Agency Problems in Public Firms

The following post comes to us from Jesse Edgerton, an economist at the Board of Governors of the Federal Reserve in Washington, D.C. The paper and post express his views only and not necessarily those of the Federal Reserve Board or its staff.

The extent of agency problems in publicly traded firms and the need for reform of executive compensation remain the subject of active debate. In the paper, Agency Problems in Public Firms: Evidence from Corporate Jets in Leveraged Buyouts, recently made available on SSRN, I bring new evidence to this debate by measuring a particular kind of firm behavior where there is potential for managerial abuse—the use of corporate jets.

Motivated by a large literature that finds improvements in efficiency and performance when firms are purchased by a private equity (PE) fund in a leveraged buyout (LBO), I use novel data to compare the fleets of jets operated by publicly traded and privately held firms. In the cross-section of firms from 2008, I find that PE-owned firms average about 40% smaller jet fleets than publicly traded firms, even after controlling for firm size, industry, and location in a variety of flexible ways. One could still worry, however, that these cross-sectional differences do not represent a causal effect of PE ownership due to omitted variables or other factors. Thus, I also measure changes in jet fleets within firms that are taken from public to private by a PE fund in an LBO between 1992 and 2007, and I find fleet reductions of a similar magnitude. Of course, the selection of firms into PE-ownership is not random, and I discuss assumptions under which these comparisons across and within firms provide estimates of lower and upper bounds on the average treatment effect of taking a firm from public to private in an LBO.

To provide further insight on the nature of the agency problems driving these results at the mean, I describe the cross-sectional distributions of jet fleets in public and private firms using quantile regressions. Results indicate that effects of PE ownership on average jet fleets are driven by firms in the top 30% of the conditional jet fleet distribution. That is, roughly 70% of public firms have jet fleets comparable to observably similar PE-owned firms.

The evidence thus suggests that executives in a substantial minority of public firms enjoy more generous perquisites than they would if subject to the pressures of private equity ownership. That is, the kind of agency problems that manifest themselves in large jet fleets are far from ubiquitous in public firms. Neither, however, are they limited to a very small number of “bad apples.”

The full paper is available for download here.

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