Performance evaluation: lessons learned in the private equity market.

• Author: Ferenbach, Carl
• Position: Putting In Place the Right Board for the 21st Century

THE INCREASED FOCUS on performance evaluation of boards and CEOs must be viewed as a positive development in corporate governance. In evaluating itself, the board should consider at least two factors: how it has managed its duty of care to the company's owners (it must be able to assure itself that proper controls exist to protect against improper, unethical, and illegal activities throughout the organization); and, the change in value of the firm. This change in value is most objectively measured annually, should employ public securities prices when available, and should compare financial performance and valuations to those of competitors and of similar companies.

The people who will have the most interest in these changes and who will ask the hardest questions about the underlying reasons will be owners who have investments that are meaningful to them. It, therefore, stands to reason that the boards that will become most involved in self-evaluation will be those whose members have investments that are significant to them.

In the private equity markets, participants have learned three lessons valuable to thinking about our duty of care and our role in creating value.

First, there are no excuses for poor investment performance that are acceptable to investors. It is not acceptable to complain about being misunderstood; or being subjected to short-term performance expectations when we all know the long-term plan will add value; or being victimized by an inefficient market. The market penalizes poor performance by withholding the capital the private equity investor needs to remain in business.

Second, because there are no acceptable excuses and because most private equity investors make significant personal financial commitments in the form of equity purchases in the company they are governing, there is no substitute for a complete, in-depth business analysis. It may consume meaningful amounts of time to complete this analysis, and it probably needs to be periodically updated, but one cannot govern effectively or self-evaluate without it.

Third, there is no substitute for common ownership amongst the board, the senior management and, often, the broad...