Oxford Saïd academic says $20 billion of hidden fees were charged by private equity firms

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Private equity firms have charged hidden fees amounting to $20 billion to companies, while some of the firm’s partners have sat on the company’s board of directors, according to a new study.

Saïd Business School

It was odd for us to read that it is quite common for board members to claim various expenses and consulting fees to a company that they supervise. We decided to have a close and systematic look into this.

Private equity firms have charged hidden fees amounting to $20 billion to companies, while some of the firm’s partners have sat on the company’s board of directors, according to a new study.

Dr Ludovic Phalippou, Associate Professor of Finance, Saïd Business School and his co-authors Dr Christian Rauch and Professor Dr Mark Umber, examined the portfolio fees of 592 US companies worth $1.1 trillion in total. In a new paper “Private Equity Portfolio Company Fees” they reveal that these companies paid a total of $20 billion to private equity firms over the last twenty years.

Dr Phalippou said the study raised questions about what these fees are for: ‘It was odd for us to read that it is quite common for board members to claim various expenses and consulting fees to a company that they supervise,’ he said. ‘We decided to have a close and systematic look into this.’

The paper found that the monitoring and transaction fees were not related to business cycles, credit cycles, or to company characteristics. When these fees became news and were subject to U.S. Securities and Exchange Commission (SEC) investigations, firms charging the least raised significantly more capital than they did before the financial crisis.

‘People speculated over the summer that these fees could be a tax evasion scheme,’ said Dr Phalippou. ‘But we are sceptical of this explanation because we found that half of the companies pay no corporate taxes, even before these fees are charged and the fees are not sensitive to the earnings before tax of a company.’

During the 2008 financial crisis the providers of capital complained about these fees and as a result many general partners (GPs) announced they would refund 100% of these fees going forward. However, the paper claims that even when a refund of 100% is mentioned, the effective refund may be less. There are restrictions and further complications in those calculations which effectively reduce the rebated amount. Even if these fees were to be 100% refunded to investors going forward, the paper shows that the amounts charged are economically relevant and significantly impact the finances of a large number of companies.

Accelerated monitoring fees have attracted the most regulatory and media attention. But the research shows that they are basically only charged by companies going public and at the time of the initial public offering (IPO). If monitoring fees are accepted practice, then it is difficult to see why a fee charged at the time of the IPO which covers the monitoring of the general partner would not be accepted, argue the researchers.

Dr Phalippou said: ‘From these findings the SEC may need to review their current approach. These practices are either legal or not. If they are deemed illegal then the SEC should target big offenders with large fines. Our results indicate that the GPs that the SEC seems to have targeted so far are more “big names” than “worst offenders.” Hopefully, this first paper to study portfolio company fees and management service agreements will catalyse further research and debate in this field.’

For more information or to speak to Dr Phalippou please contact the press office:

Jonaid Jilani, Press Officer, Saïd Business School
Tel: +44 (0)1865 614678, Mob: +44 (0)7860 259996
Email: jonaid.jilani(at)sbs.ox.ac.uk

Kate Richards, Press Officer, Saïd Business School
Tel: +44 (0)1865 288879, Mob: +44 (0)7711 000521
Email: kate.richards(at)sbs.ox.ac.uk

Notes to editors

1. About the research

The research looked at portfolio company fees charged between 1990 and 2014. It examined 25,000 pages of relevant SEC filings covering 1,044 GP investments in 592 Leverage Buy-Outs (LBOs) transactions, whose total enterprise values (TEVs), including add-on acquisitions, sum up to $1.1 trillion.

http://www.sbs.ox.ac.uk/faculty-research/privateequity/private-equity-portfolio-company-fees

2. About the authors

Dr Ludovic Phalippou, Associate Professor of Finance at Oxford Saïd.
http://www.sbs.ox.ac.uk/community/people/ludovic-phalippou

Dr Christian Rauch,Barclays Career Development Fellow in Entrepreneurial Finance at Oxford Saïd. http://www.sbs.ox.ac.uk/community/people/dr-christian-rauch

Professor. Dr. Mark Umber, Assistant Professor of Corporate Finance, Frankfurt University.
http://www.frankfurt-school.de/content/en/who_we_are/staff/umber.html
3. About Saïd Business School

Saïd Business School at the University of Oxford blends the best of new and old. We are a vibrant and innovative business school, but yet deeply embedded in an 800 year old world-class university. We create programmes and ideas that have global impact. We educate people for successful business careers, and as a community seek to tackle world-scale problems. We deliver cutting-edge programmes and ground-breaking research that transform individuals, organisations, business practice, and society. We seek to be a world-class business school community, embedded in a world-class University, tackling world-scale problems.

In the Financial Times European Business School ranking (Dec 2014) Oxford Saïd is ranked 10th. It is ranked 10th worldwide in the FT’s combined ranking of Executive Education programmes (May 2015) and 22nd in the world in the FT ranking of MBA programmes (Jan 2015). The MBA is ranked 7th in Businessweek’s full time MBA ranking outside the USA (Nov 2014) and is ranked 5th among the top non-US Business Schools by Forbes magazine (Sep 2013). The Executive MBA is ranked 2nd worldwide in the Economist’s Executive MBA ranking (Sep 2015) and 9th worldwide in the FT’s ranking of EMBAs (Oct 2015). The Oxford MSc in Financial Economics is ranked 14th in the world in the FT ranking of Masters in Finance programmes (Jun 2015). In the UK university league tables it is ranked first of all UK universities for undergraduate business and management in The Guardian (Jun 2015) and 2nd in The Times (Sept 2015). For more information, see http://www.sbs.ox.ac.uk/

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Jonaid Jilani
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