LBOs: questions for the board; Directors have some explaining to do about all these public companies going private.

• Author: Bruner, Robert F.
• Position: BIG DEAL

LEVERAGED BUYOUTS are booming again. While the improved performance of companies that have gone private commends this wave of activity, it leaves unanswered one enduring and important question: Why can't CEOs of these firms simply deliver this improvement for public investors?

The answers are as troubling as they are unsatisfying, not least for corporate directors and the private equity industry itself.

There is a small mountain of evidence that private equity investing and LBOs in particular, "pay"--in the sense of enhanced economic efficiency and large risk-adjusted returns. Cash flows increase, asset utilization rises, returns rise. Some have feared that these gains derive from cuts in advertising, maintenance, capital spending, or R & D, but the research does not support this. Kiss a private equity investor today: Our economy is better off as a result of this improvement in efficiency.

In the context of 2006's heady activity--$360 billion in going-private transactions, according to Dealogic, as I write in late November--the big question assumes some urgency. Here's a sampling of the rationale.

* Escape: CEOs decry the short-term focus on quarterly earnings imposed by public markets and regulatory burdens. Going private liberates the CEO to focus on longer-term issues and to undertake difficult restructurings without the intrusions of public investors. Yet we have prominent examples of firms that remain public but refuse to play the quarterly earnings game (Berkshire Hathaway and Progressive Insurance) and that undertake major restructurings while in the public eye (Ford and GM). Why not restructure the firm first, then take it private?

Even if it is easier to restructure as a private firm, who should harvest the benefits of this convenience? At present, the benefits of these transactions substantially flow to the entrepreneurial risk-taker--the private equity investor and the CEO of the gone-private firm. Perhaps this is correct: Let the person with special skill or insight harvest the benefit from his or her special assets in the market. But before the public firm goes private, who owns the special skill and insight of the CEO? There is no escaping the ownership by the public shareholder.

* Skills of Private Equity: Much is made of the skills of KKR and other successful private equity investors--they have the secret recipe that converts the sagging mature firm into a veritable Schwarzenegger. Thus it is argued that firms need to go...