The Global Economic Impact of Private Equity Report 2008 - World ...

Private equity and corporate governance:do LBOs have more effective boards?*FRANCESCA CORNELLILondon Business School and CEPRÕGUZHAN KARAKASLondon Business School1. IntroductionThe literature on corporate governance has long focused onthe boards of public companies. Boards monitor and provideadvice to management. When ownership of the company isdispersed, boards, and in particular outside directors sittingon boards, monitor management on behalf of the owners.If the role of boards in public companies is to providemanagement supervision, one may ask whether boards playthe same role in companies that have been acquired by oneor more private equity groups. The rationale often given forthe success of private equity is that it concentrates theownership in the hands of a few shareholders. Since theseshareholders are also involved in running the companyoperations, they have strong incentives to maximize the valueof the firm. In addition, private equity partners often haveextensive experience in restructuring companies, and thustheir advice can be very useful. As Sir David Walker statesin his July 2007 consultation document: “... alignment[of interests] is achieved in private equity through controlexercised by the general partner over the appointment of theexecutive and in setting and overseeing implementation ofthe strategy of a portfolio company. Lines of communicationsare short and direct, with effectively no layers to insulate ordilute conductivity between the general partner and theportfolio company executive team.”One may therefore argue that a company which has beenbought by a private equity fund may not need a board at all,as private equity partners can monitor and provide advicedirectly. However, usually such monitoring and advisoryfunctions are provided through the board. For example,Lerner (1995) shows that venture capitalists sit on the boardof the companies they have invested in, and their presenceon the board increases when their support is particularlyvaluable (e.g. during a change in CEO). We may thereforeexpect to find that this is also the case for leveragedbuyouts (LBOs), and the private equity sponsors may beactively involved in the company by participating in theboard. In this paper we study the boards of publiccompanies that have been taken private with private equitybacking. 1 The purpose of this is twofold. First, we want tolearn more about how boards of companies with privateequity investors function. Are these boards dramaticallydifferent from the boards of public companies? Are they justnominal boards, with no relevance for the restructuring ofthe company? Or do they serve an important supervisoryand advisory role in the restructuring process? Second, ifboards are an important part of the restructuring processof a company, given the successful performance of manyprivate equity investments, one may wonder whether privateequity boards are better structured to assist a companyin the restructuring process. Therefore, by looking at thecharacteristics of these boards we can have furtherevidence about what makes a board more effective.In this paper, we have constructed a new dataset,which follows the board composition of all public‐to‐privatetransactions that took place in the UK between 1998 and2003. 2 Out of 142 such transactions, 88 were sponsoredby at least one private equity fund. We can thus look at thechange in the composition of the board at and during thetime of private equity involvement. We examine whetherprivate equity boards are substantially different from theboards of public companies and whether there is support forthe view that boards backed by private equity funds are moreinvolved in an advisory and supervisory capacity than publicboards. When making this comparison, one has to keep inmind, as already mentioned, that the role of a board cannotbe exactly the same in these two situations. As stressed bySir David Walker (July 2007): “... the main driver of reformsof corporate governance of listed companies has been tore‐emphasize the role of the board as a guardian ofshareholder interests. But the private equity model has nomaterial deficiency in this respect.” Keeping this in mind, weuse as a control group a set of public‐to‐private transactionswith no private equity backing. Therefore the control groupconsists of either pure management buyouts (MBOs) orbuyouts backed by non‐financial sponsors. Managementbuyouts are an interesting comparison group as in these* We thank Per Strömberg for providing part of the data. We thank Paul Coombes, Denis Gromband and Josh Lerner for comments.Daniel Metzger and Kai Truempler provided excellent research assistance.1By private equity backing (or sponsorship) we mean that at least one private equity firm has invested in the equity of the company.2The focus on UK companies is due to the availability of data: only for the UK was it possible to find non‐sporadic information aboutboards of private companies in the last 10 years.The Global Economic Impact of Private Equity Report 2008 Large-sample studies: Corporate governance 65