Private Equity and Entrepreneurial Governance: Time for a Balanced View

Abstract

Private equity is best understood not as a financing method but as a governance structure, one that emphasizes strong performance incentives, rules over discretion, and a strong alignment between ownership and management. Briefly, private equity governance makes owners into active managers and makes managers behave like owners. As such, private equity is often regarded as a more “entrepreneurial” form of governance than that associated with the publicly traded corporation. We argue for a balanced view in which private equity is best regarded as a governance structure that, like all forms of organization, has benefits and costs that vary according to circumstances. Building on the “judgment-based” view of entrepreneurship, we note that managers of privately held firms, as owners, exercise a strong degree of entrepreneurial judgment over the use of assets, unlike salaried executives of publicly held companies. At the same time, however, privately held firms are often constrained from pursuing potentially attractive profit opportunities by the nature of their debt obligations. Private equity is not a panacea, and buyouts do not necessarily generate the typical outward markers of innovation such as patents, employment growth, and the establishment of new enterprises.

Keywords: private equity, entrepreneurship, judgment

JEL Classification: G32, M13, L2