Private Equity Minority Investments - Universität St.Gallen

Chapter II: Theoretical Foundationsrelationship are applied in a somewhat different context: to the majorityminority-shareholderrelationship in a closely held company. In thiscontext, instead of external managers, the controlling shareholder is in aposition to determine the quantity and quality of information that theminority investor receives. Moreover, the controlling shareholder de factoselects the minority investor, and may also determine the minorityinvestor’s exit (e.g., through call options or drag-along rights 359 ). Withinsufficient insight into corporate matters and little de facto control, theminority investor is neither able to effectively monitor and partake incorporate decision making, nor to perform an advisory role. De jure, theminority investor may participate in voting and elections at a shareholders’general meeting without, however, having any de facto say. The minorityinvestor’s function is largely confined to providing financing. Themanagerial hegemony theory describes a vivid scenario of the minorityinvestor’s de jure, but not de facto participation if his/her bargaining powerex ante is not used to negotiate for enhanced voice and access toinformation. This situation may be acceptable to purely passive financialminority investors, but hardly will it be acceptable to active PEMIs who donot want to defer to the majority shareholders or be at their mercy.The question arises then as to what strategies and tools the managerialhegemony theory assumes the PEMI can use to play a greater role incorporate decision making. Like the agency theory, the managerialhegemony theory emphasizes the importance of implementing an effectivedisclosure system with clear guidelines, standards, and procedures thatallow the minority shareholder to gain broad and deep knowledge aboutcorporate affairs. Secondly, the theory suggests that in order to play anactive role in corporate affairs, sitting on the board of directors may not besufficient to enable active participation in and guidance of the firm whichrequires more presence in the firm so as to intelligently contribute to majordecision making. Hence, the theory suggests that the PEMI must not onlyseek effective mechanisms to monitor and control the controllingshareholder, but equally focus on the third-party managers. The theoryprovides an explanation for why minority investors seek to influence theappointment of management personnel (e.g., via contractual agreements)and critical management decisions (e.g., via veto rights).3.3 LimitationsCritics of the managerial hegemony theory point to the problems ofobtaining access to board of directors to conduct research and of separating359For the term, see Section VI.A.2.1 and 2.2.69