The staying power of the public corporation

1
The staying power of the public corporation

• Based on the article
• By Alfred Rappaport
• Harvard Business Review, Jan Feb, 1990

2
The future of public companies remains bright

• Public companies are inherently flexible and
  capable of renewal.
• Leveraged Buyouts (LBOs) should not be viewed as
  substitutes for public companies.
• The heavy use of debt by LBOs can increase costs
  and reduce flexibility.
• And flexibility holds the key in a fast changing
  environment.

3
The future of public companies remains
bright(cont)

• The act of going private also does away with the
  single best source of information about the
  performance of the company, the daily stock
  price.
• There is no better barometer of a companys long
  term prospects than the share price.

4
Limitations of LBOs

• LBOs have a limited market and a limited life.
• LBOs apply only to industries where long term
  growth prospects are limited, internally
  generated funds exceed profitable investment
  opportunities and downsizing is the most
  appropriate long term strategy.
• Investors have limited appetite for LBOs since
  investments in securities without objectively
  determined market prices are not easy to
  evaluate.
• By design, the buyout is a transitory form of
  organization.
• Sponsors return it to its earlier status as a
  public company or sell out to a new group of
  investors.

5
The case for public companies

• A flourishing market for corporate control exists
  to impose discipline on management.
• New information sources, sophisticated valuation
  techniques and the growing number of talented MA
  professionals have combined to create a powerful
  infrastructure for corporate control.
• Public companies too undergo restructuring from
  time to time.
• The only thing is that restructuring in the 1980s
  was largely driven by a transactional approach.

6
The case for public companies (Cont..)

• What is needed is a more institutionalized
  shareholder value program, which incorporates
  four guiding principles
• Find the highest valued use for all assets
• Managers must develop monitoring systems that
  regularly evaluate each business unit as if it
  were a publicly traded entity and then assess
  whether there are buyers willing to pay a
  meaningful premium over its estimated value.
• Limit investment to opportunities with credible
  potential to create value.
• Mangers must not subsidise low return businesses
  with cash from high return businesses and not
  over invest in declining core businesses.
• It is also best to avoid a single hurdle rate for
  all investment decisions.
• A single hurdle rate overstates the risk of low
  risk units and understates the risk of high risk
  units.
• - -

7
The case for public companies (Cont..)

• Return cash to shareholders when value creating
  investments are not available.
• Public companies must return cash to shareholders
  when value creating investment opportunities are
  not available.
• This can be done through stock purchase, higher
  dividends and special one time dividends.
• Establish incentives for managers to focus on the
  drivers that create value.
• Incentives must be created for managers and
  employees to focus on the critical drivers that
  create value.
• The most direct way to persuade managers to act
  like shareholders is to increase their equity
  stake, putting a substantial portion of their
  personal net worth at risk in the process.

8
Conclusion

• Institutional investors, the driving force
  behind LBOs, should not write off the long term
  viability of the public corporation.
• What is needed is a governance system that
  provides effective monitoring of managers and
  imposes the necessary checks and balances.
• Large institutional investors can become directly
  involved in governance by having their nominees
  on the board.
• But a better way of monitoring managers is by
  using their collective influence to promote a
  governance process that holds managers and
  directors to a higher standard of accountability.

9
Conclusion (Cont..)

• Institutional shareholders can use their
  collective power to build a shareholder voting
  system that gives investors a stronger voice.
• But it could be wrong to lay too much emphasis on
  governance to facilitate the renewal of the
  public company.
• It is better to ensure that managers are
  motivated around the right performance measures.
• The major forces in the coming years will be the
  market for corporate control, more aggressive
  ownership incentives and compensation linked to
  shareholder value creation.