A Review of the PhD Thesis by Simon Witney
In this article, we will review and comment the thesis submitted by Simon Witney to the Department of Law of the London School of Economics in April 2017. Witney, from Debevoise & Plimpton, is one of the most prominent private equity lawyers and currently a member of the British Private Equity and Venture Capital Association (BVCA) Council.
Relatively little is known about the decision-making structures in private equity-backed companies. Witney’s thesis seeks, inter alia, to explain the outperformance that private equity-backed companies appear to demonstrate compared to their peers. The thesis presents several interesting propositions and hypotheses concerning the role of corporate governance in producing performance improvements.
Particular features of private equity governance
A key argument put forward by Witney is that, in addition to controlling agency costs and embedding a superior decision-making process, a distinct feature for private equity governance structures is to accommodate the specific ownership time horizons, risks and investment preferences, regulatory position, and reputation of the private equity fund and its manager.
Relationship between private equity governance and company law
A very common requirement of private equity investors is to reach a contractual agreement with a particular shareholder or group of shareholders to conduct the business of the company in a certain way.
Company law raises some difficult issues if a decision-making right is left to be exercised by a director nominated by the private equity investor.
Similarly, questions arise when the decision-making power is left to the private equity investor as shareholder and whether those powers can be exercised with unlimited discretion or whether there is an obligation to consider the interests of the company.
Another interesting topic discussed in the thesis in relation to company law is whether the investor could be said to be a de facto director of the company, or a shadow director.
Do private equity-backed companies outperform their peers and, if so, why?
Witney raises the important empirical question: Is there any evidence that the corporate governance structure actually affects corporate performance?
The thesis considers what evidence there is that the decisions private equity-backed companies make lead to outcomes for stakeholders that, on average, differ from those seen in publicly held companies, or other privately held companies, and whether they lead to “superior” outcomes.
Starting from evidence comparing the net returns from private equity funds with returns from the public market, Witney notes that the academic evidence remains mixed.
US academic studies cited in the thesis tend to suggest, taken together, that private equity-backed companies are taking different corporate actions compared to their peers, leading to better financial outcomes. Available evidence in Europe seems to tell a similar positive story. We note that in Finland private equity has been the best performing asset class for the pension institutions.
Does private equity governance models lead to successful outcomes?
The research carried out by Witney concerning more “active monitoring” of management, suggests a more effective system of governance and this aspect emerges as one of the central key points of the thesis.
The perceived value creation appears, according to Witney, to have two related sources:
- Improvements in operational decision-making causing performance enhancements and procedures to reduce risk of value destroying events and
- the ability to achieve a higher valuation at exit because buyers will pay a “governance premium”.
Conclusions and recommendations of the thesis
The thesis concludes that corporate governance is critically important for the private equity investors in the research sample assembled for the thesis, and a considerable investment is made to get it right.
The thesis demonstrates that agency cost reduction helps understand the objectives of the stakeholders in designing the governance system, but that it is an incomplete explanation.
Witney concludes that there are four main purposes of corporate governance in private equity-backed companies:
- Mitigating agency costs;
- shareholder-mandated procedures for sound decision-making;
- ensuring primacy of shareholder-specific interests; and
- dis-applying or contracting around company-law directed rules.
The thesis concludes that possible reforms of the law should aim to facilitate, rather than hamper, the freedom for parties to contract and should relax the existing mandatory rules that restrict it. An effective governance structure will respond to the economic incentives of those with final say (the residual claimants) and increased disclosure and transparency might help to shape those incentives.
Final thoughts
The thesis authored by Simon Witney offers an important addition to the discussion on the role of corporate governance by its rare inside view of the governance structures employed in private equity-backed companies.
However, while the thesis credibly offers that private equity-backed companies outperform their peers and makes a convincing case that governance mechanisms are contributing to the success, it will be up to later scholars to establish the significance of governance mechanisms in creating additional value in these companies.
The full-lenght version of this article by Andreas Doepel and Jyrki Tähtinen will be published in the Boardview magazine 2/2018 in December.
Simon Witney gave a presentation based on his PhD on corporate governance issues in private equity-backed companies during a breakfast seminar arranged 13 April 2018 by DIF and Borenius Attorneys Ltd. Witney’s thesis is available online and can be found here >
