Despite the economic significance of private equity (PE) firms, there has been limited investigation into the control mechanisms they implement to manage relationships with their portfolio companies. Through a comparative field study, we describe the role and characteristics of controls implemented by PE firms and the contextual factors associated with the relative importance of different control mechanisms. Evidence shows that control mechanisms play an important role in directing the actions of portfolio companies and that there is significant variation between PE firms in terms of the combination of contractual provisions, performance measurement and incentives, rules and procedures, and social interaction and trust that are relied upon. We find that the primary factors associated with the choice of control combinations are 1) whether or not the PE firm has a controlling interest in the portfolio company and 2) whether the portfolio company is managed by an entrepreneur or professional manager. We derive a framework of four control combinations that are aligned to variations in these two factors.
This paper is co-authored by David S. Bedford (University of Technology Sydney), and Angelo Ditillo (Bocconi University – Department of Accounting; SDA Bocconi), and forthcoming at the European Accounting Review.