“Why don’t CEOs of public companies manage as well when their firms are public as they do when their firms are private?” That was a central question posed at the American Enterprise Institute’s conference on the History, Impact, and Future of Private Equity in Washington, D.C. last week, attended by Warren Miller (Beckmill Research). “The answer is the age-old problem of ‘agency’,” Miller reports, from a panel discussion led by Steve Kaplan (Univ. of Chicago, formerly with Ibbotson’s). “When companies are public, CEOs tend to think like employees, largely because they can control their own boards,” Kaplan said. “When private, CEOs must think like owners because of the close and intense supervision their PE principals provide.”
Presenter Karen Wruck (Ohio State) cited PE for two achievements: reinvention of the market for corporate control and routinization of systems to organize firms for value creation. While “corporate control” used to mean competition among management teams to manage resources, it now refers to capital providers competing in the market to govern the corporation. Given their “operating expertise,” PE managers have “blurred the line between financial buyers and strategic buyers,” Wruck said, bundling residual risk-bearing and governance rights. They have reintroduced “anxious vigilance” into corporate governance, a “trust but verify” attitude that doesn’t require managers to own the firm outright but facilitates efficiencies in risk-bearing.
PE is “about organizations, not markets,” Wruck added, “about relationships, not transactions.” For instance, 64% of the $39 billion in private placements during the first nine months of 2007 were to “relationship investors.” Traditional investing—what she called “disembodied third-party investing”—no longer works because shareholders have no direct involvement in value creation and governance. In other words, publicly held firms cannot solve the agency problem. The notable exception—Warren Buffett—“proves the rule,” Wruck said.
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