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“The Governance Gap”: An untapped value driver for Private Equity

“The Governance Gap”: An untapped value driver for Private Equity

To continue to develop a data-led point of view on this increasingly important subject, we invite you to complete this 10-minute survey and share your views. The questions in this survey will cover your approach to and predictions around corporate governance, with a specific focus on board effectiveness. 

I think you are going to see private boards across VC and PE have more structure, more independents, and become more diverse. Not just because of pressure but because it is seen as a real value driver. This stuff really matters.” Partner at Large Cap PE firm


The research paper is based on interviews with more than 40 senior leaders in the global Private Equity (PE) industry in 2019 and 2020. Respondents included PE partners, and Chairs and CEOs of PE-backed portfolio companies.

Based on our research, we conclude that:

  1. The PE industry is reaching an inflection point as a consequence of its growth and because of changing market and societal conditions.
  2. Better governance of portfolio companies helps PE firms: enhance value creation, reduce risk, and build trust with stakeholders.
  3. There is a “Governance Gap” driven by poor quality execution, lack of diversity in board composition, and lack of oversight.
  4. There are practical steps that PE firms can take in order to improve board effectiveness as well as making the mindset shift from Corporate Governance as a practice determined by individual Partners to Corporate Governance as an essential element of ownership.

The research

YSC Consulting in conversation with PE leaders, October 2019 to March 2020

YSC Consulting is the world’s premier independent provider of leadership strategy services. We work extensively with the PE industry, both with the firms themselves and with their portfolio companies. We also have considerable first-hand experience of the industry: for the last seven years we have seen the benefit ourselves of having PE investment to grow our own business. (For more information see About YSC).

During our work with PE firms we have observed anecdotal differences, within and between them, in terms of how they oversee the companies in which they invest. In order to understand this in greater depth we initiated discussions with 43 senior leaders in the global Private Equity industry between October 2019 to March 2020. Participants included deal Partners and in-house human capital specialists from 19 PE firms, and CEOs and Chairs from 12 different portfolio companies. We spoke to PE industry leaders in Europe, the US and Asia-Pacific. The 19 PE firms we spoke to were mainly Large Cap PE firms, with some Mid and Small Caps. Participants reported between 8 and 40 years of portfolio company board experience, having worked on between 4 and 40 boards. All board members had international experience as Execs or non-Execs, having served on boards for global businesses and businesses headquartered outside of their home market.

Given the relatively small sample size of our research, and its emphasis on Large Caps, this paper is best seen as an illustrative snapshot of how PE operates, rather than an exhaustive analysis, and percentages should not be seen as necessarily representative of the wider industry. The purpose of the paper is to increase understanding within the industry around corporate governance and why it matters, and to stimulate further improvement in service of value creation.

We summarize the current context for the PE industry based on external research, before outlining our four key findings from our interviews, then moving into a conclusion and recommendations. We follow the Chartered Governance Institute’s (ICSA) definition of Corporate Governance as: “the system of rules, practices and processes by which a company is directed and controlled.”1 We categorized PE firms based on their Assets Under Management (AUM) as reported in Pitchbook2 at the time of the research, and defined the Small / Mid / Large Cap (capitalization) boundaries as follows: Small Cap: <US$2bn; Mid Cap: US$2bn-US$10bn; Large Cap: >US$10bn. We categorized the portfolio companies based on the capitalization definition of the investor rather than the company itself.


Greater scale requires better governance

In an article in May 2020, entitled “More money, more problems: Can private-equity firms turn a crisis into an opportunity?”, The Economist observed that, since the 2007-2009 financial crisis, the PE industry has “become far more important.… Assets under management have swollen to more than $4trn. The 8,000 firms run by PE in America account for 5% of its GDP, and a similar share of its workforce.”3 The increase in the scale of the industry over the last decade has been widely reported. In their 2019 report on the PE industry, the management consultancy Bain and Co. noted: “…total buyout value jumped 10% to $582 billion (including add-on deals) [in 2018], capping the strongest five-year run in the industry’s history.”4 A Harvard Business Review article in 2016 observed: “A silent, seismic shift has dramatically altered corporate ownership and business governance globally. From 1996 to 2015, the number of publicly traded companies in the United States alone dropped nearly 50%.”5 One impact of the growth of the industry is more PE firms, with more financial firepower, competing to buy the same companies, which in turn has been pushing up prices. In their 2020 report on the PE industry, Bain and Co. noted: “Prices set all-time highs in the US and remained near record levels in Europe, raising the bar for investors looking to create value.”6

While this shift may have been “silent” back in 2016, the growing size of the industry has now resulted in much greater “noise” in the public arena. This is especially audible in the US, where in July 2019 several Democratic members of Congress drafted legislation that was provocatively entitled “Stop Wall Street Looting”. It was aimed at changing the rules around PE firms’ liabilities for the debts of their portfolio companies and restricting payments to PE firms from companies they invest in. Bloomberg Legal noted in November 2019: “If the November 2020 election sees Democrats taking control of Congress and the White House, many of the bill’s provisions are likely to receive serious consideration.”7

Calls for change are not limited to firebrand politicians. In an Op-Ed for The Financial Times in July 2019, its City Editor, Jonathan Ford, supported some of the aspects of the Democrats’ plans, noting that: ““Heads I win, tails you lose” capitalism… hurts the taxpayers who must meet the social costs.”8 In another Op-Ed, this time in June 2020, entitled “Private markets need to be dragged further from the shadows,” Ford argued that PE’s preference to be “parsimonious with information… might have mattered less when the industry was small. But as buyout funds have ballooned relative to global public equities… its tendency to hide has become increasingly anomalous.”9 Ford concluded that “the public-private boundary needs rethinking.”

Some would argue that criticism of the PE industry is nothing new. Indeed, it has been part of the popular narrative since the 1980s and 1990s, best exemplified by the 1989 book Barbarians at the Gate10, which told the story of the leveraged buyout of RJR Nabisco. What is changing, however, is that this scrutiny is now on the cultural, ethical, legal, and moral responsibility of PE firms as well as their financial and social impact. Recent high-profile exemplars from the Venture Capital (VC) part of the industry include the replacement of CEOs at Uber and WeWork. This has led commentators and investors to ask questions around the adequacy of corporate governance, specifically to ensure that cults of personality around charismatic CEOs do not erode value. Pressure for change is not only coming from politicians and journalists, but also from PE investors themselves, the Limited Partners (or LPs) who are often large institutional investors like pension funds. Bain and Co. identified a trend in their 2020 report that: “many firms are finding they need to incorporate sustainability much more explicitly into their investment strategy to meet the needs of Limited Partners.”11

With the likelihood of increasing bankruptcies of companies, public and private, to be anticipated as part of the economic impact of the Covid-19 crisis, and with PE investors sitting on uninvested capital, we expect there to be even greater attention paid to the industry in the months and years ahead. We predict this will be double-sided, as PE investments go bad and at the same time PE firms take over distressed assets. The article from The Economist quoted at the start of this section makes the latter explicit: “For years PE barons have boasted of their huge piles of dry powder, which, if spent in a downturn, might generate outsized returns. Now it is time to pounce.”12

So, the growth of the industry brings two challenges: first, there is greater competition among PE firms for companies to invest in, which means that prices are higher and it is more difficult to generate returns; second, the industry is facing intensifying scrutiny around how it operates. These themes came out strongly in our interviews. An experienced Chair in PE-backed companies noted that this is leading to an increased focus on corporate governance: “Now PE firms think more like a strategic investor than a financial investor…. The new model is of organizational transformation and requires more attention to the who and how of corporate governance and more of a consensus model.” This was echoed by a Partner at a Large Cap firm: “Prices are going up and up. If you want to keep returns at expectations, you need to create more value. We need to execute better. That starts with governance.”

Prices are going up and up. If you want to keep returns at expectations, you need to create more value. We need to execute better. That starts with governance.” Partner at Large Cap PE firm

Finding 1

The landscape is changing, and the industry is at an inflection point.

In our interviews we asked respondents what they believed portfolio company boards should be worried about now and how that would change in the future. 50% of respondents are currently concerned about ESG, and 30% saw it as something that would become more important over time. A Partner of a Large Cap PE firm commented: “ESG is a key focus for us. We have to do a lot. Environment is key. The social part is key to the board.” The CEO in a Large Cap portfolio company reinforced this: “Sustainability – we don’t spend time on it in the board, which I can expect to happen more in the future. Given that, PE will need to operate differently to what they’re used to.” The pressure from LPs was noted by the Chair in a Small Cap portfolio company: “Now LPs are insisting on ESG and corporate impact. Governance is becoming more important. This is being led by LPs.” Cybersecurity is much more of a current than a future concern: 50% of respondents are worried about it at present, but none identified it as a significant area of change in the future.

While 13% of respondents are currently concerned about talent and diversity, 40% saw it as becoming more important over time. The Head of Human Capital at a Large Cap PE firm shared the issues he wrestles with: “Is it the right mix of directors? Talent reviews and succession planning. Diversity.” A Managing Director of Large Cap PE revealed how his firm is grappling with the extent to which they set Diversity and Inclusion (D&I) policy for their portfolio companies: “We wrote a very direct but encouraging letter to the CEOs of our portcos to lead these initiatives. But what we didn’t do is step in and insist/mandate it to our portcos.” The CEO of a Large Cap portfolio company commented on the composition of his own board: “[we need] more equality… Our board is 100% men.” Since we completed these interviews in March 2020, the focus on Diversity and Inclusion has intensified further, supported by the Black Lives Matter movement and other public calls for change.

The final key trend our participants predicted, albeit in smaller numbers (15%), was greater independence for boards of PE-backed companies from their firms. They mentioned indicators of this as being more independent members of the board, more structure and greater scrutiny and transparency. As the Principal of a Large Cap PE firm commented: “I think people are going to want more independence. Diversity will come up more.” This was echoed by the CEO of a Large Cap portfolio company: “Over time I think we may see more independence from [name of firm]. And a greater role of the independent directors.” Similarly, the Partner of another Large Cap PE firm linked this to greater public oversight: “It will be more public. People that sit on Boards have a public duty, even if it is a private company. The acceptance is that we’re not just optimizing shareholder value, but we’re optimizing stakeholder value – the shareholder is just one stakeholder…. Our investors are asking more for it. We have to do it.”

Some in the industry, however, do not believe there is a need for change. One Partner in a Large Cap PE firm complained that she hears repeatedly from colleagues: “In your lifetime you will not change PE Boards”. She went on to tell us: “That’s the mountain to get up. That is what you’re dealing with. That’s a commonly held view. It won’t be long before the regulator comes after us.” Similarly, the Head of Portfolio Talent at a Mid Cap PE firm commented on the difficulties to get the firm’s leadership to pay attention to governance: “It is at the bottom of their agenda, for me it’s at the top… All my arguments fall on deaf ears unless something is really broken.” The Operating Director at Mid Cap PE firm linked this to a generational shift in the industry: “The younger generation want more balance and values. PE is behind industry trends on this.”

And, while some firms are treating board governance as a low priority, others are devoting considerable focus to it. A Partner at a Large Cap PE firm reported: “We’re spending a lot of time thinking and talking about it and what governance means. Our sense is there are lots of different models. We are not trying to copy models. We need to tailor to our model.” For those PE firms that are taking governance more seriously, we see two different approaches. Some firms are going down the route of increased standardization. They are becoming more centralized, driving consistency across the whole value creation process, including board governance. A talent specialist at one reported: “We have a playbook – 100 pages – that has captured what we do and how we do it. Every Chair has a Chair welcome pack.” Other firms, however, are wary of standardization. A Partner at a different Large Cap PE firm took the following view: “Because governance needs to be tailored to the context of the company we invest in, we prefer as a firm to focus on developing judgement in our Partners rather than having a consistent process.” An industry advisor commented on this difference in philosophies: “There is a big debate in PE about judgement versus process…. There is the balance between being entrepreneurial and playing to the strengths of the firm.”

Much faster, responsive, decisive, and agile in the PE-backed board. Real-time interactions.” Operating Partner from a Mid Cap PE firm

Finding 2

PE-backed boards have an inbuilt governance advantage.

One of the commonly cited strengths of the PE model is that it significantly reduces the “agency problem”13 of publicly listed companies where shareholders are reliant on a third-party board to represent their interests. This is a recurrent theme in academic research on the “Governance Advantage” of PE. For example De Fontenay (2019) noted that: “Private Equity’s governance advantage has always been that companies are the servant of only one master.”14

Several of our respondents highlighted what they see as the positives of PE corporate governance, especially as it compares with that of public companies. A Chair at a Small Cap portfolio company commented on the long-term focus of PE: “I think PLCs take a very short-term view: you are only as good as your last results. PE firms have to sell the business at the end and the best way to do that is to show a company with momentum and significant potential.” Another Chair of a Small Cap portfolio company noted the “heavy admin burden” of being on a PLC board. A CEO of a Large Cap portfolio company told us: “PE is more focussed on value maximization.”

This fundamental difference then translates into greater speed and agility. A Chair from a Small Cap portfolio company noted: “The beauty of the PE board is that it’s fast moving and focussed but it’s not the be all of shareholder meetings. If we have a problem with the board, we’ll change it and it will be done in the day.” Similarly an Operating Partner from a Mid Cap PE firm remarked: “Much faster, responsive, decisive, and agile in the PE-backed board. Real-time interactions.” This sense of being hands-on was echoed by a comment from the Chair of a Large Cap company: “A lot of corporate boards keep out of the kitchen, but a PE board needs to get involved.”

Respondents also noted positives that are not unique to the PE board. Some told us how effective governance reduces risk, both protecting against corporate failure and in building high-performing companies. A Partner at a Large Cap PE firm remarked: “We look to create something that a strategic buyer would love to own…. Governance around compliance is an opportunity to create strategic value.” Others observed that the quality of individuals on the board can also play a positive role in the value creation process. A Managing Director at a Large Cap PE firm posed the questions: “How do we use the board to mentor, train, strengthen the team? What kinds of experiences do we want to have on the board so the journey is maximally supportive?”

Finding 3

There is a complex picture around variability of approach.

The “Governance Advantage” enables investors to adapt board arrangements in order to meet the needs of an individual company. This is helpful because deals can differ greatly across a number of dimensions, including size and complexity of asset, local versus international footprint, nature of investment thesis, point of time in deal cycle, and ownership structure (especially whether a PE firm has a minority or majority stake, and if there are multiple PE investors). As the COO of a mid-size fund noted: “There is no one size fits all. Local standards don’t apply internationally. Different businesses require different levels of governance.” But while there was an over-arching theme of variability, we also found broad consistency among our respondents on the basic mechanics of corporate governance of PE-backed companies (see Typical Features of a Portfolio Company Board).

There was also moderate commonality from respondents on best practice, identifying: disciplined execution of board processes (52%); optimizing board composition (43%); ensuring that the board is aligned to value creation (38%); regular board evaluation (33%); effective use of sub-committees (29%). Creating clarity here was a key theme, as articulated by an Operating Director at a Mid Cap PE Firm: “You need to clearly describe the relationship expectations of the board, shareholders and management team. Lines get significantly blurred in PE boards.” Another was alignment, as commented on by a PE Partner: “You need to tie it to value creation – what needs to have happened and being clear on it – and time-bound expectations…. The value creation process is mirrored at the board.”

We saw greater variation from participants around what the board is for: strategic alignment (46%); corporate governance (39%); selection and management of the executive team (36%); hands-on involvement in running the business (21%). These differences reflect divergent views on the philosophy of the PE firm: whether it is a largely passive investor that gives an executive team a long leash to run the business; whether it is a much more active player, directly involved in the practicalities of operational execution; or whether it sits somewhere between these extremes.

These differences in investment philosophy also played out when we asked about the involvement of PE firms in decision-making and interacting with management. There were opposing views on whether the board or the majority investor should make the decisions (38% vs 62%), and for some PE firms there is no distinction between the PE firm and the Board. There were also opposing views around whether the PE firm should go through versus around the board to interact with the executive team (31% vs 38% respectively). The Managing Partner at a Large Cap PE firm remarked: “We always respect the hierarchy. We don’t take action without going through the Chair or CEO.”

This is not, however, as black and white as it may seem. 31% of participants reported that there tended to be flex between the PE team directly engaging with the management team and engaging indirectly via the Chair. When interactions shift to the latter, Chairs mentioned that their involvement often happens because something had gone “wrong” in the relationship between the PE investors and the management team.

So, while having investors around the board table means that shareholder views are literally in the room, thus negating the “agency problem” there is a risk that PE firms can take on too much agency. In so doing, they risk disempowering the board by holding onto decision-making power too tightly and by treating the board as a reporting forum rather than a governance forum. Linking back to the comment by the Chair earlier in the paper, this is especially important where: “organizational transformation… requires… more of a consensus model.”

The variability in approach and philosophy is not only seen between PE firms, but also within many firms. This may come as a surprise to those unfamiliar with the industry, but insiders will recognize that many PE firms operate as partnerships, where senior individuals have considerable autonomy. As one Partner of a Large Cap PE firm commented: “It varies Partner by Partner. Our model is fairly decentralised so the deal Partner is responsible and empowered and he can run it the way he deems best. That leads to differences.” A Partner from a mid-sized firm reinforced this: “We have got some best practice but much of it is not mandatory.” This helps to explain the extent of the challenge that some PE firms are facing as they seek to adapt to a changing external context. As a Partner from a different Large Cap PE firm commented: “We are trying to influence the agenda on boards [within the firm]. It is highly embryonic and individualistic.”

It varies Partner by Partner. Our model is fairly decentralised so the deal Partner is responsible and empowered and he can run it the way he deems best. That leads to differences.” Partner at Large Cap PE firm

Typical Features of a Portfolio Company Board*

  • PE boards are usually smaller than those of publicly listed companies, made up of three to five members.
  • They usually include the CEO, and in 75% of cases the CFO, as well as two senior representatives from the PE firm.
  • 44% of respondents reported that they will always have a non-executive Chair on the board.
  • For bigger companies with more complex strategies, boards will often include additional non-executive directors who bring expertise to specific elements of the strategy.
  • 42% of respondents said that there will be additional “observers” from the PE firm, more junior investment professionals who attend but do not have an official role.
  • Most boards will meet monthly, either as a formal board meeting or in an informal finance and performance review.
  • 30% of participants noted a high degree of flexibility around board cadence, for example more meetings happening early in the investment cycle, or when there are key strategic decisions to be made.

*Excluding where there are specific local legal requirements for a different board structure, and where PE firms hold minority stakes or where there are multiple PE investors.

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“The Governance Gap”: An untapped value driver for Private Equity