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Private Equity, Financial Development, and Corporate Governance Reform

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Private Equity and Financial Development in Latin America

Part of the book series: Latin American Political Economy ((LAPE))

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Abstract

This chapter presents the book’s main theoretical contributions. First, it frames the question about the origins of private equity markets within the broader literatures on financial development and corporate governance reform. Private equity provides firms with a distinctive source of financing that is otherwise elusive in the develo** world. It combines three characteristics: it is risky, institutional, and—at least relative to other financial investors—patient. Second, it contrasts rules-based arguments about capital market development centered on investor protections with the book’s more direct focus on institutional investors. Third, it discusses different hypotheses regarding the sources of corporate governance reform and presents a “quiet politics” approach centered on the role of industry associations. And fourth, it updates the literature on the role of the state in finance and characterizes a novel model for financial productive policymaking.

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Notes

  1. 1.

    For “external finance,” I refer to funds obtained outside—external—to the firm (e.g. bank loan, equity investor), not necessarily from external—foreign—countries.

  2. 2.

    See, for example, Fuller (2016), Jones Luong and Weinthal (2010), Post (2014), Taylor (2016), Wang (2015), and Yadav and Mukherjee (2016).

  3. 3.

    See King and Levine (1993), Levine et al. (2000), Beck et al. (2008), and Ayyagari et al. (2021). For a summary, see Levine (2005) and for a more recent evaluation of capital markets growth Laeven (2014).

  4. 4.

    For a comprehensive discussion of the multiple dimensions of financial development, see World’s Bank Global Financial Development framework (Cihak et al. 2012). Latin America has reasonable levels of access to financial services, at least given its level of development. But its financial markets, in particular the region’s equity markets, are significantly underdeveloped, see Heng et al. (2016).

  5. 5.

    Instead, there is some evidence that foreign bank entry limited firm and household access to finance. For example, Beck and Martinez Peria (2008) associate the increase of foreign banks participation in Mexico with a decline in bank’s outreach. Beck et al. (2018) show that foreign bank loans in Bolivia have shorter maturity than domestic bank loans (to the same group of firms) while relying more on collateral. Also see Mian (2006) and Gormley (2010). For a review of the literature on foreign banks, see Claessens and Van Horen (2014).

  6. 6.

    See, for example, for the Chilean case, Larrain and Urzúa (2016) and Donelli et al. (2013), who show that ownership structure for business groups in Chile, most of them family controlled, did not change while the economy liberalized extensively. In terms of capital structure, if any, these groups seem to have concentrated their ownership structure and increased leverage. In Brazil, Kayo et al. (2018) show that family-owned firms tend to be more leveraged than non-family firms.

  7. 7.

    The lack of atomized shareholders shifts corporate governance problem from a principal-agent to a principal-principal one. The key relationship is no longer the relationship between professional managers and dispersed shareholders but rather between controlling shareholders and minority shareholders (see, for example, Young et al. 2008).

  8. 8.

    For private equity, see how property rights affect the type of instrument used to make investments (Lerner and Schoar 2005), in Latin America, see Chong and Lopez-de-Silanes (2007) and Khoury et al. (2015).

  9. 9.

    Using individual-level survey data, Kerner (2018) shows that the expansion of the population who owns corporate securities through pension reforms did not increase support for pro-market reforms in Latin America and “neoliberalism,” against one of the possible mechanisms that could connect democracy and financial reforms.

  10. 10.

    Given the shorter time span of the book’s analysis, it could be argued some of the reforms still have to mature in order to observe changes in firm-level ownership structures and governance models: with time, ownership structures would gradually become more dispersed and institutional. But this is not in line with the evidence. While business groups in Latin America indeed appear to have professionalized their management, their ownership structure has remained mostly unchanged, even when the institutional conditions for change appear to be fulfilled. When looking at large “incumbent” companies in Chile during the last thirty years, Larrain and Urzúa (2016) find that rather than dispersing, owners—typically families—have concentrated their ownership stakes through debt financing. More “open” models of governance appear to come through new companies that have grown with PE financing rather than through the gradual reform of incumbent firms.

  11. 11.

    For reviews of this literature, see Aguilera and Jackson (2010) and Roe and Vatiero (2015).

  12. 12.

    Pagano and Volpin (2005) also propose a model—and provide evidence—about the relationship between proportional electoral systems, weaker investor protections, and more concentrated shareholdings.

  13. 13.

    Beyond just refraining from high-informality industries, a former executive from one of the largest PE funds in Brazil described me how they researched in detail which sectors/ industries government was tightening the enforcement of taxation and regulations to then deploy a “buy-and-build” investment strategy.

  14. 14.

    As mentioned, the number of listed companies in Latin American stock markets is quite small. Firms typically have a controlling shareholder, dual shares, and pyramidal structures. These features generate a gap between political and cash flow rights that incentivize controllers to expropriate minority shareholders (Dyck and Zingales 2004; Nenova 2003). From this perspective, and notwithstanding the agency problem between PE fund managers and institutional investors, private equity may have an advantage over domestic public equities.

  15. 15.

    For a more complete assessment of this debate, see Musacchio and Lazzarini’s (2014) Chapter 3. Also see Mazzucato and Penna (2016), Musacchio et al. (2015) and Yeyati et al. (2007).

  16. 16.

    For a theoretical discussion on the state’s role in finance, also see Mazzucato and Penna (2016).

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    Ignacio Puente

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Puente, I. (2022). Private Equity, Financial Development, and Corporate Governance Reform. In: Private Equity and Financial Development in Latin America. Latin American Political Economy. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-88983-8_2

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