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Private equity vs. public equity

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The New York Times has an article this weekend about Hertz’s makeover by private equity and goes through some advantages private equity firms may have over public owners in improving operating earnings of companies.

Private equity firms may be able to foist a lot of change on a company in a short period of time, force a focus on cashflow since most private equity owned firms take on a lot of debt and need to generate money to make interest payments, and offer enormous incentives for success to the management team.

If this is so – and I suspect the truth varies dramatically based on the private equity firm- we need to consider the implications for how most people in this country are saving for retirement.

At this point, there is about $16 trillion in pensions and retirement acounts. Half of that money is in IRAs, 401(k)s and the like. Virtually 100% of the equity allocation in that $8 trillion pool of money is in public equities.

When traditional pension plans were the norm, the pension plan manager had the option to invest in public or private equity and generally did both.

Currently, individuals in defined contribution plans have little choice. You can choose really really big and expensive mutual fund ABC or maybe if you are lucky index fund XYZ.

Laura Resnikoff, a business school professor who studies the kinds of changes that private equity makes, is quoted in the the article as saying,“A good management team at a public company could do all of this, of course. And yet, we don’t see management teams doing it.”

IF we don’t want drastic changes in the current system of retirement saving, we need to think very hard about why this is because as the system exists today, the outsized rewards of change largely go to private equity investors and the public equity investors (us) look like chumps.

This is a problem – my generation is largely reliant on the performance of the country’s largest couple hundred public companies to fund their retirement. And there is quite a lot of evidence that the current management and ownership structure of these companies is significantly less than optimal and an impediment to change.

Less than optimal is okay. Optimal is not realistic for many reasons but I think it’s likely we are further away from optimal than we need to be.

One way in which the current system falls short is that we make it really hard for motivated, qualified groups to make changes at a company without going to the extreme of taking it over.

You know those really irritating proxy forms you get, asking you to rubber stamp the board of directors the company’s management has handpicked? Well, they aren’t even binding in most cases.

I’d love to see a serious policy discussion start about how to improve corporate governance. We’ve spent a lot of time on Sarbanes-Oxley trying to avoid fraud. I’m quite confident that mediocrity is a lot more costly to American investors than a little pumping and dumping by corporate executives…

Topics: Investments, Retirement policy | No Comments »

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