January 2, 2007
Private Equity Lessons
The success of private equity fund buyouts should raise questions about public firm governance. Here is a too common story. A publicly traded firm hires a CEO with a "golden hello" and the performance languishes. The CEO is paid handsomely regardless. A private equity firm appears, triggers the CEO's "golden parachute," pays the CEO "consulting fees" and other inducements, and buys the company or a part of the company for a "premium" over market trading price, all with the CEO's blessing. The fund releverages the capital structure and streamlines operations and then resells to the public a few years later for a substantial profit (sometimes tripling their money!). (Hertz and Vivendi are examples that come to mind.) The troublesome question: Why are the assets not better managed in the hands of the public firm managers for the benefit of the public firm shareholders? Is the agency cost in publicly traded firms as large as is suggested by the profits of private equity funds? Or have the private equity funds just picked the low hanging fruit? If the problem is endemic, where have regulations failed? Henry Manne argues in todays WSJ that we have over regulated takeovers. Others argue that we have under regulated public company managers. It does suggest that our fixation on executive salary excess is a drop in the bucket compared to losses due to sloppy management of many of our publicly traded companies.
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