Private Equity and Corporate Governance: Retrospect and Prospect

Abstract

Manuscript Type: ReviewResearch Question/Issue: We assess the corporate governance role and the impact of private equity. Research Findings/Results: Private equity firms are heterogeneous in their characteristics and activities. Nevertheless, a corporate governance structure with private equity involvement provides incentives to reduce agency and free cash flow problems. Additionally, private equity enhances the efficacy of the market for corporate control. Private equity investment is associated with performance gains, with such gains not simply being a result of transfers from other stakeholders. In the short term, the benefits appear clear to outgoing owners and to the new owners and management while in the longer term the benefits are less clear. While non-financial stakeholders argue that other stakeholders suffer in the short and long term, the evidence to support this view is at best mixed. Theoretical Implications: By reviewing a comprehensive selection of theoretical and empirical papers published in refereed academic journals in finance, economics, entrepreneurship, and management as well as publicly available working papers and private equity industry studies, we develop a more complete understanding of private equity investment. Agency theory has shortcomings when applied to the broad sweep of private equity-backed buyout types, as in some cases pre-ownership change agency problems were likely low (e.g., family firms), in some cases the exploitation of growth opportunities owes more to the entrepreneurial behavior of managers than to improved incentives, and in some institutional contexts outside Anglo-Saxon countries traditional agency issues are different and stakeholder interests are more important. There is a need for further theorizing on the heterogeneity of buyout and private equity types and the contexts in which they occur. Particularly useful perspectives seem to be entrepreneurial perspectives (e.g., entrepreneurial cognition, strategic entrepreneurship), stewardship theory, and institutional theory. Stakeholder governance theory (e.g., relating to employee ownership and participation) may also be useful for explaining wider distribution of gains. Practical Implications: Private equity investment is a positive feature of the corporate restructuring landscape. There is a need for managers and their advisors to be aware of the heterogeneity of the opportunities to create value and the expertise of different private equity firms. Policymakers designing mechanisms to regulate private equity need to be aware of the systematic evidence that shows a more positive impact of private equity than some have claimed, but also that there are heterogeneous effects relating to different types of buyouts and private equity firms that need to be taken into account.

The liability of foreignness in capital markets: Sources and remedies

“…However, private equity firms represent an innovation in the ability to provide capital to unquoted firms (Wright et al, 2009 (Meyer & Shao, 1995) and can diminish the commitment of venture capitalists in foreign markets (Maula & Mäkelä, 2003). Bruton et al (2010) Finally, another promising avenue for future would be examining whether overcoming CMLOF in equity markets would lead to spillover benefits in other capital raising activities (for example, in credit markets), or even in product market activities.…”

Reassessing the relationships between private equity investors and their portfolio companies

“…We now know a substantial amount about the influence of PE firms in value creation (Cumming et al 2007;Wright et al 2009). However, while we are beginning to gain insights into whether secondary and tertiary deals generate further value creation (Nikoskelainen and Wright 2007;Jelic and Wright 2011), understanding The economic environment, particularly the recent financial crisis, may also play an important role in the nature of involvement that is required of investors.…”

“…Detailed reviews of formal VC are provided by Manigart and Wright (2012), of PE by Wright et al (2009) and of business angel VCs by Kelly (2007). Most empirical studies covered by these reviews find that the post-investment growth and/or performance of investors' portfolio companies is higher than that of nonventure capital backed companies.…”

Sustainable Entrepreneurship in China

“…Existing research based on firms in mature financial markets (hereafter mature firms) has documented three possible mechanisms: First, PE investment brings in new financing to the firm, which releases financial constraints faced by the firm and supports the firm's real activities (e.g., Brown and Floros, 2012). Second, PE investment improves corporate governance of the recipient firm because PE investors being the firm's new shareholders will strengthen the monitoring of managers and influence the firm's decision making (e.g., Wright et al, 2009). Third, PE investment sends a positive signal about the recipient firm's future perspectives to outside potential investors (e.g., Megginson and Weiss, 1991;Janney and Folta, 2003).…”