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Chapter 8: Problem 12

Private equity firms, such as Blackstone and Kohlberg Kravis Roberts \& Co., search for firms where the managers appear not to be maximizing profits. A private equity firm can buy stock in these firms and have its employees elected to the firms' boards of directors and may even acquire control of the targeted firm and replace the top management. Does the existence of private equity firms reduce any problems in corporate governance? Briefly explain.

Short Answer

Expert verified
Yes, the existence of private equity firms can reduce problems in corporate governance. They can do so by aligning the interests of the management with the shareholders, steering firms towards optimal profitability, efficiency, and balanced decision-making, ultimately helping to rectify corporate governance issues.

Step by step solution

01

Understanding Corporate Governance

Corporate governance is essentially the system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community.
02

Role of Private Equity Firms

Private equity firms are investment management companies that provide financial backing and make investments in the private equity of startup or operating companies. As described in the exercise, these firms can buy stock in other firms that are not maximizing profits. They can place their employees on the firm's board of directors, essentially giving them a say in the firm's decisions. In extreme cases, they can acquire control of the firm and replace top management.
03

Impact on Corporate Governance

By assuming control or influencing decision-making in firms that are not maximizing profits, private equity firms can essentially steer these companies towards better profitability and efficiency. This can rectify problems in corporate governance where, for example, management's decisions may not be aligning with shareholder interests. Therefore, private equity firms can indeed mitigate some issues in corporate governance.

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