Private Equity Firms Research Articles

Board 3.0: What the Private‐Equity Governance Model Can Offer Public Companies∗

The authors view board structures as an adaptive institution that responds to the key challenges faced by public companies: helping management solve the problems of production and organization of large‐scale enterprise; limiting managerial agency costs; serving as a delegated monitor of the firm's compliance obligations; and responding to the governance environment of changing shareholder ownership patterns. U.S. company board structures are shown to have evolved over time, often through discontinuous lurches, as particular functions have waxed and waned in importance.This article is part of a larger project that traces two iterations of the public company board, what the authors call Board 1.0 (the “advisory board”) and Board 2.0 (the “monitoring board”). The authors argue in particular that Board 2.0, as embedded in both current practice and regulation, now fails the functional fit test for many companies. First, it does not scale to match the dramatic increase in the size and complexity of many modern public corporations. Second, at a time of reconcentrated ownership achieved through institutional investors and increased activism, it does not have the expertise and commitment needed to resolve the tension between managerial or market myopia, or “short‐termism,” and managerial “hyperopia.”This article holds out an optional alternative, Board 3.0, which would bring to the public company board some strategies used by private equity firms for their portfolio company boards. Such “Portco” boards consist of directors who are “thickly informed,” “heavily resourced,” and “intensely interested.” Bringing such “empowered directors” to public company boards could facilitate evolution of the public company board model in response to dramatic changes in the corporate business environment. The authors also suggest possible routes for implementing Board 3.0, including the enlisting of PE firms as “relational investors” that would have both capacity and incentives to engineer changes in board structure.

Signal Strength, Media Attention, and Resource Mobilization: Evidence from New Private Equity Firms

Past research has shown that new firms can facilitate resource mobilization by signaling their unobservable quality to prospective resource providers. However, we know less about situations in whic...

Human Capital Evaluation in Private Equity Investment Decisions: Contemporary Practice & Challenges

This paper investigates the processes involved in human capital (HC) evaluation in the investment of organisations by private equity (PE) firms. The significance of this issue relates to both the increasing importance of the PE industry in the wider corporate environment and the increasing recognition, within business and regulatory and financial communities, that the valuation and reporting of HC as a corporate asset requires attention. We examine the issue through the conceptual frame of HC evaluation by PE as an agency problem centred on asymmetric information. Findings are discussed from twenty-three semi-structured interviews with senior representatives of nineteen different PE firms with collective experience of over 3700 investments, to elicit insights into the nature, challenges and consequences of HC evaluation. The findings reinforce the agency perspective and characterise this setting as one featuring an aggravated form of asymmetric information-based agency problem. We find that the commonly employed HC evaluation methods are regarded as suboptimal in their susceptibility to heuristics and biases and to factors such as time pressure and interpersonal dynamics, potentially resulting in flawed judgements and negative investment decisions. We provide an analysis of the most commonly-reported consequences of shortcomings in HC evaluation, and offer recommendations for future research.

COVID-19 and the Indian Private Equity Industry: Time to Use the Dry Powder

The article throws light on the impact of the pandemic on the major funding industry for the country, that is, private equity (PE) firms. About 59% of the FDI comes via this route, and growth of major sectors is impacted by their investment. Last few years, there have been discussions about dry powder availability with the PE firms. This is the time to create opportunity in crisis for both the parties (the investors and the target firms). As seen during the 2008 crisis, many deals which materialized gave huge benefits to the investors. The article motivates the industry not to take a backseat and make the best out of the situation.

Hail the New Private Debt Machine: Private Equity, Leveraged Loans, and Collateralised Loan Obligations

The COVID-19 pandemic and the subsequent worldwide economic slowdown have exposed the fragility of the financial sector, among others. This article argues that the seeds of this fragility, while being exposed by the pandemic, were sown earlier, in the post-2008 years, through the revived synergy of three elements of the financial system: private equity firms ascending the role of ultimate intermediaries in the system of private debt creation; leveraged loans becoming the new asset class that replaced what mortgages represented in the pre-2008 years; and collateralised loans obligations (CLOs) which in some ways replicated the function of CDOs as mechanisms of private debt creation. This article explains this phenomenon, analysing in particular how CLO structures morphed during the last decade and how this new transactional innovation facilitated a return to dangerous levels of leverage. As of 2019, the level of CLO issuance neared $120bn in the US, whereas in the EU they were close to Euro30bn. While the IMF warned at the end of 2019 about the dangers associated with the increasing levels of corporate leverage, confidence in the banking system was reiterated, largely due to the alleged safeness of CLOs, and particularly the capacity of these transactional structures to shift risks away from systemic banks. This article provides some clarity on these apparently contrasting statements, drawing inter alia some parallels with the crisis of 2008.

ESG Factor Integration into Private Equity

Although more and more private equity (PE) firms are integrating environmental, social, and governance (ESG) factors into their investment strategies, there is no clear understanding of their reasons, the details of their activities, the tools they use or the barriers they face. Our study covers these gaps and provides an overview of current trends. We adopted a mixed-method approach, using both qualitative and quantitative data. We first interviewed ESG and PE experts and then submitted a survey to top PE players. Most PE firms integrate ESG issues because investors and other stakeholders pay increasing attention to them. We found that the tools used to assess ESG factors are checklists and that only a few PE firms used external advice from industry experts. Among the main barriers that PE firms face are difficulties in finding information and the lack of a comprehensive way to measure ESG issues. Our findings reveal that PE firms have two main approaches to ESG integration—risk management and value creation—and that the former is dominant. We contribute to the literature by explaining ESG integration in the PE industry and showing that an opportunity for value creation is being missed.

Management innovation in leveraged buyout companies

ABSTRACT The purpose of this paper is to advance knowledge on innovation in Leveraged Buyout (LBO) companies with a particular analysis of management innovation (i.e., innovation in strategy, practices, organization and marketing). This area in innovation research is underexplored, with very few studies in the LBO context. Based on a multi-stage model of innovation, we contend that private equity firms are change agents and external knowledge sources which influence the emergence and adoption of management innovation. We thus hypothesize that, after a leveraged buyout, LBO companies should be more likely than non-LBO companies to introduce management innovations. In addition, we argue that, in order to ensure that targets can implement innovations brought by PE firms, target companies should exhibit higher-than-average absorptive capacity before the LBO. We use firm-level evidence from three rounds of the UK part of the Community Innovation Survey (CIS) to validate our hypotheses empirically. The results of the analysis support these arguments.

Hail the new private debt machine: private equity, leveraged loans, and collateralised loan obligations

The Covid-19 pandemic and the subsequent worldwide economic slowdown have exposed the fragility of the financial sector, among others. This article argues that the seeds of this fragility, while being exposed by the pandemic, were sown earlier, in the post-2008 years, through the revived synergy of three elements of the financial system: private equity firms ascending the role of ultimate intermediaries in the system of private debt creation; leveraged loans becoming the new asset class that replaced what mortgages represented in the pre-2008 years; and collateralised loan obligations (CLOs) which in some ways replicated the function of CDOs as mechanisms of private debt creation. This article explains this phenomenon, analysing in particular how CLO structures morphed during the last decade and how this new transactional innovation facilitated a return to dangerous levels of leverage. As of 2019, the level of CLO issuance neared $120bn in the US, whereas in the EU they were close to Euro30bn. While the IMF warned at the end of 2019 about the dangers associated with the increasing levels of corporate leverage, confidence in the banking system was reiterated, largely due to the alleged safeness of CLOs, and particularly the capacity of these transactional structures to shift risks away from systemic banks. This article provides some clarity on these apparently contrasting statements, drawing inter alia some parallels with the crisis of 2008.

Financialised Private Equity Finance and the Debt Gamble: The Case of Toys R Us

ABSTRACT In this paper, we pursue a financialisation line of argument exploring the specific features of private equity finance, with a focus on the activity undertaken at scale by the largest management groups or firms. The largest private equity firms wield considerable resources, affect ownership patterns and have the capacity to acquire literally any company. What they do matters. The bankruptcy of Toys R Us and the more general ‘crisis of retail’ illustrate a ‘debt gamble’. A company’s capital structure is radically restructured and equity is reduced and replaced by debt. The gamble is that there will be no change to the external environment that the GP cannot adequately adjust to and that the GP will in fact be able to maintain debt servicing. Although bankruptcy is a ‘worse case’, we contend that from a financialisation perspective, there are a whole set of attendant issues.

An Inconvenient Fact: Private Equity Returns & The Billionaire Factory

Private Equity (PE) funds have returned about the same as public equity indices since at least 2006. Large public pension funds have received a net Multiple of Money (MoM) that sits within a narrow 1.51 to 1.54 range. The big four PE firms have also delivered estimated net MoMs within a narrow 1.54 to 1.67 range. Three large datasets show average net MoMs across all PE funds at 1.55, 1.57 and 1.63. These net MoMs imply an 11% p.a. return, which matches relevant public equity indices; a result confirmed by PME calculations. Yet, the estimated total performance fee (Carry) collected by these PE funds is estimated to be $230 billion, most of which goes to a relatively small number of individuals. If all vintage years are included to 2015, Carry collected is $370 billion, with a performance similar to that of small cap indices, but higher than that of large cap stock indices. The number of PE multibillionaires rose from 3 in 2005 to 22 in 2020. Rebuttals from the big four and the main industry lobby body are provided and discussed.

Does Private Equity Ownership Make Firms Cleaner? The Role Of Environmental Liability Risks

This paper studies how Private Equity (PE) firms affect firms' environmental outcomes in the oil and gas industry. On average PE ownership leads to a 70% reduction in the use of toxic chemicals and a 50% reduction in satellite-based measures of CO2 emissions. However, this average effect hides significant heterogeneities. PE-backed firms increase pollution in locations and periods where environmental liability risk is low, as shown by a novel natural experiment that reduced these risks for projects located on federal and Native American territories. Overall, high-powered incentives to maximize shareholder value may benefit environmental outcomes when the risk of environmental regulation is high.

The Growth Of Private Equity Investment In Health Care: Perspectives From Ophthalmology.

The growth of private equity investment in health care has dramatically changed the landscape of health care delivery over the past decade. Private equity firms are rapidly acquiring physician practices, with ophthalmology practices being one of the most frequently acquired types. We present perspectives from thirty-five semistructured interviews conducted with a wide range of knowledgeable people on private equity investment in physician practices, with a specific focus on ophthalmology. Acquisition by a private equity firm can be an attractive option for physicians, particularly older ones. However, interviewees had starkly conflicting perspectives on the likely impact of private equity acquisitions on the cost, quality, and use of medical care.

Private Equity Characteristics, Corporate Governance and Firm Value: Empirical Evidence from Small and Medium‐sized Enterprises*

To extend existing research, this study examines whether private equity (PE) and corporate governance affect firm value using empirical data on the small and medium‐sized boards of listed initial public offering companies in China. The empirical results show that PE investment can raise firm value as well as affect management behavior at the macro level. At the micro level, the greater PE firms' shareholding, the higher is firm value, which is positively influenced by the time the PE stake has been held. PE reputation and foreign PE are also positively related to firm value. Finally, corporate governance plays a partial mediating role in the relationship between PE investment and firm value.

The Corporate Practice of Medicine: Ethical Implications of Orthopaedic Surgery Practice Ownership by Non-Physicians.

There has been an upsurge in the number of practices owned by non-physicians. With orthopaedic surgery as the next frontier in this market, orthopaedists need to consider the ethical consequences of such acquisitions. The history and trends of practice ownership are reviewed alongside how laws shifted to reflect a changing health-care climate. The 4 tenets of bioethics (beneficence, nonmaleficence, autonomy, and justice) are explored with regard to practice acquisition by non-physician entities. Although non-physician-owned corporations and private equity firms provide liquidity to the health-care sector, there are ethical concerns that may ultimately impact patient care. Orthopaedic surgeons must be cautious when engaging in acquisitions with non-physician-owned entities, as the goals of each party may not align. This may yield situations that infringe on the basic principles of bioethics for both physician and patient.

For-Profit Nursing Homes in the Netherlands: What Factors Explain Their Rise?

This exploratory, mixed-methods study analyzes characteristics of the emerging for-profit nursing home industry in the Netherlands and identifies the interrelated set of factors (context, trends, and sector conditions) that contribute to its growth. Until recently, the Dutch nursing home sector relied almost exclusively on nonprofit providers. Even though profit distribution in nursing home care is still banned, the for-profit nursing home sector is expanding. The study uses economic theory on nonprofit organizations and mixed-form markets to understand this expansion. We find that changes in the regulatory framework have unlocked the potential of the for-profit nursing home sector, enabling for-profit nursing homes to circumvent the for-profit ban. The expansion of the for-profit sector was mainly driven by the low responsiveness of the nonprofit sector to increased and changed demands. For-profit providers took advantage of this void. Moreover, they exploited “cream-skimming” potential in the market and used the wider care system to reduce their labor costs by relying on external specialist care. Another main driver was the access to financial capital from private investors (e.g., private equity firms).

CLOs, Private Equity, Pensions, and Systemic Risk

There has been much recent discussion of the increasing risk of Collateralized Loan Obligations (CLOs) and their feeder collateral, leveraged loans (LLs). The models ratings agencies use rely on similarly flawed methods in place since the mid-2000s and the nature of the collateral coupled with dramatic recent increases in risk of the underlying loans and conflicts of interest suggest that CLO ratings should be capped at a level far below AAA. Just as in 2008, the market is engaging in a collective grand illusion without adequate scrutiny of the actual risk and meaning of a AAA rating. The risk goes far beyond CLOs and permeates the larger economy. There is frothiness and irrational exuberance permeating an “Iron Triangle” of private equity firms, CLOs, and pension funds. Systemic risk may be realized through significant job losses, rising pension fund deficits, credit losses for funds, insurance companies, and banks, and significant disruption to critical industries. The risk could be on the scale of the global financial crisis (GFC). The main systemic risks include 1) Employment: Private equity-owned companies employ nearly 9 million people; 2) Pension funds: Face potential losses on existing investments and perhaps more importantly may need to revise lower future return assumptions—these factors put millions of pensions at risk; 3) Investment losses: Banks, insurance companies, and funds are exposed to CLO and/or leveraged loans and face significant potential losses; and 4) Critical industry fallout: Many industries controlled by PE companies face widespread disruption should the funding vehicles of CLOs and leveraged loans freeze up. <b>TOPICS:</b>CLOs, CDOs, and other structured credit; financial crises and financial market history <b>Key Findings</b> • This article argues that Collateralized Loan Obligations (CLOs) do not justify AAA ratings and that there is significant systemic risk emanating from the “Iron Triangle” of CLOs, private equity (PE), and pension funds. • The AAA rating should be challenged across two broad fronts: the rating agency approach and the substantial increase in risk in the underlying leveraged loans in recent years. • Systemic risk: The Iron Triangle between CLOs, PE, and Pensions create significant systemic risk potentially on the scale of the Global Financial Crisis (GFC).

Private Equity Buyouts in Healthcare: Who Wins, Who Loses?

Private equity firms have become major players in the healthcare industry. How has this happened and what are the results? What is private equity’s ‘value proposition’ to the industry and to the American people -- at a time when healthcare is under constant pressure to cut costs and prices? How can PE firms use their classic leveraged buyout model to ‘save healthcare’ while delivering ‘outsized returns’ to investors? In this paper, we bring together a wide range of sources and empirical evidence to answer these questions. Given the complexity of the sector, we focus on four segments where private equity firms have been particularly active: hospitals, outpatient care (urgent care and ambulatory surgery centers), physician staffing and emergency room services (surprise medical billing), and revenue cycle management (medical debt collecting). In each of these segments, private equity has taken the lead in consolidating small providers, loading them with debt, and rolling them up into large powerhouses with substantial market power before exiting with handsome returns.

Economics of Leveraged Buyouts: Theory and Evidence from the UK Private Equity Industry

Empirical analysis of a sample of companies with private equity (PE) ownership in the UK shows that PE firms act as deep-pocket investors for their portfolio companies, rescuing them if they fall in financial distress. In contrast, external financing is expensive for companies without PE-ownership in financial distress. The paper builds a model that shows how companies form rational expectations about the costs of financial distress, and how these expectations affect ex-ante policies. The model explains the empirically-observed differences in how companies with and without PE-ownership invest, pay dividends, and issue debt. In particular, the model quantitatively explains the difference in leverage of companies with and without PE-ownership. The model shows that greater tax-shield benefits and superior growth of PE-backed companies can explain 6.4% of the abnormal return of PE firms. The conclusion that follows from the paper, however, is that abnormal returns PE firms cannot be replicated by other investors.

Inquiry Into the Moroccan Private Equity Industry: A Proposal of an Adapted Value Creation Framework

The Private Equity (PE) activity in Morocco has received so little attention until now. Aside from the professional association of PE in Morocco and other professional bodies concerned with the topic, the literature stream exploring the generation of value creation during a PE transaction is quite inexistent.The proposed paper is considered as the first attempt to tackle the value generation within a Private Equity transaction in the Moroccan context. We attempt during this paper to present a conceptual analysis of how PE firms may generate value on their portfolios level. Since data is a scarce resource in this field and especially in the context of emerging countries, we propose for this explanatory study to use the semi constructed interview with four major PE firms in the Moroccan landscape, which represents 50% of the PE transactions that occurred in the last three years, in order to (i) understand the general partners (GPs) decision-making process for a given transaction and (ii) explain what are the main value generation levers that are intended to be made into practice in order to maximize the value in a given transaction.

Capturing the Illiquidity Premium

We show that the largest U.S. life insurers entered corporate loan markets as banks refocused on commercial banking from 2009, against a backdrop of unconventional monetary policies and tighter bank regulations. Through complex on- and off-balance sheet arrangements, these insurers, many of whom are controlled by private equity firms, are acquiring and deploying vast amounts of insurance liabilities to fill the void left by banks. Using the COVID-19 pandemic, we show that life insurers have become more vulnerable to an aggregate shock to the corporate sector and disproportionately benefited from the Fed response to the pandemic.