BOSTON - As private equity becomes an increasingly larger part of its asset allocation pie, the Massachusetts Pensions Reserves Investment Management Board is taking a closer look at the governance structure of private companies in which it invests.
State Treasurer Shannon O'Brien, who chairs the PRIM Board, introduced a policy last week that requires general partners to encourage portfolio companies at the initial public offering stage to adopt sound governance structures. "It should be a lot easier to teach the companies good behavior while they're young and dependent, before they grow up and take their place in the public securities market," said Ms. O'Brien.
Massachusetts PRIM's private equity governance initiative is one of the first among pension funds.
Last May, the $171 billion California Public Employees' Retirement System, Sacramento, adopted alternative investments guidelines for direct investments that included the quality of corporate governance.
In June, the $5 billion New Hampshire Retirement System, Concord, began issuing side letters with new general partners encouraging them to make their "best efforts" to make IPO-stage portfolio companies adopt best corporate governance practices.
Richard Bennett, corporate governance director at Lens Asset Management LLC, Portland, Maine, said the initiative makes sense. "These are fledgling companies and most of them have plans for an IPO, so it's best to get these expectations in place early," he added.
Particularly now that the "luster" is off some of the dot-com companies, corporate governance becomes more important before companies go public, said Mr. Bennett. He believes it's important for shareholders as well as the individual companies to have guidelines in place to protect themselves from the downside.
"No one cares about corporate governance when the company is performing well," said Mr. Bennett, "but it's in times when companies are extremely challenged that it's beneficial to have these systems in place."
Peg O'Hara, managing director at the Council of Institutional Investors, Washington, said the focus on corporate governance at the private equity level could be the next step for some pension funds. Institutional investors' governance attention has been focused primarily on large-cap companies; but in recent years, she said, investors have started to look at the governance of midcap and small-cap public firms. "This is just another outgrowth of that," said Ms. O'Hara.
Moves like Mass PRIM's probably won't become widespread, though. Larger pension funds might be able to pull it off, but that might not be the case for smaller pension funds that don't have the same clout, Ms. O'Hara said.
Scott Henderson, executive director at Mass PRIM, developed the initiative along with Ms. O'Brien. "There is a real difference in the amount of attention that is paid to good governance on the public side vs. the private equity side," said Mr. Henderson. He said the idea bridges the gap between being a private equity investor and a public securities investor. "We want to take that same level of scrutiny and apply it to the venture side or the LBO side."
He approached Ms. O'Brien about the concept and wanted to come up with an initiative that would promote good governance at private companies.
"If you accept the premise that good governance pays off in the long run in terms of shareholder value, then whatever we can do at an early stage to get new companies to adopt good governance ought to be in our interest," said Mr. Henderson.
The governance policies that would apply are the same policies that adhere to public companies as outlined by the Council of Institutional Investors, said Mr., Henderson.
He said the idea is not to draft an onerous provision in a partnership agreement. With its existing partners, the PRIM Board would encourage them to urge their portfolio companies, particularly those at the IPO stage, to follow these policies. With new partnerships, Mr. Henderson he would like to see the wording included in a side letter.
The PRIM board oversees the $32 billion Pension Reserves Investment Management Trust, which has about 6%, or $2 billion, invested in private equity firms.
Mr. Henderson said the general partners he spoke with were receptive to the idea. "We were looking for something that is very much not antagonistic to the general partner community," said Mr. Henderson. The purpose is to seek good governance at the IPO stage, he said.
Mario Giannini, president of Hamilton Lane Advisors Inc., a Bala Cynwyd, Pa.-based private equity consultant, doesn't think a policy that encourages corporate governance would be a problem with general partners. Still, "there may be situations where there are good reasons not to do something that is on the list of corporate governance practices," said Mr. Giannini. "You have to make sure you don't interfere with the general partner being able to do what it thinks it needs to do."
