http://blog.robertsalomon.com/2007/04/04/the-role-of-private-equity-in-the-strategic-reorientation-of-firms/ Mon, 06 Feb 2012 15:52:29 +0000 hourly 1 http://wordpress.org/?v=3.3 http://blog.robertsalomon.com/2007/04/04/the-role-of-private-equity-in-the-strategic-reorientation-of-firms/comment-page-1/#comment-10 Mike Barnett Thu, 05 Apr 2007 16:48:36 +0000 http://blog.robertsalomon.biz/?p=8#comment-10 Well, Rob, one must certainly agree that there are substantial costs to firms in relying on the public equity market, and that privatizing the firm can eliminate a substantial part of these costs -- to include not only the direct and obvious costs of compliance, investor relations, etc., but also the indirect costs of releasing strategic information that might otherwise have been kept private from rivals. But there are plenty of costs to going opaque and losing public scrutiny. These firms are banking on the judgment of a few insiders being superior to the collective wisdom of a fairly efficient (though often short-term-focused) market. We've addressed this notion of managers, as decision-making specialists, having some superior capacity, being smarter than the market they're betting against, in my prior post on executive compensation. I'm not convinced that, on average, they do better, and I believe that they often do worse -- perhaps much worse. Richard Branson can take money from his cash cows and prop up his crazy ultra-long-term visions. Donald Trump can buy all the money-losing Atlantic City casinos he wants, drawing the funds from his high-priced NYC real estate . . . and so on. I believe some researchers have referred to internal capital markets as "intrafirm socialism" and have found that they tend to do worse, bringing down the high flyers and investing too much in the downtrodden, creating an overall unprofitable portfolio. So, the problem with an LBO is that it replaces the market's judgment with insider judgment. These insiders are certainy filled with hubris, to even take on the task of betting they know more than the market. These insiders also have their own biases and pet projects. If you think they're smarter than the market, it makes sense; if not, you've got real troubles. I'm curious what studies would show if they got inside these firms after they were private (there's, of course, no public secondary data sources to make such studies easy, so I don't know of any). You mentioned a study that showed they do better when relaunched. That's interesting, and gives some sense that perhaps they did get improved. But why would they then be taken public? Isn't that hypocritical sort of, giving back into the public beast they belittled to justify privatization? I guess it's just cashing out, maybe no more. Some raiders go back and forth, buying up private, taking them public later, then believing they get undervalued again, then taking them private again, fixing them up, going public again . . . look at the history of MGM Studios. So perhaps a few folks have the decision-making expertise (not convinced here) or the luck, or the ability to move the market (perhaps this) to make this happen. But a study like this would be interesting. Of course, it would be biased toward a favorable finding, since the firm would gain the benefit of cost reduction associated with public equity transacting, so factor that out, and see if the positive effect holds . . . I'm rambling, but I think you get the idea. Well, Rob, one must certainly agree that there are substantial costs to firms in relying on the public equity market, and that privatizing the firm can eliminate a substantial part of these costs — to include not only the direct and obvious costs of compliance, investor relations, etc., but also the indirect costs of releasing strategic information that might otherwise have been kept private from rivals. But there are plenty of costs to going opaque and losing public scrutiny. These firms are banking on the judgment of a few insiders being superior to the collective wisdom of a fairly efficient (though often short-term-focused) market. We’ve addressed this notion of managers, as decision-making specialists, having some superior capacity, being smarter than the market they’re betting against, in my prior post on executive compensation. I’m not convinced that, on average, they do better, and I believe that they often do worse — perhaps much worse. Richard Branson can take money from his cash cows and prop up his crazy ultra-long-term visions. Donald Trump can buy all the money-losing Atlantic City casinos he wants, drawing the funds from his high-priced NYC real estate . . . and so on. I believe some researchers have referred to internal capital markets as “intrafirm socialism” and have found that they tend to do worse, bringing down the high flyers and investing too much in the downtrodden, creating an overall unprofitable portfolio. So, the problem with an LBO is that it replaces the market’s judgment with insider judgment. These insiders are certainy filled with hubris, to even take on the task of betting they know more than the market. These insiders also have their own biases and pet projects. If you think they’re smarter than the market, it makes sense; if not, you’ve got real troubles. I’m curious what studies would show if they got inside these firms after they were private (there’s, of course, no public secondary data sources to make such studies easy, so I don’t know of any). You mentioned a study that showed they do better when relaunched. That’s interesting, and gives some sense that perhaps they did get improved. But why would they then be taken public? Isn’t that hypocritical sort of, giving back into the public beast they belittled to justify privatization? I guess it’s just cashing out, maybe no more. Some raiders go back and forth, buying up private, taking them public later, then believing they get undervalued again, then taking them private again, fixing them up, going public again . . . look at the history of MGM Studios. So perhaps a few folks have the decision-making expertise (not convinced here) or the luck, or the ability to move the market (perhaps this) to make this happen. But a study like this would be interesting. Of course, it would be biased toward a favorable finding, since the firm would gain the benefit of cost reduction associated with public equity transacting, so factor that out, and see if the positive effect holds . . . I’m rambling, but I think you get the idea.

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