. This limited longevity of the syndicated investments may create moral hazard problems associated with the “principal-principal” relationship between syndicate members. The lower the level of cooperation among syndicate members, the greater the levels of relational risk and hence the associated agency costs. The origins of the agency costs in the syndicate may arise from the diverse objectives of members and the time-consuming nature of coordination. However, these agency conflicts may be less prevalent when institutional factors make the network and reputational aspects of syndicates particularly important. Reputational considerations of syndicate members that are so important outside the US plus longer-term
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collaboration among syndicate members suggest that the investors’ perception of the extent of principal-principal conflict within the syndicate will be lower in institutional contexts that support informal relationships and collaboration. Therefore, future research should address the questions: How do national institutions shape the nature and extent of agency conflicts in private equity investments? How do they affect the effectiveness of corporate governance remedies that private equity firms deploy to mitigate these conflicts and reduce associated agency costs?
Data and methods Cognizance needs to be taken of the data and methods adopted to address this research agenda. Bigger datasets are now available compared to the first wave of private equity and LBO studies. However, many of the datasets available are commercial files, where non-PE backed buyouts are missing. Further, the heterogeneity of LBO and PE-backed deal types needs to be recognized. For example, insider driven MBOs, whether or not PE-backed, are distinct from outsider driven LBOs or MBIs in terms of managerial ownership, access to information, etc. which has implications for the governance of these firms. Datasets and hence studies are needed to at least control for these differences. To overcome some of the shortcomings of commercial datasets, some studies have utilized proprietary datasets held by funds of funds or PE funds. While these datasets may provide access to rich data that is absent from commercial datasets they may be biased to more successful and larger funds. As with commercial datasets, there may also be an emphasis on larger deals, raising questions as to their representativeness of the PE market as a whole. This may be especially a problem with datasets covering several institutional environments.
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A substantial amount of recent research, especially in finance, has involved the building of global datasets but has been accompanied by little theorizing or analysis of crosscountry differences. The richness of these global datasets would seem to us to offer many so far unexploited opportunities for the examination of between institution effects. Apart from the empirical research based on large firm- or plant-level datasets, more qualitative, case study-based research is becoming increasingly important. These studies, such as Gospel et al.’s paper in this issue, are able to explore process-related aspects of private equity that empirical studies cannot capture because of their design. There is a growing appreciation of qualitative studies in corporate governance research in general since traditional, finance-driven empirical studies are unable to provide a full understanding of governance processes and mechanisms, and here we see an important contribution that qualitative studies on private equity can make to the mainstream governance research.
Policy and practical implications Evidence presented in this special issue of the role of insider information in private equity and other acquisitions suggests a need to adapt regulatory efforts to examine acquisition processes more closely. Such attention particularly seems warranted as there appears to be a growing interest in the private negotiation of acquisitions rather than a public takeover process. Although the private equity industry was at centre of a storm of criticism in 2007 and 2008, we now have a great deal more systematic evidence about its impact. Evidence presented in this special issues suggests that policymakers designing mechanisms to regulate alternative investors need to recognize the heterogeneity of impact of different types of investors. The impact of the corporate governance mechanisms involved in hedge funds and sovereign wealth funds especially does not appear to be the same as for private equity funds.
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The evidence presented also seems to indicate that the impact of private equity firms varies according to type of private equity and the type of portfolio company in which they invest.
CONCLUSIONS In this introductory article, we summarized the findings of the papers presented in this special issue. We also outlined an agenda for further research on the governance aspects of private equity with a particular focus on international dimensions. While there have been important global developments in private equity, we have identified that systematic research on the governance aspects of the international dimensions of private equity firms remains under-developed at various levels of analysis. Although there is growing evidence on the effects of governance structures of private equity firms and their portfolio companies in different countries, these insights have not been matched by findings into the international cross-border governance mechanisms and processes of private equity value creation through cost reduction, growth and turnaround. While there has been a focus on direct actions to increase returns to shareholders, limited attention has been paid to the role of other stakeholders through consideration of corporate social responsibility aspects and the involvement of employees in corporate governance in private equity deals. These issues also highlight important dimensions of international governance, given differences in approaches to CSR and labor regulation between institutional contexts that may be of particular interest to readers of this Journal.
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Table 1: Summary of papers in the special issue Authors
Research Question
Data and Methods
Conclusions
Gong and Wu
What is the role of private equity (PE) firms in removing entrenched CEOs or CEOs who cause agency problems?
Archival data; 126 PE sponsored US LBOs between 1990 and 2006
CEO turnover rate of 51 percent within two years of LBO; Boards more likely to replace CEOs in companies with high agency costs; Unlike boards of directors in public companies, boards in post-LBO companies are: (1) likely to replace entrenched CEOs; (2) boards are more likely to replace CEOs if pre-LBO return on assets is low
Cumming and Li
Is there evidence of insider trading in public and private acquisitions, including privateequity backed acquisitions?
Archival data; 736 Canadian acquirers, acquiring targets in Canada, the U.S. and 31 other countries, during the period 1991-2008.
The evidence presented is consistent with insider trading of acquirer’s stock.
Sudarsanam, Wright and Huang
What is the impact of bankruptcy risk of the target firm on the completion and subsequent exit, including bankruptcy, of private equity backed public to private buyouts?
235 UK companies that went from public to private (P2P) company status from 1997 to 2005; archival data,
P2P deals involve targets with a higher risk of bankruptcy; independent boards pre-buyout and managerial ownership associated with lower post-buyout bankruptcy; high bankruptcy risk at going private increases the chance the target will end up in receivership
Goergen,
What are the
Quantitative and
(1) Significant decrease in employment in PE backed 27
O’Sullivan and Wood
Gospel, Pendleton, Vitols & Wilke
qualitative; Pre and postacquisition analysis of employment and performance characteristics for a sample of 73 PE backed IBOs completed 2000-6, and a size and industrymatched sample of nonacquired firms. What are the labour Interview data; Three consequences where case studies in Spain, companies are Germany and UK acquired by either private equity, hedge funds, or sovereign wealth funds? employment consequences of private equity acquisitions, in particular institutional buy-outs (IBOs), in the UK?
IBOs after buyout; (2) No increase in employee productivity
National systems of labor regulation do not seem to impact substantially on the scope for employment reductions, but they do affect the extent to which worker representatives receive information after (though not during) the acquisition
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Table 2: An agenda for further research PE and other PE firm actions acquirers What are the effects of Where do the gains in PE stem from – PE versus traditional deals or M&A? How do the restructuring differences between management acquirer types vary entrepreneurship? How do across institutional these gains differ between different deal types? contexts?
PE portfolio companies How do Private equity backed firms deal with employee relations during the economic cycle, especially in recession? To what extent do PE firms reduce employment conditions more?
Individuals and Employees What are the implications for management team conflict and cohesion during restructuring and recession?
Institutions
How do national institutions shape the nature and extent of agency conflicts in private equity investments? How do the roles of boards in PE portfolio companies vary across institutional environments? How do they affect the effectiveness of corporate governance remedies that private equity firms deploy to mitigate these conflicts and reduce associated agency costs?
What are implications for PE bidders against traditional corporate acquirers? Will they [continue] to outbid? Why? How do PE deals compare with non-PE deal perform over the economic cycle?
How do PE firms’ actions differ in build –up deals that require multiple rounds of funding? What are the longer term effects of private equity deals, including following IPO?
How does total factor productivity in PE firms differ according to PE experience/reputation/skills; MBO/I; Managerial equity and CEO turnover; extent to which deal is growth or restructuring oriented?
What links do employees, trade unions and employees ownership have with PE providers? Even without ownership, do employee representatives exert a governance effect? What are the challenges to further employee ownership in PE deals?
How do the roles of distressed funds, secondary funds, funds of funds and listed PE funds differ from traditional private PE funds?
What are the dimensions of PE firm heterogeneity and how does this impact involvement in portfolio firms? How do PE firms adapt their incentives and structuring in recessionary conditions
What is nature of changes to managerial practices? What governance roles are involved in PE firms taking stakes in listed corporations? What are the changes to CSR behavior by PE firms and their portfolio companies?
How do the impacts of private equity on employee involvement in governance vary across jurisdictions? How do PE firms balance the ‘plan’ with the ‘team’?
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What are the national differences in terms of deals volume, structure and control mechanism used by private equity? How are cross-border syndicates governed?
