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

transactions. To begin with, note that members of the privateequity groups actively sit on the board of firms that haveundergone LBOs: the percentage of LBO sponsors sittingon the board after an LBO is 31%. This implies that privateequity firms are active investors. Figure 3 also shows thatbefore being taken private through MBOs, boards have alarger proportion of insiders than is the case for both LBOsand other transactions. Insiders (defined as CEO, othermanagement and other non‐management insiders) make up61% of the board in MBOs, 55% in LBOs and 45% in theother transactions. For MBOs and LBOs, the proportion ofoutsiders drops dramatically after the company is takenprivate: 11.8% for MBOs (this includes outsiders with PEconnections) and 9.3% for LBOs. Given the size of the boardafterwards (5.4 for LBOs and 4.2 for all others), we find thatmost of the companies have no outsider on the board. 15The role of expert outsiders in private equity boards is oftenmentioned, since it is usually assumed that outsiders have animportant advisory role, because of their industry knowledge(see, for example, Kester and Luehrman 1995). However, ouranalysis shows that there are few outsiders on companyboards after a private equity transaction.To make sure this result was not driven by some anomalies,we have performed the following checks. First, we havelooked at the change in the board composition if we drop thecompanies in the real estate industry (since the private equityfirms backing real estate deals are usually different) but thecomposition did not change (the percentage of outsidersincreased by 1%). Second, we check whether this resultcould be due to the difficulty in identifying outsiders. In thecase of LBOs, 7% of the seats were on average occupiedby individuals whose identity we could not determine withcertainty, and therefore were classified as unknown. It ispossible that most of these individuals are outsiders. If weassume that all unknown individuals are outsiders, this willconstitute an upper bound to the number of outsiders sittingon the board of a private equity firm. In such cases, onaverage outsiders make up 16% of the board. Given anaverage board size of 5.43 individuals (as reported in Table2), this tells us that the average number of outsiders on aprivate equity board is 0.87, i.e. still less than one personper board (and in fact there are several deals where nooutsider was sitting on the board).In MBOs, 1% of the board is made up of people with someprior or present private equity connections.The percentage change of insiders on boards after an LBOis not statistically significant, but increases significantly afterMBOs (the mean increases from 61% to 86%). After anMBO, a company removes all outside directors and replacessome, not all, with insiders, thereby decreasing the averagesize of the board. This is consistent with the view thatfollowing an MBO the company is completely owned bythe managers. Following an LBO, although managementmay also have an equity stake, the board is comprised ofboth owners and managers. The private equity firms sit onthe board and assume roles similar to that of outsidedirectors who monitor the managers. The proportion ofoutsiders and LBO sponsors remains more or lessunchanged post‐LBO transaction: the mean decreases from43% to 40% and the decrease is not statistically significant.In LBOs the presence of insiders on the board remainsunchanged, and the outside directors are replaced by LBOsponsors, i.e. by directors from the private equity fundsbacking the deal.In some cases there may be a higher need for private equityinvolvement in the board, either for monitoring or advisorysupport. In Table 3, we separate the LBOs into two groups:LBOs where the CEO was replaced when the companywas acquired by a private equity group and LBOs wherethe CEO was not replaced. In companies where the CEOwas replaced it is likely that the CEO was not performingsatisfactorily before the LBO transaction. We may thereforeexpect to observe fewer outside directors on the boards ofthese companies before they undergo the LBO, since moreoutside directors are usually associated with better managerperformance (as in Weisbach 1988). In Panel A, we look atthe percentage of outsiders sitting on the boards of thesetwo groups. Despite our expectations, there is no significantdifference between the two groups. However, when we lookin Panel B at the percentage of insiders on the board, we findthat when there was no CEO change, the fraction of insidersin the board increases after the company goes private, whileit decreases if the CEO was replaced. The difference isstatistically significant. Similarly in Panel C, the percentageof LBO sponsors is 25% when there is no change of CEOand 37% when there is a change. In this last case, the LBOsponsors are more heavily involved. The difference betweenthe two cases is statistically significant. In other words, whenthe management team performed well before the buyoutor had the confidence of the private equity sponsors, theirpresence on the board did not change (or slightly increasedon average). When the CEO changes post‐LBO, thepresence of insiders on the board is reduced and the LBOsponsors are more heavily involved. Such a change suggeststhat the private equity sponsors believed that there was roomfor improved performance and considered the presence ofinsiders on the board excessive and possibly responsible forthe company’s unsatisfactory performance.We also looked at the change in the average age of theboard following an MBO or an LBO. 16 In the case of an MBOthere is no significant change, while in the case of an LBOthe board is on average seven or eight years younger. Ingeneral, the private equity directors are much younger thanthe outside directors who were sitting on the board whenthe company was public. In fact, Figure 4 shows the age15In the other transactions the fraction of outsiders is more substantial, 30.7%, but this could be due to the fact that it is more difficult in this caseto establish a connection with the insiders (since often the acquirer is another company or a private individual) and therefore we may be overstatingthe fraction of outsiders.16The age is measured at the time of the board: to the extent that some people remain on the board, they will automatically be one or two years older.70 Large-sample studies: Corporate governanceThe Global Economic Impact of Private Equity Report 2008