Is private equity still special? Although the industry’s returns have been envied for decades, recent studies show that they have declined over time and converged with public-market returns. In Private Equity’s Governance Advantage: A Requiem, I document that the means by which private equity generates those returns have changed as well.
Private equity’s original value proposition was optimizing companies’ governance and operations. Reuniting ownership and control in corporate America, the leveraged buyout (or the mere threat thereof) undoubtedly helped reform management practices in a broad swath of U.S. companies. In a leveraged buyout, the private equity fund acquires a public or private company, adds a heavy debt load to its capital structure, makes operational improvements, and then sells the company or takes it public after a few years. The potential governance advantages of LBOs are many, including the sponsors’ willingness to cut costs and replace management, the disciplining effect of high leverage, and the careful monitoring provided by a small, incentivized board that meets frequently.