Paper: "Agency Problems in Public Firms: Evidence from Corporate Jets in Leveraged Buyouts"

I was just reading a paper by a Federal Reserve economist, "Agency Problems in Public Firms: Evidence from Corporate Jets in Leveraged Buyouts". A welcome relief, as I have thought enough about macroeconomics now for one lifetime. From the abstract:

"This paper uses rich, new data to examine the fleets of corporate jets operated by both publicly traded and privately held firms. In the cross-section, firms owned by private equity funds average jet fleets at least 40% smaller than observably similar publicly-traded firms. Similar fleet reductions are observed within firms that go private in leveraged buyouts. [...] Results thus suggest 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."

One of the big problems in corporate governance and in politics is the difficulty of motivating one party to act on behalf of another: the principal-agent problem. The question at public companies is, are the jets saving the executives’ valuable time and functioning as an efficient form of compensation, or are executives overusing corporate aircraft because shareholders are unable to monitor the executives effectively?

There is empirical evidence that private equity portfolio companies create economic value by operating more efficiently, so this author (Jesse Edgerton) interprets the private equity portfolio companies' jet fleets as a benchmark of efficiency against which to compare the fleets of public firms. [A classic example of private equity operating a company more efficiently is the story of RJR Nabisco, which was taken private in a leveraged buyout in 1988.]

The paper finds that:

"In a sample of all public and private U.S. firms with 2008 sales greater than one billion dollars... PE-owned firms operate significantly smaller jet fleets, even when controlling for size, industry, and location in a variety of flexible ways. Estimates suggest that PE-owned firms are at least 25 percent less likely to operate a jet. Conditional on operating at least one jet, they have smaller fleets as measured by total passenger seating capacity. Overall, PE-owned firms average a ratio of jet seats to firm sales more than 40 percent lower than observably similar public firms."

He also examined the changes in jet fleets within a panel of 69 buyouts of large, standalone public firms that were taken private between 1992 and 2008, and found that:

"buyout targets are about 32% less likely to have a jet in the three years after their LBO than in the year before, even after controlling for changes in firm size following the buyout. Their average seats-to-sales ratio falls by more than 40% over the same period."

So, it seems pretty clear that executives at public companies waste money on corporate jets. Public ownership leads to agency problems, especially when the companies are owned by retail investors or by long-only mutual funds that are asleep at the switch because they have hundreds of positions. This is the problem that activist hedge funds have been invented to solve.