It’s spring and a young man’s fancy turns to joining a private equity consortium to take over one of Canada’s most blue chip public market institutions. It seems that just about every pension fund in the country is salivating at the thought of the potential returns(and fees)associated with the possible privatization of BCE.
The potential transaction raises several interesting public policy issues. Should CPPIB be the preferred suitor since it holds investments for all Canadians(rather than the mere 200,000 or so represented by each of the other plans)thus fully diversifying the potential ownership? Should all pension funds be encouraged to join the same consortium thus reducing the bid competition and guaranteeing an attractive return for the pension funds’ beneficiaries(and ultimately benefiting taxpayers)even though this implies that the current BCE shareholders may not be fairly compensated for their investment?
But what are the factors arguing in favour of the involvement of public sector pension funds in the privatization of corporate Canada?
One argument is governance. While the public market corporate boards are sometimes assumed to be sleepy hollows, populated by cronies of the CEO who shun from asking the embarrassing questions(or who sign off on non-compete payments without noticing the fine print), the pension fund private equity teams overseeing the investments are assumed to be independent and autonomous, focused purely on encouraging sensible business decisions so as to deliver attractive investment returns. Private equity owners also have the luxury of being able to hand pick management teams, without pesky external review of compensation practices.
The flaw with this argument is that the pension fund boards have their own political challenges and could just as easily be caught up in conflicts of interest or distracted from pure business outcomes as the corporate boards. Although private equity has delivered superior returns to pension funds in the past, it may be argued that this reflects the higher risk in these(start-up)businesses and not superior governance.
Another argument in favour of pension fund ownership is that pension funds have a long-term horizon, whose vision extends beyond the next release date for quarterly earnings. They can afford to be contrarian investors, the so-called Nile crocodile who only needs to catch a wildebeest at the watering hole every 40 years or so.
While public sector pension funds should indeed have a long-term horizon, the truth is that an emphasis on hedge fund strategies and the pursuit of “alpha” encourages short-term thinking. The trend towards frequent market valuation of both assets and liabilities(on the assumption that markets are efficient on a day-by-day basis)removes the economic perspective of a long-term investor. For many pension funds, “long-term” incentive compensation design covers only a three-year period. Some of the private equity teams in question have not been together long enough to claim a long-term performance record. Thus the jury is still out on the time horizon argument.
Pension funds that can claim a strong governance model and a true long-term horizon could be ideal as stalwart owners of this country’s core strategic businesses. In fact this could be Canada’s best defence against the growing trend towards foreign ownership of our national resources, without needing to recourse to protectionist legislation! However, unless these conditions are met, it could simply be a case of “out of the frying pan, into the fire”, with no value being created other than in the pockets of the dealers.