The crippling effect of ‘governance correctness’

Partners Group's Steffen Meister believes the days of being able to buy private assets cheaper than public ones are over, but PE will continue to outperform public equities.

Let me start with some bad news: I believe the era of private markets investors being able to buy private assets more cheaply than those in public markets has come to an end. The current parallels that we are witnessing between valuation levels in private and public markets are to me indicative of a structural, not cyclical, shift in market dynamics. Although prices may eventually come down, the parallels will remain – in fact, I think we may even see higher valuations in private markets in many cases, given the greater ease of transacting.

Now, the good news: I predict that private equity will continue to outperform public equity, even as the industry becomes more competitive and valuations remain more directly comparable to or higher than those in public markets. This is because in my opinion the fundamental driver of private equity outperformance is its superior corporate governance, which is the enabling factor behind all of the value creation levers that a private company’s board of directors and management can bring into play.

In contrast, public companies are becoming increasingly mired in corporate governance practices that, in many jurisdictions, have evolved so far beyond their original mandate to protect shareholders that they have instead become obstructive to long-term value creation, a phenomenon we at Partners Group have christened ‘governance correctness’.

Partners Group is itself a listed company – we launched on the SIX Swiss Exchange in 2006 – and I have seen the pressures of some of these practices first-hand. We have been successful as a listed company by continuing to apply a corporate governance philosophy that balances entrepreneurial growth over the long term with the interests of all our stakeholders – ie, by taking a private equity approach to governance.

There are many things wrong with public market corporate governance today. To give just one example, the boards of many public companies are hamstrung in their ability to direct and drive forward strategy due to the prevailing obsession with board “independence” as a cornerstone of best practice in public markets corporate governance.

Many public company boards have simply become “neutral agents” sitting between the management team and shareholders, with board discussions mostly given over to checks and controls. Unfortunately, the long-term added value of an independent board like this is likely to remain low, no matter how skilled and talented the individual directors are, because neutrality in itself does not build and develop good businesses.

In contrast, independence or neutrality is generally much less of a priority in the boards of private equity-owned companies. What is critical instead is the ability of each board member, individually and as part of a combined leadership group, to actively contribute to defining and driving forward strategy and ultimately achieve ambitious business objectives. Private equity boards typically view their role as leading the development of a company’s strategy and then directing its execution by top management.

In my view, this single-minded focus on long-term value creation is the key difference between the boards of public and private markets. Ultimately, when combined with other critical weaknesses prevalent in public market corporate governance, such as a short-termism of outlook, a single-minded focus on accounting earnings, and a misalignment of compensation structures, it is one of the key factors underpinning the long-term outperformance of private equity over public equity.

We have all witnessed the decline in the number of public companies in the US and UK in the past two decades and I believe that excessive corporate governance may be one reason behind this. Investors and entrepreneurs are increasingly wary of the corporate governance changes required in order to go public, especially during more entrepreneurial stages of corporate growth and development.

Luckily, these entrepreneurs and management teams have an alternative: private equity firms will continue to emphasize entrepreneurial governance models as they refine and specialize their value creation skillset. And the outperformance over public markets will continue.

Steffen Meister is a partner at Partners Group and executive chairman of the board of directors of Partners Group Holding, based in Zug. He is also a member of the Board’s strategy committee and the markets committee. To read Meister’s report on corporate governance, click here.