The Agency Costs of Multi-Product Private Equity Suites: Towards a Post-Jensenian Paradigm

Abstract

In 1989, the late Professor Michael C. Jensen predicted the eclipse of the public corporation at the hands of the U.S. private equity sector. In so doing, Jensen provided what was, and largely still is today, the dominant intellectual rationalization of private equity as a market-institutional phenomenon. In essence, Jensen presented private equity buyouts as a golden bullet for the so-called agency costs problem in widely held companies, which he had first expounded over a
decade earlier in his landmark 1976 article on the topic co-authored with William Meckling. Although private equity buyouts did not initially figure in this institutional landscape, Jensen succeeded in slotting them into the conceptual frame a decade later in two epochal articles where he presented them as a revolutionizing positive force in corporate finance and governance. However, over the course of the succeeding three and a half decades, the private equity sector has changed almost beyond recognition. Consequently, a world which in the 1980s was heavily U.S.-centric and characterized by relatively small-scale, boutique finance firms has morphed into a globalized arena dominated by very large, multidivisional and bureaucratically complex financial conglomerates, which are largely indistinguishable from their more established investment banking and financial-accounting counterparts. Notwithstanding these seismic contextual changes, the Jensenian model of private equity, together with its now-simplistic focus on mitigating owner-manager agency costs, remains the central theoretical paradigm through which private equity buyouts are understood within law and finance scholarship. Accordingly, in this article, we posit that a critical reappraisal of the continuing descriptive relevance of the Jensenian theory of private equity is now long overdue.