London Business School Coller Institute of Private Equity

Private Equity; Adding Value to Impact your Organisation

06 July 2010 by Francesca Cornelli

I gave this talk at the Global Leadership Summit at London Business School on 5th July 2010

You can also catch a bitesize on Google Think

I'd like to start by asking the simple question - What is the PE role?

Believers in value creation will reply "better monitoring, advice, governance and performance" whilst the sceptics will voice concerns of value release via "rent" appropriation "gains through financial and tax engineering".

Whatever your stance the more difficult question is - Are PE firms good selectors or good managers of businesses?

This is the important question; the former will create a "rent" for the PE firm but does not enhance economic growth whilst the other provides a real contribution to the economy through enhanced management skills.

So this is the question that academics seek to answer. Unfortunately we are thwarted in our quest by several hurdles:

• Data - the basis of all rigorous analysis may be available to LPs but only rarely to academics
• Causality - good company selection will blur source of ex post returns
• PE transactions are not homogeneous ie private to private, public to private, spin outs

Even looking at the results from research where academics have had data, the picture on outperformance is mixed but this again may be due to endogeneity and factors such as the timing of measuring. The control test of seeing how the exact same company would have performed without PE intervention is simply not possible!

On balance we can say the research shows a moderate but not dramatic improvement in operating performance, with variations across geography and deal types. Of course this is also on average and the results are aggregated across companies, funds and GPs so that the best and worst performing are not known except to their LPs, details of which both parties may not wish to share. Acharya, Hahn and Kehoe (2008) found the highest returns in those deals with greater intensity of engagement by PE. Evidence of engagement can be observed through portfolio company Boards and actual intervention.

I have adopted two approaches in current papers:

• PE representation on Boards (Is the Corporate Governance of LBOs Effective - Cornelli & Karakas 2008-2010)
• PE intervention in countries where the law changed to facilitate such intervention (Monitoring Managers, does it matter? - Cornelli, Kominek, Ljungqvist 2010)

Acharya, Kehoe and Reyner (2008) found in their comparative study:

• PE Boards focus on value creation
• PE Directors invest more time and hold more informal meetings

and in the first paper listed above I find that those PE firms with the most experience and active involvement have smaller Boards. When a CEO is changed, the Board is smaller and has greater PE representation. Likewise deal complexity increases PE involvement. However PE involvement does not in itself create increased CEO turnover. On the contrary CEO turnover is lower post an LBO especially where the original CEO is retained and also where the PE involvement is high.

So what you ask, high PE involvement implies lower CEO turnover but what about performance? We obtain the same "on average" results as others, namely no significant improvement. But wait, when we distinguish according to the level of PE involvement we see again the best performing deals have the highest levels of engagement, such as those deals where the CEO is changed.

My second paper is based on a sample of deals in Central and Eastern Europe where the EBRD is the LP. With management skills being a scarce resource the impact of PE involvement may be more easily detected. This is a rich data source comprising hard(quantitative,objective) and soft data(qualitative,subjective). Again we measure intervention by the CEO turnover and determine what data points create turnover event.

The CEO is fired when either hard data reports company under performance or the soft data considers the CEO incompetent even though the company may be performing to plan. Allowing for the causality problem, performance improves as a result of this intervention. Firing the CEO:

• increases the probability of an exit within 3 years from 40% to 70%
• improves next year performance by 1.4 points (on a 1-5 scale)

So from this we can conclude that PE involvement can add value and provide a better form of governance.

Thank you to all that came to listen this week and for your questions, a selection of which I have outlined below together with my abbreviated response. Please continue to add your comments, questions and thoughts.

Questions that arose afterwards included:

• What is the impact of a Chairman on a PE Board ? Studies have not identified a role linked to performance and so we surmise it is one of style
• To what extent is CEO turnover consistent with finding the right CEO ? Yes there is certainly some truth in this - as companies evolve through booms and crises there are CEOs who are a better fit for purpose than the incumbent
• To what extent is the Board composition of deal and operating experience key to performance ? We are hoping to add this to our next stage of analyses
• This is an average- there must be huge dispersion- can we not get to this data ?Unfortunately we are bound by the data. Some academics (Phalippou and Gottschalg) have found decreasing returns to fund size but the ability to raise a fund is not in itself a predictor of high performance. More importantly the economic impact of private equity goes beyond the investor returns and this is our quest as I said at the beginning.

Very Many thanks

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