The Public Corporation Is Finally in Eclipse


In his classic 1989 HBR article “Eclipse of the Public Corporation,” Michael Jensen analyzed early leveraged buyouts and identified a new form of corporate organization, the LBO association. He believed it would outperform the traditional public company thanks to “pay-for-performance compensation systems, substantial equity ownership by managers and directors, and contracts with owners and creditors that limit both cross-subsidization among business units and the waste of free cash flow.” To Jensen, the inherent advantages of this structure were so great that it was bound to become the standard. Yet here we are, 25 years later, and public corporations still dominate the business landscape. In a world supposedly changing at unprecedented speed, how can this be?

It’s certainly true that big changes can take a long time. It was in 1959 that Peter Drucker announced to the world that “knowledge workers” would eclipse manual workers to become the key human asset in modern business and that companies had better start learning the entirely different way they needed to be managed. He turned out to be right, but it took almost half a century for the eclipse to occur.

I believe that Jensen’s critique was valid. The weaknesses he saw in the public corporation in 1989 have only become more pronounced, what with the rise of predatory hedge funds, the growing power of equity analysts, and rapid turnover in the C-suite. More and more executives sacrifice the long-term prospects of their companies in order to meet the short-term expectations of the financial markets.

I think the delay in seeing Jensen’s future come to pass stems from a structural paradox embedded in the LBO model that he thought might replace the public corporation. LBO firms have traditionally obtained capital from limited partners on the promise of a return within five to seven years—and to provide that, they need to take their privatized acquisitions public again. They can hardly eclipse public corporations as long as they need a robust public market to make their own model work.

But LBO associations are not the only way to take a company private. Institutional investors are increasingly adopting private ownership of giant corporations as a strategy. An early case in point was the attempt by a group led by the Ontario Teachers’ Pension Plan to take Canada’s leading telecom provider, Bell Canada, private for $51.7 billion in 2007–2008. The fund wanted not to take the company public again but, rather, to own the asset privately for the long term.

Institutional investors are adopting private ownership of giant corporations as a strategy.

Although Bell’s bondholders blocked that deal, it set the stage for Berkshire Hathaway to take Burlington Northern private in 2009. This was not the first purchase by Warren Buffett of an entire company, but at $44 billion the total value of the deal was double that of his largest previous acquisition (General Re). And Buffett has no intention of returning Burlington to the public market for a profit. He wants to run it for its cash flow. In 2013 Buffett struck again, with a $28 billion privatization of H.J. Heinz, and soon afterward Michael Dell took Dell Inc. private in a $25 billion deal. Although these latter deals involved private equity partners, a return to the public realm was not the logic behind them.

So I believe that Jensen will indeed prove right, but on Drucker timing—50 years. Smart institutional investors will continue the trend, set by Buffett and Dell, of steering their investments away from public corporations, and by 2039 we will be wondering why we ever thought they were a superior form of business organization.

A version of this article appeared in the April 2014 issue of Harvard Business Review.


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