Corporate Governance & Management Practices

People (Management and Board of Directors)

Gompers, Kaplan and Mukharlyamov (2016) based on a survey of private equity investors find that nearly 58% of the surveyed PE firms hire their own top management before or after they invest as part of their governance strategy, which suggests that PE investors are actively involved in monitoring and governing their portfolio companies. They also document that PE investors provide strong incentives to portfolio company management, in the form of substantial equity ownership. According to the findings, PE investors prefer to structure a smaller board of directors with a mix of insiders, PE investors and outsiders with more than 90% having between five and seven members. Larger PE investors tend to have portfolio companies with larger boards. PE investors take around three of the board seats while allocating one or two to management and one or two to outsiders who are not affiliated with private equity firms. PE investors are also actively involved in advising their portfolio companies in their acquisitions.

Biesinger, Bircan and Ljungqvist (2020) find that replacing top executives is a significant aspect of governance strategy. They notice that 20% of the value creation plans for the individual private equity funds mention replacing the CEO, while 20% mention replacing the CFO and 26% indicate replacing other senior managers. They report that recruiting better managers matters as the execution ability of top management is paramount in the successful implementation of value creation action plan, which in turn leads to higher returns.

While PE investors tend to replace a portfolio company’s management before and after their investment, Cornelli and Karakas (2015), based on a study of public-to-private LBOs in the UK, show that once the PE deal is closed, PE investors are less likely to replace management during the holding period. They argue that more inside information and effective monitoring practices allow PE investors to evaluate CEOs’ performance over a longer horizon relative to their publicly listed counterparts.

Acharaya, Kehoe and Reyner (2009) study the board dynamics of UK-based portfolio companies. Comparing the board structures of PE-owned portfolio companies to those of U.K. public companies (PLCs) in the FTSE 100, they report that private equity boards demonstrate greater efficiency and a stronger emphasis on value creation. In contrast, PLC boards face challenges due to their larger size and are more focused on quarterly profits and market expectations rather than the impact of their decision on business performance.

Public company boards usually focus on supervision, providing support to the management team while deliberately staying away from day-to-day operations. On the other hand, boards of public equity owned companies tend to be much more hands-on. These boards frequently filled with ex-CEOs, are more likely to engage in shaping strategy and culture, providing information to the company, and actively interacting with future CEO candidates well ahead of succession. What Boards of Public Companies Can Learn from Private Equity.

Management practices

Cronqvist and Fahlenbrach (2013) find that private equity investors provide strong compensation packages to the management of portfolio companies. The study shows that PE investors increase the CEO’s base salary and bonus by 25%, with the salary increases concentrated in companies with newly appointed CEOs. They also report that PE investors tie CEO compensation to cash-flow based measures (e.g. EBIDTA), away from qualitative, non-financial and earnings-based performance measures. In addition, about 50% of equity grants to CEOs only vest at the time of an exit event, aligning the CEOs’ incentives with the investors’ need to create value over the long term. The severance agreements for CEOs of portfolio companies are also typically more rigid with regard to unvested equity which is often fortified.

Cornelli, Kominek and Ljungqvist (2011) suggest that PE investors (in contrast to the boards of companies with dispersed ownership) engage in active monitoring of the CEO’s competence based on ‘soft’ information, moving beyond purely relying on ‘hard’, financial data. Therefore, the process of understanding the CEO’s true ability emerges as a crucial aspect in the effectiveness of corporate governance.