Private equity compensation

08Sep06

As noted in a prior post the high yield market calendar is filling up with management-led buyout (MBO) deals. Justin Lahart in the Wall Street Journal speculates that if demand stays steady for these types of deals, this could embolden additional MBO deals in the future.

If September’s issuance of bonds — which could approach $80 billion — gets swallowed by investors without pushing yields much higher, private-equity firms are likely to be emboldened to aim higher, bidding up the values of bigger companies, confident the bond market will help finance their offers.

This speaks to the notion that deals are happening in part because they simply can happen. Another reason for MBO-type deals is they allow for management to get an even bigger slice of the company’s future economic pie.

Henny Sender and Dennis K. Berman also in the Wall Street Journal report on the growing force that is MBOs. With this increase in deals it also calling into question the fairness of these deals in light of the many conflicts of interest that arise when a public company is being sold (in part) to those individuals who are currently running the show. The big lure to current management is of course, the potential for a big payout down the line.

There is little that is more important to a private-equity firm than courting the management of a potential target. A critical part of the wooing process is to offer management lavish incentives. Those incentives generally involve as much as a 10% stake in the reorganized company — far more than managements can usually hope for either as a public company or from a strategic buyer. If management hits financial and operational targets set by the new owners, the executives generally receive stock and options. If the executives exceed those targets, they get more of both. And when the company is recapitalized or goes public, the executives often get windfalls valued at hundreds of millions of dollars.

Given the vast sums involved it should not be all that surprising that the topic of MBOs is controversial. Going Private has a reasoned defense against those who see a fundamental “unfairness” when management is involved in taking a company private.

The potential payouts from going private transactions is a part of the larger question of income inequality and compensation growth. The question of managerial compensation is not limited to the question of MBO transactions. Even in the day-to-day running of a company compensation practices can look awfully unfair to an outsider.

Julia Angwin in the Wall Street Journal reports that News Corp. (NWS) is paying $50,000 a month to rent an apartment for Chairman Rupert Murdoch, who also happens to control a roughly 30% stake in the company.

Patrick McGurn, a corporate-governance expert at Institutional Shareholder Services, a shareholder advisory firm, said he had never heard of a company paying for an executive’s personal residence in the city in which the company has its headquarters.

“Does News Corp. pay for his primary residence? No. So why would they pay for the replacement residence?” Mr. McGurn said. “That just boggles the mind.” He said some companies have paid toward the cost of executives maintaining residences in another city. “While I don’t love that, that’s fairly common,” he said.

Some would contend that a more populist political era will soon be afoot in the United States. If and when it does, executive compensation will surely come under rhetorical, if not, legislative pressure. Corporate executives and private equity firms alike should keep in mind that appearances do matter. Especially those that look like a $50,000 a month compan-paid apartment.

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