Corporate governance and the relevance of private equity

Abstract

In this thesis I examine the impact of private equity on improving the quality of corporate governance.

Using stochastic frontier analysis I create a direct estimate of governance effectiveness having controlled for company and industry characteristics and also for chance events over time (following Habib et al. 1997). Using data from the U.S. for 2002-2006 I find that the average company’s value is 15 percent lower than that of a value maximising company.

I then investigate the association between the shortfall and governance measures, employing both governance variables and governance factors that represent different dimensions of corporate governance.

I find that governance can account for much of the shortfall in company value. The significance of incentive and monitoring mechanisms however varies according to the moral hazard environment.

Given the mixed results in the literature on governance and performance, I corroborate and expand my findings by examining companies who were targets of private equity firms during the private equity wave of 2003-2007.

Private equity practitioners see their contribution as “governance arbitrage”. I find evidence that supports this assertion. The data also suggest that the average company reduces its shortfall at a faster pace when there is a higher likelihood of a bid from a private equity firm. The relevance of private equity to the corporate governance process is therefore both direct (i.e., from a buyout and, in many cases, a later relisting) and indirect.

These results cast new perspectives on the proposition that the public corporation has been “eclipsed” (Jensen 1989). Our results reveal that private equity does not so much threaten to eclipse the public corporation as act as a complementary external corporate governance mechanism to prevent the public corporation, in the longer term, from being eclipsed. I conclude that capital market participants such as private equity are therefore relevant to ensuring the survival of the public corporation by providing an additional mechanism to instigate change in a company’s governance.