My kids taught me why the private equity governance model works

kids-walking-to-schoolSimon Thornton, @PEARonlineSimon

My wife and I are trying to bring up our kids to be financially responsible human beings.  Four things jump out at me in this process:

  • We are hugely motivated to succeed – the more financially responsible we can make them, the sooner we can afford the fun stuff we used to do again.
  • We have a long-term commitment to the process, so we are prepared to take short-term pain (the backlash from “you’ve spent your allowance so, no, you can’t buy more Legos this week”) to instill good long-term habits
  • We have very good information about their income (as it comes from us) and expenditure (at least for the moment – they’re nine and ten)
  • We have a very direct relationship: two parents and two children.

Good alignment, long-term horizons, good information, and direct relationships are the hallmarks of a private equity GP’s relationship with the management team of a portfolio company.  Let’s paint a very different picture.  What if someone told us that the responsibility for our children’s financial education was going to be split equally between all of the parents in their respective classes – and we were going to take a similar role for all the other children?

  • There would be no alignment – other parents wouldn’t have to fund our kids, or bail them out when things go wrong.
  • There would be no long-term commitment – other parents would have no further responsibility when their kids or our kids change school a few years down the road.
  • Information would be poor – how would we track the spending of 40 or 50 kids across the classes?
  • And if all parents had to agree the spending plans for each child, and agree sanctions if those plans were breached….

Yet isn’t that pretty much the model used for shareholder governance in the tens of thousands of public companies?  Shareholder representatives with little or no incentive when things go well or badly; short term horizons with the ability to sell out at will; limited information and limited time to digest that information; and poor coordination between large and diverse groups of investors?  What could possibly go wrong?

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