Corporate Governance & Directors' Duties

• Governance Indices Are A Poor Predictor Of Performance

• Bulwark Against Increased Shareholder Activism: More Transparency

• How (And Why) Boards At Private And Public Firms Differ

• D&O Premiums Soar For Financial Services Firms

Global Markets

• China's Securities Regulation Does Not Need Private Actions

Securities Regulation & Disclosure

• Changes In Risk Management Must Be Assessed And Disclosed

• Outline For Preparing Annual Disclosures

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Superior performers. Companies owned by private equity firms are an important component in both Europe and the United States. While most academic studies find similar returns between private equity investments and the public markets over the last 15 to 20 years, some evidence suggests that even after the impact of fees, the funds from larger, well-established buyout firms outperformed the Standard & Poor's 500 Index by a significant margin. Business professor Viral Acharya and consultants Conor Kehoe and Michael Reyner attribute some of the out-performance to the funds' use of leverage and their ability to exit investments at attractive multiples. Yet most of the alpha comes from the ability of private equity companies to generate superior growth characteristics and the expectation among investors of sustainable growth in the future. Directors of public companies can take a lesson from the practices common at a private equity fund's portfolio company.

Public versus private boards. An intense, performance-driven atmosphere and nimble corporate culture help to illuminate why companies controlled by private equity show superior operating performance. The directors' respective roles in decisionmaking may help explain some of the performance gap. The authors' interviews with directors who have served on both public and private boards in the United Kingdom, coupled with quantitative data, reveal critical differences in how the boards operate. According to the interviewees, boards at companies financed by private equity top boards at public companies. They are far more effective, add greater value, and garner higher marks for strategic leadership and oversight. The private directors play a more active role in formulating strategy and decisionmaking than their public counterparts, who typically challenge or react to management's strategic proposals. The more-active directors drive performance management, monitor progress, address underperformance, and identify and support key initiatives, all with notably greater intensity. Public-company boards do excel in a few key areas. Those directors are more likely to be involved with succession plans and human resource issues, are more effective in handling investor relations, and have a greater working knowledge and control of governance and risk management issues. Still, private equity boards are superior in focusing on creating value and identifying or articulating performance priorities. The directors also spend considerably more time on their board duties, a point the authors find significant.

Lessons for public companies. The practices of boards at large, established companies financed by private equity ultimately lead to superior company performance, the authors' findings suggest, but public companies can emulate those practices and thereby improve corporate performance. For example, do not let concerns about governance crowd out the board's attention on value creation. Make the board an active participant in formulating corporate strategy. Create smaller boards or reduce the size of existing boards, which will yield a more effective, collaborative team. Increase both the time commitment and the compensation of outside board members as their roles expand. Spend more time familiarizing the outside directors with the company and its managers, and keep them informed about business trends and important value drivers such as cashflow.

Abstracted from Journal of Applied Corporate Finance, published for Morgan Stanley by Wiley-Blackwell, 350 Main Street, Malden MA 02148 (USA); and PO Box 808, 1-7 Oldlands Way, Bognor Regis PO21 9FF (England). To subscribe, call (800) 835-6770 or 44 (0) 1865-778315; or visit www.morganstanley.com/views/jacf/index.html.