The more successful it becomes, the more private equity is coming under scrutiny. This month, Britain's Financial Services Authority warned of the growing riskiness of the industry as private equity firms set their sights on ever bigger targets and take on ever higher debt in the process. Some firms may well discover they have bitten off more than they can chew. But there are no signs that the challenge posed by private equity firms to the public equity model is about to ease.
The top 25 per cent of private equity firms outperform the relevant stock market index over time. Moreover, they do so by some distance and, unlike in other areas of finance, the same group of firms manages to do so persistently.
The source of their success is the governance model they apply to the companies they own. It is an advantage that public companies find hard to emulate. The top private equity firms have created a means to exert ownership control over management that can create sustainable above–average performance. The contrast in governance style is particularly striking when these firms are measured against traditional public companies, with their typically diffuse shareholder bases, powerful chief executives and under–resourced non–executive directors.
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