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Private Equity and Entrepreneurial Governance

April 13, 2013 in Economics

By Peter G. Klein

I have a new paper with John Chapman and Mario Mondelli, “Private Equity and Entrepreneurial Governance: Time for a Balanced View,” in the February 2013 issue of the Academy of Management Perspectives. (Ungated SSRN version here.) The paper is part of a symposium called “Private Equity: Managerial and Policy Implications.” Our paper builds on the “judgment-based view” of entrepreneurship that builds on Mises and Frank Knight and evaluates how judgment rights are assigned between private equity investors and companies receiving private equity funding. Here’s an excerpt:

Judgment refers to decision making that cannot be represented by formal models or decision rules, but is nonetheless different from luck or chance. Unlike other entrepreneurial attributes such as alertness (Kirzner, 1973), judgment is manifest in the ownership of productive assets. It reflects ultimate decision authority—residual rights of control, in Grossman and Hart’s (1986) terminology—about the deployment and use of valuable resources under conditions of uncertainty. Entrepreneurs act to combine and recombine heterogeneous capital resources, whose attributes are subjectively perceived, to pursue financial or other gain. As Lachmann (1956, p. 16) put it: “We are living in a world of unexpected change; hence capital combinations … will be ever changing, will be dissolved and reformed. In this activity, we find the real function of the entrepreneur.”

Are PE firms more entrepreneurial, in this sense, than publicly traded firms? Yes and no. Both theory and the empirical evidence, summarized below, support a balanced view in which PE is best regarded as a governance structure that, like all forms of organization, has benefits and costs that vary according to circumstances. As Jensen (1989) famously argued, PE has substantial potential governance benefits over public equity due to a closer alignment of ownership and control. The high-powered incentives associated with ownership can lead to what Wright, Hoskisson, Busenitz, and Dial (2000) termed a “change in managerial mindset” that prefers long-range, strategic, holistic thinking over a short-term focus on quantitative performance metrics. At the same time, however, privately held firms are often constrained from pursuing potentially attractive profit opportunities by the nature of their debt obligations. Put succinctly, PE favors management by fixed rules while public equity allows a greater degree of managerial discretion, and both rules and discretion have benefits and costs.

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What Margaret Thatcher Did for Eastern Europe

April 13, 2013 in Economics

By Dalibor Rohac

Dalibor Rohac

When Václav Havel first visited the United Kingdom as Czechoslovak President in March 1990, Margaret Thatcher hosted a dinner in his honour at 10 Downing Street. By then, Havel’s team, populated partly by chain-smoking dissidents, had been in active politics for only a couple of months. The Prime Minister did not hesitate to use the opportunity to coach the group of unlikely Czechoslovak leaders. ‘She was very direct in giving us advice about economic transition, about what we should and should not be doing,’ remembers Havel’s former press secretary, Michael Žantovský, who is currently serving as the Czech Ambassador in London.

As last week’s street parties in Glasgow, Liverpool and Brixton showed, Margaret Thatcher remains a deeply divisive figure in the UK. To Eastern Europeans, this is puzzling. From our side of the iron curtain, it was always exceedingly clear how lucid she was about the evil of collectivism — an impression amplified by the amount of propaganda used by communist regimes to depict her in the worst possible colours.

In part, her role was symbolic. When she visited Gdańsk in November 1988, twenty thousand Poles came to the streets to greet her enthusiastically. After her historical meeting with Lech Walesa, she said that she had ‘felt the spirit of Poland for [herself]‘. The value of her visit, giving hope not only to Solidarity supporters but to the entire dissident movement, was enormous.

Thanks to her example, Eastern Europeans of the early 1990s understood well that bold and sometimes painful reforms were a necessary condition for Western levels of prosperity.”

Symbols matter. In Czechoslovakia, the communist party newspaper, Rudé právo (‘The Red Law’) chose to ignore the Gdańsk episode, providing instead a short notice about her talks with the Polish government about ‘the need to energise economic cooperation between the two countries’. But there was no coming back. In Poland it took less than two months since Thatcher’s visit for the Polish regime to recognise that it was fighting a losing war and start talks with Solidarity, which would lead to dismantling of communism in the country. Czechs and Slovaks had to wait for another year.

It is difficult to assess to what extent she and Ronald Reagan were directly instrumental in bringing down communist regimes, by taking a hard line on the Soviet Union at various international fora. However, it is clear that her personal and intellectual …read more
Source: OP-EDS