Private Equity’s Accountability Deficit: The Case for Mandatory Disclosure

Private equity is now a major driver of U.S. economic activity and has transformed entire industries. And yet, as the sector’s assets under management have skyrocketed, traditional mechanisms for accountability have eroded. In particular, the near-term exit of a portfolio company via an IPO or an arm’s-length sale to another company has become increasingly rare. Thus far, scholars have focused on this development as presenting risks for private equity fund investors. We share their concern, particularly as private equity seeks to capture retirement dollars from ordinary investors, although our focus is different. Instead, our Article describes the threat to the U.S. economy and efficient capital allocation when private equity sponsors face minimal external discipline.

In support of our thesis, we present an empirical study of private equity transactions over the past two decades that shows that portfolio company holding periods have lengthened and the verifiability of exit realizations has deteriorated. When sales occur at all, they are increasingly made to other members of the private sponsor community or via self-sales through continuation funds, where the back-scratching incentives are high. We further show that other sources of accountability—including internally-generated measures of performance and performance-based compensation—are either biased or eroding.  

Without accountability, the private equity sector risks significant resource misallocation, akin to an earlier era where management teams built large and inefficient conglomerates that contributed to slow economic growth. It also creates systemic risk in the form of a self-inflating bubble, whereby sponsors can maintain artificially high portfolio valuations via conflicted sales and opaque valuations. This burgeoning form of risk is greatly exacerbated by the inclusion of retail capital and requires a rethinking of the regulatory landscape for private equity. Accountability depends on investors having the ability to assess the comparative performance of private equity sponsors and their portfolio companies. We therefore propose mandatory annual disclosure of financial and operating results of “significant” private equity portfolio companies. Because sponsors typically collect and provide such information to the creditors that finance initial acquisitions, a mandatory disclosure regime should not unduly burden the industry. Such a regulatory change could be adopted without new legislation, pursuant to existing SEC regulatory authority, or could be made a condition for a fund’s inclusion in a menu provided by a “prudent” ERISA trustee.  By mitigating the risk of inefficient resource allocation, such disclosure would protect not only investors but also the U.S. economy.