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What Is the Impact of Private Equity Buyout Fund Ownership on IPO

Companies’ Corporate Governance? June 2009

Authors: Annalisa Barrett, Senior Research Associate; Paul Hodgson, Senior Research Associate; Beth Young, Senior Research Associate; Ric Marshall, Chief Analyst; Kimberly Gladman, Director of Research and Ratings; Michelle Lamb, Research Associate Data Analysis and Research Support: Melanie Allen, Greg Ruel, Cheri Grimmett, Sasha Pagella, Damion Rallis, Lauren Warmington

The Corporate Library | 56 Northport Drive | Portland, Maine 04103 www.thecorporatelibrary.com

This report is for educational purposes. It was prepared by The Corporate Library Inc., under contract for the IRRC Institute. Whilst appropriate care has been taken by The Corporate Library in compiling this report, neither The Corporate Library nor the IRRC Institute accept any liability whatsoever for any loss (including without limitation direct or indirect loss and any loss of profit, data, or economic loss) occasioned to any person nor for any damage, cost, claim or expense arising from any reliance on this report or any of its content (save only to the extent that the same may not be in law excluded) Information contained in this report has been obtained from sources believed to be reliable, but is subject to change. No representations or warranties are made as to the accuracy of the information presented, and no responsibility or liability, including for consequential or incidental damages, can be accepted for any errors, omissions or inaccuracies in this report. Nothing in this report should be deemed a recommendation or offer to purchase or sell any security.

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TABLE OF CONTENTS

EXECUTIVE SUMMARY .............................................................................................................................. 3

INTRODUCTION........................................................................................................................................... 4

METHODOLOGY AND STUDY OUTLINE ..................................................................................................7

OWNERSHIP ................................................................................................................................................ 9

Summary Findings ...............................................................................................................................................9

Discussion .............................................................................................................................................................9

BOARDS OF DIRECTORS ........................................................................................................................ 19

Summary Findings .............................................................................................................................................19

Discussion ...........................................................................................................................................................19

RELATED PARTY TRANSACTIONS ........................................................................................................ 28


Discussion ...........................................................................................................................................................28

TAKEOVER DEFENSES............................................................................................................................ 36


Discussion ...........................................................................................................................................................36

COMPENSATION—POLICY ANALYSIS .................................................................................................. 44

Methodology ........................................................................................................................................................44


Discussion ...........................................................................................................................................................45

Larger policy sample........................................................................................................................................45

Matched Pairs Analysis – Compensation Policies ......................................................................................50

COMPENSATION—QUANTITATIVE ANALYSIS ..................................................................................... 52

Methodology ........................................................................................................................................................52


Discussion ...........................................................................................................................................................53

CONCLUSIONS AND RECOMMENDATIONS.......................................................................................... 64

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EXECUTIVE SUMMARY

It is often argued that companies taken public by private equity firms avoid many aspects of the classic agency problem of the dispersely-owned corporation—that is, the conflicts of interest between executives and investors that arise from the separation of ownership and control of a company. Private equity firms claim to prevent these conflicts through a number of corporate governance mechanisms that closely align management interests with those of shareholders. The present study assesses this claim in the particular context of private equity buyout funds, by examining the ownership, board characteristics, takeover defenses and compensation policies of a representative sample of buyout-fund-backed initial public offerings occurring in the United States during 2004-2006.

The analysis does not support the private equity claim to superior corporate governance as the companies enter the public markets. On the contrary, it indicates that buyout-fund-backed companies exhibit, in a higher proportion than average, a number of features that have the potential to benefit executives at the expense of shareholders, including takeover defenses and boards whose independence may be compromised. In addition, the often-made assertion that private equity firms design compensation packages well suited to link pay to performance is not supported by this study. The companies lacked the key compensation structures that are widely believed to link pay to performance. We did not, however, study either operational performance or stock price performance during the course of this analysis, and are making no claims about the actual performance of companies with these structures.

While this study was not designed to investigate the reason for these differences between buyout-fund-backed companies and their non-PE-backed peers, previous researchers have speculated that buyout funds may be incentivized to protect the management of the firms they take public, in order to preserve their access to future deals. The evidence gathered here may lend support to this theory. At least in the initial years following an initial public offering (IPO), the governance features of many buyout-fund-backed companies may be more likely to reward executives for past service than to motivate them to future achievement.

Finally, the research presented here suggests that institutional investors with holdings both in private equity funds and in initial public offerings should use their influence to encourage private equity funds to improve their approach to governance in the companies they take public, ensuring that they more closely align management interests with those of all shareholders.

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INTRODUCTION

Over the past several years, buyouts (i.e.deals in which mature public companies are taken private by one or more private equity funds) have assumed greater importance in the mergers and acquisitions landscape. They accounted for 22% and 20% of global announced mergers and acquisitions deal volume in 2006 and 2007—both record years for M&A deal volume—up from only 4% in 2000.1 In 2007, more than half of IPOs had private equity firm sponsors.2

Although few buyouts have occurred recently as a result of the tighter credit market,3 buyouts will not be disappearing from the landscape altogether. Fundraising in the last quarter of 2008 fell sharply from the previous quarter; however, fundraising had been robust throughout late 2007 and much of 2008 despite the credit crisis.4 According to management consultant Bain & Co., as of May 2009, private equity funds had $1 trillion in uninvested, but committed, equity capital.5 Thus, while the number and size of buyouts may not soon reach the levels seen in 2006 and 2007, when Equity Office Properties Trust and hospital operator HCA went private, buyout funds should not be counted out.

Many academics and practitioners have argued that the success of buyouts stems at least in part from a more effective corporate governance structure implemented after a company goes private. Most obviously, ownership changes from a dispersed base of public shareholders, none of which may have adequate incentives to participate fully in governance, to a small number of buyout funds whose own success (and compensation) depends on the returns provided by their investments and which are thus highly motivated to maximize value. The board of directors, according to this perspective, is smaller, better informed and more engaged than a public company board and compensation is marked by much higher levels of pay/performance sensitivity, with equity ownership by management aligning the interests of management and the firm’s equity owners.6

Many companies purchased by buyout firms eventually re-enter the public markets through an initial public offering (IPO). In 2006, 43% of operating company IPOs were backed by private equity firms. Moreover, they were generally the larger IPOs, accounting for 55% of IPO proceeds.7 Indeed, the IPO exit may become more popular if credit markets remain constrained, making secondary buyouts (sales to other private equity firms) more difficult.8

When a portfolio company completes an IPO, the buyout fund sponsor usually does not dispose of its entire investment in the offering; instead, it retains an equity stake, which diminishes over time. From time to time, criticism has been leveled at buyout funds’ retention of what some see as disproportionate influence in a company’s governance structure after an IPO. For example, sponsors of a “vote no” campaign against directors at Safeway in 2004 objected to the presence on Safeway’s board of four directors affiliated with buyout sponsor KKR, which owned only 9% of Safeway’s shares, as well as the existence of related party transactions involving KKR.9 (Our analysis has also investigated patterns of buyout fund influence and related party transactions, which will be discussed in several sections of our study below.)

More broadly, some institutional investors have complained that companies brought public by private equity firms enter the public markets with governance features (generally takeover defenses) that are less friendly to public shareholders—as measured by institutions’ proxy voting guidelines—than companies not backed by private equity funds. The members of the Council of Institutional Investors (CII), an association of pension funds with over $3 trillion in assets under management, approved an addition to CII’s Corporate Governance Policies stating that “consistent with their fiduciary obligations to their limited partners, the general members of venture capital, buyout and other private equity funds should use appropriate efforts to encourage companies in which they invest to adopt long-term corporate governance

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provisions that are consistent with the Council’s policies.”10 CII’s policies, which are oriented toward public companies, disfavor takeover defenses, advocate for increased shareholder power over board elections (e.g., declassified boards, majority vote threshold for director election, proxy access) and promote transparency and dialogue between boards and shareholders, among other things.11

CII’s policy was adopted following a speech by Massachusetts Treasurer Shannon O’Brien at CII’s fall 2000 meeting in which she asserted that IPO companies backed by private equity had more provisions that are “harmful to shareholder interests”—specifically, takeover defenses—than IPO companies without such backers and exhorted other CII members to “educate” private equity general partners about the “benefits of good governance.”12 To that end, CII provided a model letter for its members to send to private equity general partners noting that institutional investors that expend significant resources trying to improve public company governance are also significant investors in private equity funds and supplied model language for fund limited partnership agreements obligating general partners to use “reasonable efforts” to “encourage” portfolio companies to adopt governance structures consistent with CII’s governance policies.13

Several studies have examined certain governance features of IPO companies with private equity or specifically buyout fund sponsorship to determine the extent to which governance structures indeed differ between these companies and companies without private equity or buyout fund sponsorship. The features discussed above that are typical of private company governance, such as small, engaged boards and high pay/performance sensitivity, can be adopted by public as well as private companies; the only structure for which this is not the case is the concentrated private ownership itself. Accordingly, one might expect private-equity sponsors—given their own performance-based compensation and retained equity stakes—to ensure that their companies retain at least some of these features that are believed to add value even through and following an IPO. This impulse, however, might be outweighed by the expectations of institutional investors for public companies, including best practices related to board independence and dilution from equity compensation plans.

A 1996 unpublished study by Robert Gertner and Steven Kaplan compared board characteristics of 59 companies that had been purchased by a buyout sponsor and then taken public again, a process called reverse-leveraged-buyout (reverse-LBO), between 1987 and 1993 and a group of non-reverse-LBO IPO companies matched for size and industry.14 To be included in the reverse-LBO group, the financial sponsor needed to retain an ownership stake after the IPO. The authors found that the reverse-LBO companies’ boards were smaller, owned more equity and met less frequently. The directors on reverse-LBO company boards were younger, had served for shorter time periods, were less likely to be women and were at least as likely to serve on other boards.15

A very recent study by Jerry Cao examined post-IPO ownership by buyout sponsors and insiders of reverse-LBO companies taken public from 1981 through 2006. He also studied the performance and basic board characteristics of reverse-LBO companies using industry-matched comparison IPO firms, industry-matched mature firms and year-matched LBOs.16 His ownership and governance analysis was limited to a sub-sample of reverse LBOs from 1995 through 2003. Cao found that buyout sponsors, on average, went from 60% equity ownership before the IPO to 40% immediately following the IPO. The sponsors’ ownership diminished to an average of 24% three years after the IPO. Insider ownership went from 54% before the IPO to 34% after it.17

Cao found that buyout sponsors’ ownership interest and their “board” share were highly correlated; in other words, the degree to which the sponsors controlled the board closely tracked their ownership stake, in the aggregate. Cao’s statistics showed, however, that on average the buyout sponsors retained control

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over compensation and nominating committees disproportionate to their ownership stakes.18 Reverse-LBO boards were small, averaging eight members.19

Takeover defenses—devices such as shareholder rights plans or “poison pills” and structures such as classified boards, limitations on director removal and replacement, and restrictions on shareholders’ ability to amend bylaws that impede accomplishment of a hostile takeover—have not been central to the narrative around buyout company governance. The use of takeover defenses at public companies has been widely criticized by institutional investors on the ground that they allow the board unilaterally to preclude a takeover that shareholders view as value-maximizing. Such defenses are unnecessary, however, in a private firm and are arguably less necessary at public companies with concentrated ownership and direct investor representation on the board.

A 2003 study by Michael Klausner assessed the extent to which companies with private equity or buyout fund sponsorship that went public between 1988 and 1999 were more likely to have certain charter-based takeover defenses than IPO companies in that period without private equity backing.20 Specifically, Klausner found that for 1993 through 1997 (data for other years were not available for this data point), 47.2% of IPO companies with buyout fund sponsorship went public with a classified board, compared with 43.4% of IPO companies backed by venture capital firms and 40.7% of companies not backed by buyout or venture capital firms.21 Similarly, at 33.2% of reverse-LBO companies, shareholders did not have the right to call a special meeting or act by written consent, while shareholders lacked those rights at just 23.6% of venture-capital-backed IPO companies and 15.9% of companies not backed by venture capital or buyout firms.22

Klausner observed that it might appear surprising that private equity firms would include takeover defenses in IPO companies’ charters, despite evidence that they reduce firm value (and thus could erode returns if that reduction in value were reflected in a lower IPO sale price). He theorized that this might be because in order to ensure continued access to deals, buyout firms need to maintain positive relationships with corporate managers, who choose which firm will take them private (and eventually public again). Tolerating takeover defenses that protect pre-existing management after an IPO could be a way for the firms to maintain reputations for working well with company managers.23

In sum, previous research has suggested that buyout-fund-backed IPO companies may have somewhat smaller boards, stronger takeover defenses, more concentrated ownership and more board-level influence by major owners than do IPO companies in general. However, no clear consensus has emerged on whether or not buyout fund backing can be said to promote good corporate governance, if the latter is defined as serving the interests of investors at large.

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METHODOLOGY AND STUDY OUTLINE

The present study seeks to further explore the impact of buyout fund backing and private equity fund backing in general on general shareholder interests by examining a number of aspects of corporate governance at buyout-fund-backed IPOs, and by studying each of these aspects in a different way than has been done previously.

Our study is based on a sample of 90 companies that went public during 2004-2006, 48 of which were backed by private equity buyout firms and 42 of which were not backed by private equity sponsors of any kind. It should be noted that the sample excludes IPO companies backed by venture capital (VC) firms, because the characteristics of such companies are likely to be very different from those brought public by buyout funds. In general, VC firms provide funding to companies in early stages of their development, and the money they provide is used as working capital for the firm. Buyout firms, in contrast, work with mature companies, and the funds they provide are used to compensate the firm’s existing owners. Often, buyout funds take public companies private, restructure them, and then take them public again. In other cases, buyout funds may acquire a privately-held company, or a division of a public company which did not trade separately prior to the buyout. For all of the resulting IPOs, however, the companies involved are at a much later stage of their growth than those launched by VC firms.

We have studied the companies in two ways, each of which is intended to help to identify the effects of buyout fund backing in IPOs. First, for each subject area of our study, we have analyzed the sample as a whole, describing what can be said about the buyout-fund-backed companies, in the aggregate, and how they compare to the non-PE-backed companies as a group. In order to highlight differences between IPO companies in general and the US market as whole, we also drew comparisons between the IPO companies and samples of over 3,000 US companies analyzed in our 2007 and 2008 Governance Practices reports.24 (Note: these studies used proxy filings and, therefore, reflect data reported by the company regarding the previous fiscal year. For example, the report draws on proxy filings made in 2008 that report fiscal 2007 information.) In addition, for compensation and takeover defense we have conducted a matched-pairs analysis, which focused on pairs of companies matched on the basis of industry affiliation and market capitalization. To select the non-PE-backed companies for the analysis, we reviewed all companies that went public during the study years and, for each buyout-fund-backed company, we identified a match that went public in the same year, was in the same or similar industry (based on GICS and Thompson industry classifications), and had similar market capitalization. These pairs were intended to help further isolate the effects of buyout fund backing (since the companies in each pair should tend to share any governance characteristics that are more common in a given industry or for companies of a particular size.) The list of companies in the whole sample, as well as those in the matched pair analysis, are included in Appendices A and B.

Our study is organized as follows. First, we examine ownership structures in considerable detail, describing a range of typical ownership types for buyout-fund-backed companies and identifying ways that they differ from those found at US public companies generally. Second, in order to assess the degree to which buyout fund backers retain influence over their companies post-IPO, we examine board composition and the characteristics of key committees; related party transactions between the company and members of its board and management; and takeover defenses, seeking to evaluate the degree to which the mechanisms of control at these companies are amenable to change by shareholders.

Next, we examine compensation practices at buyout-fund-backed companies, in order to evaluate the claim that they better align executive pay with company performance. It should be noted that we did not examine either operational performance or total shareholder return for the companies in this study, and we are making no claims about the actual achievements of their executives according to these measures.

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However, our analysis carefully examines the structure of their compensation packages and assesses which are likely to align CEO pay with the interests of shareholders by incorporating mechanisms that have been widely believed to link pay to performance.

We conclude with some suggestions for further research, and for possible action by institutional investors.

For all items except compensation, our study is a primarily quantitative analysis of the prevalence of various governance features; the compensation section also has a quantitative portion, but is more focused on policy, which we believe may give greater insight into governance quality. The compensation section also focuses primarily on comparing policies before and after IPO, which we believed would best illustrate any effects of buyout fund influence, while the other sections include data through 2008 for the companies, if available.

Notes on Study Populations and Sources

Takeover Defenses

The primary source of takeover defense information is a company’s charter and by-laws, the format and content of which vary somewhat for different types of entities and legal jurisdictions. For this reason, two companies, Macquarie Infrastructure Trust and Copano Energy, were entirely omitted from the Takeover Defenses analysis because they are limited liability companies to which the data points studied here do not apply. A third company, SMART Modular Technologies, lacked most data because is incorporated in a non-U.S. domicile. However, because it could be determined that the company had an unclassified board, SMART was included in calculations on this data point, as well as several others which tracked some combination of a classified board with other features (since it was obvious that if SMART did not have a classified board, it certainly did not have a classified board in combination with these other elements). As a result, the sample size for takeover defenses was 88 for data points involving a classified board and 87 for all others.

2008 Acquisitions

Seven companies in the sample had ceased to trade publicly by the end of 2008 because they were acquired by other companies (these seven firms are marked in Appendix A). However, two of these companies (Nymex Holdings and Darwin Professional Underwriters) had filed proxy statements before being acquired and delisted, which allowed us to include full data for them for the 2008 proxy year. The other five companies (Bois d’Arc Energy, Clayton Holdings, Eagle Test Systems, FTD Group, and UAP Holdings) did not file proxy statements in 2008, but partial data was available from other sources, such as 10-Ks. These five companies were not included in our 2008 analysis of related party transactions, director attendance, or frequency of board meetings. UAP Holdings and FTD Group were also omitted from our analysis of ownership, but ownership data was available and included for Bois d’Arc, Clayton Holdings, and Eagle Test Systems.

Notes on Data Sources and Dates

Throughout this study, data marked as of “December 31st” of a year reflects information available in SEC filings (proxy statements and/or annual reports) as of that date, which in some cases may differ from year-end facts at the company. For example, as noted above, ownership data for a few companies comes from proxies or 10-Ks filed in 2008, although the companies were acquired by the end of the year. Similarly, committee and board membership was recorded as of the company’s annual meeting; any changes made after the annual meeting were not reflected in our data.

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OWNERSHIP

Summary Findings

Immediately after IPO, buyout-fund-backed firms have more concentrated ownership and a higher proportion of shares held by directors and officers of the firm than non-PE-backed companies. Immediately after IPO, buyout funds retained a majority of shares in almost half the companies they backed, and they retained significant, although diminishing, stakes in the firms for at least a few years post-IPO.

Discussion

Ownership Categories

When analyzing corporate governance practices, it is always important to take the ownership structure of the company into consideration. The following are the categories used by The Corporate Library when examining corporate ownership structure:

Concentrated Ownership Models:

• Principal Shareholder Firm - A company where one shareholder or shareholding block owns at least 10 percent of the outstanding shares.

• Controlling Shareholder - A company where a single shareholder or shareholding block (but not a family or employee block) controls more than 50 percent of the outstanding shares.

• Founder Firm - A company where the CEO or Chair is both a founder and a principal shareholder.

• Family Firm - A company where family ties, most often going back a generation or two to a founder, play a key role in both ownership and board membership.

Dispersed Ownership Models:

• Mixed Ownership - A company with a balanced mix of individual and institutional owners. • Indexed Stock - A company where no shareholder owns more than 1 percent to 1.5 percent of

the outstanding shares. • Institutions Dominant - A company where institutional owners, mainly pension or mutual funds,

dominate the holdings with a combined total of at least 59% ownership, but where no fund controls more than 10% of the outstanding shares.

Private Equity Firm Ownership

In this section, we examine the ownership stakes of the buyout firms that were involved as backers of the initial public offerings for the buyout-firm-backed companies in the study. The ownership levels of the buyout firm backers immediately after their companies’ initial public offerings and their ownership levels as of December 31, 2007 and as of December 31, 2008 are discussed in the sections to follow. A summary of the data can be found in Table 2 below.

Ownership Levels after IPO

The buyout fund backer owned a stake in the company immediately after the initial public offering of all of the buyout-fund-backed companies studied. The backers’ ownership levels in the new public companies

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ranged from 9 percent to 68 percent. Chart 1 presents the breakdown of the percentage ownership retained by the buyout funds immediately after the buyout-fund-backed companies went public.

Chart 1: Percentage of Buyout-Fund-Backed Company Owned by Private Equity Backer Immediately After IPO (Source: The Corporate Library)

The initial ownership percentages reported are based on an assumption that the underwriter’s over-allotment option was not exercised. The underwriter's over-allotment option allows underwriters to sell more shares in an IPO to subscribers than the underwriter was originally allotted in the offering. To accomplish this, the option permits an underwriter to borrow shares from the issuer's major shareholders if the price of the shares rises following the offering. (If the price falls, the underwriter would not exercise the option and would instead buy the shares on the open market.)

Notably, at nearly half (49 percent or 23 companies) of the buyout-fund-backed companies studied, the private equity backer retained a majority stake in the company after the IPO. Of these 23 companies that were majority-owned by the buyout-fund-backer after IPO, most (78 percent or 18 companies) elected to take the controlled company exemption, which allowed the companies to not comply with certain listing standards required by the US stock exchanges (including many of the corporate governance-related listing standards).

Private Equity Firm Ownership Levels at December 31, 2007 and December 31, 2008

One of the questions often raised about the involvement of a private equity firm in an initial public offering is how long the firm plans to remain invested in the newly-public company. At many of the companies that were majority-owned by the buyout fund backer after IPO, the private equity backer’s involvement was not long-term.

At 21 of the companies, the backer no longer owned a large enough portion of the company to require disclosure (i.e. the ownership stake, if any, is less than 5 percent), as of December 31, 2008.

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Table 1: Ownership by Buyout Fund Backer (Source: The Corporate Library)

Company Name Ticker IPO Year

PE backer still owned stock as of 12/07?

PE backer still owned stock as of 12/08?

% owned after IPO by PE backer **

% owned at 12/07 by PE backer **

% owned at 12/08 by PE backer **

Accuride Corporation ACW 2005 Yes No 38% 22% 0%

Alpha Natural Resources, Inc. ANR 2005 No No 49% 0% 0%

Altra Holdings, Inc. AIMC 2006 Yes No 33% 31% 0%

Asset Acceptance Capital Corp.

AACC 2004 Yes Yes 43% 36% 36%

Aventine Renewable Energy Holdings, Inc.

AVR 2006 Yes Yes 28% 28% 28%

Beacon Roofing Supply, Inc. BECN 2004 No No 32% 0% 0%

Blackbaud, Inc. BLKB 2004 No No 68% 0% 0%

BlueLinx Holdings Inc. BXC 2004 Yes Yes 61% 58% 56%

Bucyrus International, Inc. BUCY 2004 No No 43% 0% 0%

Builders FirstSource, Inc. BLDR 2005 Yes Yes 59% 25% 25%

CB Richard Ellis Group, Inc. CBG 2004 Yes Yes 43% 11% 12%

Citi Trends, Inc. CTRN 2005 Yes No 66% 46% 0%

Clayton Holdings, Inc. CLAY 2006 Yes Yes 43% 39% 37%

Consolidated Communications Holdings, Inc.

CNSL 2005 No No 15% 0% 0%

Copano Energy LLC CPNO 2004 No No 16% 0% 0%

Dresser-Rand Group Inc. DRC 2005 No No 67% 0% 0%

DSW Inc. DSW 2005 Yes Yes **** **** ****

DynCorp International, Inc. DCP 2006 Yes Yes 56% 56% 56%

Eagle Test Systems, Inc. EGLT 2006 Yes Yes 44% 27% 27%

EnerSys ENS 2004 Yes No 53% 49% 0%

FTD Group, Inc. FTD 2005 Yes NA 54% 32% NA

GateHouse Media, Inc. GHS 2006 Yes Yes 60% 58% 42%

GeoMet, Inc. GMET 2006 Yes Yes 43% 42% 42%

H&E Equipment Services, Inc. HEES 2006 Yes Yes 41% 38% 40%

Hornbeck Offshore Services, Inc.

HOS 2004 No No 32% 0% 0%

Huntsman Corporation HUN 2005 Yes Yes 63% 59% 20%

Huron Consulting Group, Inc. HURN 2004 No No 59% 0% 0%

ICF International ICFI 2006 Yes Yes 56% 51% 49%

ITC Holdings Corp. ITC 2005 No No 58% 0% 0%

Kenexa Corporation KNXA 2005 No No 28% 0% 0%

Knoll, Inc. KNL 2004 No No 65% 0% 0%

MWI Veterinary Supply, Inc. MWIV 2005 Yes No 40% 19% 0%

Nalco Holding Company NLC 2004 No No 66% 0% 0%

NTELOS Holdings Corp. NTLS 2006 Yes Yes 30% 29% 27%

NYMEX Holdings, Inc. NMX 2006 Yes Yes 9% 8% 7%

Obagi Medical Products, Inc. OMPI 2006 Yes Yes 45% 45% 21%

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Pike Electric Corporation PEC 2005 Yes Yes 48% 40% 40%

Republic Airways Holdings Inc. RJET 2004 Yes No 64% 11% 0%

Rockwood Holdings, Inc. ROC 2005 Yes Yes 51% 52% 42%

Sealy Corporation ZZ 2006 Yes Yes 55% 51% 51%

SMART Modular Technologies (WWH), Inc.

SMOD 2006 Yes Yes 68% 40% 39%

Susser Holdings Corporation SUSS 2006 Yes Yes 42% 39% 39%

Symmetry Medical Inc. SMA 2004 No No 63% 0% 0%

Syniverse Holdings, Inc. SVR 2005 Yes Yes 58% 58% 23%

TRW Automotive Holdings Corp.

TRW 2004 Yes Yes 57% 57% 46%

UAP Holdings Corp. UAPH 2004 No NA 42% 0% NA

Warner Music Group Corp. WMG 2005 Yes Yes 38% 38% 38%

Wellcare Health Plans Inc WCG 2004 No No 63% 0% 0%

* Ownership percentages are based on an assumption that the underwriter’s over-allotment option was not exercised. ** If there was more than one private equity backer for the IPO, the backer with the larger ownership stake is recorded. *** Ownership level was not high enough to trigger disclosure requirement. **** Prior to its IPO, DSW, Inc. was owned entirely by Retail Ventures, Inc., which was, in turn, owned by a combination of Schottenstein Shoe Corporation (SSC) and Cerberus, a large PE buyout firm led by Stephen Feinberg. Post IPO, Retail Ventures continued to hold 94% of DSW’s voting shares, via a combination of both Class A and Class B Common Shares. Cerberus also holds one or more very large credit instruments related to both Retail Ventures, Inc. and DSW, as well as warrants that could be redeemed for up to 9.99% of the voting shares in DSW. Thus while Cerberus is not listed as a direct holder of DSW beyond the 0.5% position listed for Mr. Feinberg, it has retained its ability, post-IPO, to assert a significant degree of control over DSW.

As an example of a company where the backer’s ownership declined over time, Olympus Partners owned 63 percent of Symmetry Medical Inc. (SMA) after the company went public in December 2004. By 2006, Olympus Partners owned only 14 percent and it did not own enough to require disclosure in 2007.

However, many of the private equity buyout firms that backed the IPOs of the companies in our study are still invested in the newly-public companies. More than five percent of the shares outstanding continued to be held by the private equity backers as of December 31, 2007 at two-thirds (67 percent) of the buyout-fund-backed companies in the study. As of December 31, 2008, this percentage had decreased to 54 percent. Since the companies included in this study went public during 2004, 2005 or 2006, the assessment of the length of involvement of the private equity backers must take the year of the IPO into consideration.

2004 IPOs: Of the 17 buyout-fund-backed companies in our study that went public in 2004, ten were majority owned by their private equity backers after IPO. However, only two of these companies continued to be majority owned by their private equity backers by the end of 2007 and at 11 companies, the holdings by the PE-backers had dropped below the 5% reporting threshold. By the end of 2008, only one company was majority owned by its private equity backers, and at 12 companies, the holdings by the PE-backers had dropped below the 5% reporting threshold (and an additional one, UAP, was no longer a stand-alone company).

2005 IPOs: Of the 16 buyout-fund-backed companies in our study that went public in 2005, we have information regarding the level of ownership of the private equity backers for 14 companies. (For one, DSW, the precise percentage owned by buyout firm Cerberus could not be established and FTD Group has been omitted from this analysis because of its acquisition by United Online.) Among these 14 companies, eight were majority owned by their private equity backers after IPO. By the end of 2007, three companies continued to be majority owned by their private equity backers and at five companies, the holdings by the PE-backers had dropped below the 5% reporting threshold. By the end of 2008, none

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of the these companies continued to be majority owned by the private equity backers, and at eight companies, the holdings by the PE-backers had dropped below the 5% reporting threshold.

2006 IPOs: Of the 15 buyout-fund-backed companies in our study that went public in 2006, five were majority owned by their private equity backers after IPO. By the end of 2007, four companies continued to be majority owned by their private equity backers, and all of the companies still had at least 5% owned by the PE-backers (none fell below the reporting threshold). By the end of 2008, two were still majority owned by their private equity backers and at one company, the holdings by the PE-backers had dropped below the 5% reporting threshold.

Thus, fewer of the companies that went public in 2004 – and therefore have been public for a longer period of time than the other companies in the study – continue to have significant ownership stakes held by their buyout fund backers.

Similarly, the likelihood that there has been a decrease in the percent of company stock held by the buyout fund backers depends on the number of years since the IPO. For example, at none of the companies that went public in 2004 has the ownership level of the private equity backer gone unchanged since the IPO. In contrast, over half (60 percent) of the companies that went public in 2006 had the same percentage ownership (within 3 percentage points) by their private equity backer as of December 31, 2008 as that recorded after the IPO.

In sum, for the buyout-fund-backed companies in our study, it appears that the buyout fund backers continue to be involved at a very significant level for at least a few years after the IPO. However, after several years have elapsed, the ownership profile of the buyout-fund-backed companies generally resembles that of Principal Shareholder companies, the most common type in the US economy.

Ownership 2007-2008

When The Corporate Library analyzed over 3,000 companies for our 2007 Governance Practices report, we found that the most common ownership structure among this broad sample was Principal Shareholder (at 39 percent of companies). The second most common ownership structure in that study was the Institutions Dominant model, in place at just under one-quarter (21 percent) of the companies. In the 2008 national study, the most common structure was still Principal Shareholder (41 percent) and second was still Institutions Dominant (19 percent).

When the companies in our current study sample are analyzed as of December 31, 2007 and as of December 31, 2008, the Principal Shareholder category is also most common, as shown in Chart 2 below. However, the companies in the sample in our current study are more likely than the companies in the national studies to fall in the Family or Founder Firm or Controlling Shareholder categories, while they are much less likely to be in the Institutions Dominant category than those companies in the broader studies. Since the sample in the current study exclusively includes companies new to the public markets, this finding demonstrates the fact that new IPOs often continue to have large blocks of stock held by people who were involved before the IPO, and are therefore less likely to have a diversified ownership base.

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Chart 2: Ownership Categories, Current Study – Whole Sample As of December 31, 2007 and December 31, 2008 (Source: The Corporate Library)

Note: 2008 data for ownership was unavailable for two companies: FTD Group and UAP Holdings Corp., each of which are no longer stand-alone companies.

In fact, as shown in Charts 3 and 4 below, the majority of the buyout-fund-backed companies in the current study fall into the Principal Shareholder category both as of December 31, 2007 and December 31, 2008.

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Chart 3: Ownership Categories, Current Study – Analysis by IPO Status As of December 31, 2007 (Source: The Corporate Library)

Chart 4: Ownership Categories, Current Study – Analysis by IPO Status As of December 31, 2008 (Source: The Corporate Library)

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Management Ownership

Ownership by directors and officers of the company can also have an influence on the governance of the company. In this section, we compare the level of ownership by directors and officers as a group at the buyout-fund-backed companies with that of the non-PE-backed companies.

Immediately after the IPO, nearly all of the companies studied had some portion of company stock owned by directors and officers. Chart 5 below presents a comparison of the levels of ownership held by directors and officers immediately after the IPO.

Chart 5: Percentage of Company Stock Owned by Directors & Officers Immediately After IPO (Source: The Corporate Library)

The average and median percentages of company stock owned by directors and officers at the buyout-fund-backed and non-buyout-fund backed companies are presented in Table 1 below for the period immediately after IPO.

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Table 2: Percent of Company Stock Owned by Directors & Officers Immediately Post-IPO (Source: The Corporate Library)

Average Median

Buyout-fund-backed companies 41.0 53.6

Non-buyout-fund backed companies

38.3 39.6

In general, it appears that the companies backed by buyout funds were more likely than the control group to have a higher level of stock ownership by directors and officers immediately after the company went public.

Stock ownership guidelines

Management stock ownership guidelines

While no buyout-fund-backed companies had stock ownership guidelines for their executives at the time of their IPO, one non-PE-backed company – Darwin Professional Underwriters – had guidelines that ranged downwards from a five times base salary requirement for the CEO. The company also expected executives to retain three-quarters of its after-tax equity awards until they reached the specified ownership level.

As of December 31, 2007 however, a greater proportion of buyout-fund-backed companies had adopted management stock ownership guidelines than had non-PE-backed companies; a quarter (12 companies) compared to a fifth (nine companies), respectively, though the requirements were at roughly the same level. As of December 31, 2008, this trend had continued. One-third of the buyout-fund-backed companies had adopted management stock ownership guidelines while only one-fifth of the non-PE-backed companies had adopted them.

As of December 31, 2007, median and average requirements under the stock ownership guidelines for management were five times salary at buyout-fund-backed companies, while one company expressed its ownership requirements as a specified number of shares. These statistics had not changed as of December 31, 2008. (Note: the highest multiple cited in the guidelines was recorded for this analysis. For example, if the guidelines call for the CEO to own five times his or her salary in company stock, while the executive officers other than the CEO have a guideline of three times salary, the multiple five was recorded.)

As of December 31, 2007, at non-PE-backed companies median requirements were five times salary, while the average figure was slightly lower at 4.5 times salary. One of the companies in the latter group expressed the holding requirements as retention stipulations for vested equity grants. As of December 31, 2008 the median was still five times salary yet there was a slight reduction in the average figure, to 4.4 times salary.

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Director stock ownership guidelines

A single company from each of the two groups (2% of companies in each group) had stock holding requirements for directors at the time of IPO. The buyout-fund-backed company was Aventine Renewable Energy Holdings, while the non-PE-backed company – Darwin Professional Underwriters – was the same one that had management stock ownership guidelines at the time of IPO.

Although the same number of each group of companies (five companies each) had director stock ownership guidelines as of December 31, 2007, the smaller number of non-PE-backed companies meant that this represented a slightly higher proportion of that group. As of December 31, 2008 more buyout-fund-backed companies had adopted director stock ownership guidelines. By this time, just over one-fifth of the buyout-fund-backed companies had adopted stock ownership guidelines for directors while only 14 percent of the non-PE-backed companies had adopted director stock ownership guidelines.

As of December 31, 2007, director ownership requirements were slightly more rigorous at companies not backed by buyout funds, with three companies requiring shares worth five times the cash retainer, one requiring twice the retainer and the final company expressing ownership requirements as retention stipulations for existing stockholdings. At the buyout-backed companies, requirements were set at three or four times the retainer, or 5,000 shares or $200,000 worth of shares.

As of December 31, 2008, this pattern continued to hold. The median multiple of annual retainer or equity award for directors at non-PE-backed companies was five, while the median multiple at buyout-fund-backed companies was three. The average multiple at non-PE-backed companies was 3.8, while it was 3.7 at buyout-fund-backed companies.

The differences in the findings for stock ownership requirements are not so marked as to present any conclusive evidence. However, one could speculate that ownership requirements may be more common, though less stringent, at buyout-fund-backed companies because non-PE-backed companies tend to be Founder or Family Firms (43 and 12 percent, respectively, as of December 31, 2008) and would therefore have management that already owns high levels of stock in the company. (See possible further support for this assertion in the CEO stockholdings analysis in the Compensation section below.) Also, it is notable that more companies in each group had ownership requirements for managers than for directors, perhaps reflecting the fact that there are slightly higher numbers of non-independent directors (in other words, directors who are more likely already to have a significant stake in the company) on IPO boards than is typical of recently-public companies as a whole.

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BOARDS OF DIRECTORS

Summary Findings

All the companies in our sample had boards that were slightly smaller, younger, and had fewer female directors immediately after IPO than the national average; since this was true of both buyout-fund-backed and non-PE-backed companies, these may be characteristics of IPO boards in general. However, there were significant differences between buyout-fund-backed companies and those brought public by non-PE types of sponsors in the area of director and committee independence. The non-PE-backed companies tended to have more employee directors, possibly reflecting the fact that management teams tend to be involved in these IPOs and retain board seats afterward. However, in a large number of cases, the buyout funds retained control post-IPO over key committees in the companies they brought public, by means of directors (including committee chairs) with significant ties to the buyout fund backer. This phenomenon was particularly striking in the case of compensation committees. Immediately post-IPO, a majority of the compensation committee chairs at companies backed by buyout funds had ties to the buyout firm, as did a majority of the directors serving on the compensation committees.

Discussion

As discussed previously, it has been argued that the boards of companies brought public by private equity firms are more effective than average because they are aligned with shareowners and mitigate the agency problem. Although board alignment should not be defined exclusively by board composition, committee structure, or the number of board and committee meetings held, these variables are informative when considered in combination with others.

Therefore, in this section, we compare the board composition and practices of the buyout-fund-backed firms to the non-PE-backed companies in the study.

Board Size

The number of directors can have a significant influence on the effectiveness of a board. The Corporate Library’s study of governance practices in place at more than 3,000 US companies as of August 2008 found that 52 percent of companies had from seven to nine directors. The most common number (the mode of the distribution) was seven, while both the average and median number was nine.

Only 15% of the US companies studied had fewer than 7 directors. The study also found that the size of US boards has not changed much recently. In fact, the median and average number of directors on boards included in our 2008 national study was not significantly different from those reported in our 2007 and 2006 studies. 25

The boards of the companies included in the current study tend to be initially smaller, on average, than those at companies included in the national study. Immediately after IPO, the average for the 90 companies in this study was 7.6 directors and the median was seven directors. As of December 31, 2007, the board size for the companies in our study had increased; on average the number of directors on their boards was 8.2 directors, with a median of eight directors per board. As of 2008, the average board size for the IPO companies had increased further to 9.1, with a median of nine. Over time, then, the sample begins to approximate national trends.

Table 3 below presents the median and average board sizes for the buyout-fund-backed companies and the control group. Immediately after the IPO, the average board size among the buyout-fund-backed

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companies in our current study was 7.5 directors and the average board size among the non-PE-equity-backed companies was 7.8 directors. As of December 31, 2007, board size had increased, on average, to 8.1 directors for the buyout-fund-backed companies and 8.2 for the non-PE-backed companies. As of December 2008, the average board size had increased further to 9.3 for buyout-backed companies and 8.8 for non-PE-backed companies. It is interesting to note that the increase at buyout-backed companies was more dramatic in terms of averages, although the medians for the two groups were the same.

Table 3: Board Size (Source: The Corporate Library) Buyout-Fund-Backed Companies Non-PE-backed Companies US Study

After IPO

As of 12/31/07

As of 12/31/08

After IPO

As of 12/31/07

As of 12/31/08

2007 2008

Median # of Directors

7 8 9 7 8 9 9 9

Average # of Directors

7.5 8.1 9.9 7.8 8.2 8.8 9 9

Chart 6: Board Size (Source: The Corporate Library)

Insiders on the Board

Over half (58 percent) of the companies in the 2007 national study had only one inside director – an employee of the company – serving on the board. In the 2008 study, the figure rose to 60 percent. However, 12 percent of the companies had three or more insiders serving on the board in 2007 and 11 percent in 2008.26

This pattern is similar to that among the companies in the current study: 63 percent of the 90 companies in our study had one inside director serving on the board immediately after the IPO and 14 percent had three or more insiders serving on the board. For the group of 90 companies, this pattern changes slightly

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as of December 31, 2007, when fully 67 percent of the companies had only one insider serving on the board and only 11 percent had three or more insiders. As of December 2008 the figures returned somewhat to the earlier state, with 64 percent of the companies having only one insider on the board and 11 percent having three or more. Additionally, as of the 2008 analysis, there was one company with no insiders serving on the board.

However, the findings are much different when the analysis is broken down by buyout-fund-backed versus non-PE-backed companies.

Immediately after IPO, 57 percent of the non-PE-backed companies had one insider on the board and 21 percent had three or more insiders serving on the board. This 21 percent compares to the 12 percent found in the 2007 national study and 11 percent in 2008, indicating that a higher percentage of non-PE-backed companies have three or more insiders on the board. As of December 31, 2007, this pattern had changed to become much closer to that of the broader study: 52 percent of non-PE-backed companies had only one insider director serving on the board and only 17 percent had three or more insiders serving on the board. As of December 2008, 55 percent of the non-PE-backed companies had only one insider on the board and 17 percent had three or more.

The buyout-fund-backed companies included in our study also have a pattern that differs from the findings in the national study. The buyout-fund-backed companies studied are more likely than those in the national study to have only one inside director (that is, an employee) on the board. In fact, immediately after the IPO, 69 percent of these buyout-fund-backed companies had only one inside director serving on the board, and only 8 percent had more than three inside directors. As of December 31, 2007, the percentage increased dramatically to 79 percent of buyout-fund-backed companies having only one inside director on the board, yet as of December 31, 2008 the percentage fell to 73 percent. The percentage of buyout-fund-backed companies with three or more inside directors fell to 6 percent as of December 31, 2007 and stayed at 6 percent as of December 2008. One of the buyout-fund-backed companies had no insiders serving on the board as of the end of 2008. In sum, non-PE-backed firms had a notably greater degree of insider representation than the national average, immediately after IPO, and buyout-fund-backed firms had less. Both groups’ statistics tended toward the national levels over time.

An analysis of the average number of inside directors per board also demonstrates this difference between the two groups. Immediately after the IPO, the average number of inside directors on the 48 buyout-fund-backed companies in the study was 1.4. By December 31, 2007, this number fell to 1.3 and stayed at 1.3 as of December 31, 2008. This compares to an average of 1.8 inside directors on the 42 non-PE-backed company boards after the IPO, 1.7 as of December 31, 2007 and 1.6 inside directors, as of December 31, 2008.

It is likely that the higher number of inside – or employee – directors at the non-PE-backed firms reflects the fact that management teams tend to be involved in these IPOs and to retain board seats immediately afterward. The lower number of employee directors at buyout-backed firms does not, however, necessarily mean that these companies’ boards are in practice more independent and thus more able to serve shareholders’ interests than boards at their non-PE-backed peers. As will be discussed below, buyout firms frequently continue to exert influence over key board committees through directors who are not employees of the company; the directors therefore meet listing exchange definitions of independence, but have significant ties to the buyout firm itself.

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Director Demographics

Among the 90 companies in our current study, there were a total of 686 directors serving on the boards immediately after IPO; 360 of these directors served on the boards of 48 buyout-fund-backed companies studied and 326 directors served on the boards of the 42 non-PE-backed companies studied. As of December 31, 2007, the total number of directors serving on the boards of all 90 companies in our study had risen to 741; 390 served on boards of buyout-fund-backed companies and 351 were directors of non-PE-backed companies. As of December 31, 2008, the number of directors was 722; 385 served at buyout-fund-backed companies and 337 on non-PE-backed companies. Note that these totals reflect director positions and may include duplicate directors (directors serving on more than one board who are therefore counted twice).

Director Ages

Ages were available for nearly all of the directors in the current study and this information is presented in summary form in Table 4 below. Data is presented for the directors in place immediately after the IPO of the companies in the study, as of December 31, 2007 and as of December 31, 2008. This analysis would not be necessary if all directors remained on the boards throughout the period, with no new additions. Since age is a chronological variable, one would expect that the ages would increase by the number of years that have elapsed since the IPO. However, the composition of the boards did change during this time period, with many directors being added or removed. (It should be noted that – as is the case throughout this study – the year considered in the “Immediately After IPO” category ranges from 2004 to 2006, depending on the year in which the company went public.)

Table 4: Director Ages (Source: The Corporate Library)

Immediately After IPO As of December 31, 2007

As of December 31, 2008

US Study

All Firms

Buyout-Fund-

Backed Only

Non-PE-

Backed Only

All Firms

Buyout-Fund-

Backed Only

Non-PE-

Backed Only

All Firms

Buyout-Fund-

Backed Only

Non-PE-

Backed Only

2007 2008

Age of Youngest Director

29 29 31 28 31 28 29 32 29 26 27

Median Age

54 53 56 56 56 56 57 58 57 60 60

Average Age

54 52 55 55 55 55 56 57 56 59 60

Age of Oldest Director

79 75 79 79 75 79 81 77 81 98 99

On average, the directors serving on the boards included in our current study are younger than those serving on boards across the US. In our 2007 and 2008 Governance Practices reports, we found that most directors of public companies across the US are in their fifties or sixties. The median age of the directors in the 2007 national study was 60 years and the average age was 59 years; in the 2008 study

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both the median and average ages were 60. Table 4 above shows that the average age of directors at the companies in the current study was 54 immediately after the IPO, 55 as of December 31, 2007, and 56 as of December 31, 2008. These younger ages (versus the national study statistics) may be attributable to the type of companies included in this study – i.e., IPOs; newly-public companies may tend to have younger directors serving on their boards.

Chart 7: Average Director Ages (Source: The Corporate Library)

Additionally, the range of ages is not as wide for the companies in the current study as it was in the national studies. The ages of directors in the 2007 national study varied widely, ranging from 26 to 98, and from 27 to 99 years old in the 2008 report. However, the range for directors in the IPO companies as of December 31, 2007 was 28 to 79 and 29 to 81 years old as of December 31, 2008. Again, this may be attributable to the fact that newly-public companies tend not to name many people in their eighties or nineties to their boards. In most cases, when people at these advanced ages are serving on boards across the US, they have been in that role for several decades.

When we compare the ages of directors serving on the boards of buyout-fund-backed companies and those on non-PE-backed companies, a trend emerges. Immediately after IPO, the directors at buyout-fund-backed companies are, on average, younger than the directors at non-PE-backed companies. Specifically, the average age of a director at a buyout-fund-backed company immediately after IPO was 52 years old, while the average age of a director at a non-PE-backed company was 55 years old immediately after IPO. However, by December 31, 2007 – one, two, or three years after IPO, depending on the company – the age differentials at the average had disappeared with directors of both groups having an average age of 55 years. As of December 31, 2008 the differential was still minimal. In this respect, the differentiation of average director age between the buyout-fund-backed and non-PE-backed companies lessens over the first few years the company is traded on the public markets.

Director Gender

The vast majority of directors of the companies included in the 2007 and 2008 national studies are male. In fact, fewer than one in ten (9 percent) of the directors who were included in the national studies are female.27

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The directors serving on the boards of the companies in the current study are also nearly all male. Table 5 below presents the prevalence of male and female directors among the companies in the current study, by category and time period.

Table 5: Director Gender (Source: The Corporate Library)

Immediately After IPO As of December 31, 2007 As of December 31, 2008 US Study All

Firms Buyout-Fund-

Backed Only

Non-PE-

Backed Only

All Firms

Buyout-Fund-

Backed Only

Non-PE-

Backed Only

All Firms

Buyout-Fund-

Backed Only

Non-PE-

Backed Only

2007 2008

% Male 96.4% 97.5% 95.1% 93.7% 94.4% 92.9% 93.1% 92.8% 93.5% 91% 91%

% Female

3.6% 2.5% 4.9% 6.3% 5.6% 7.1% 6.8% 7.0% 6.5% 9% 9%

In general, the boards of the companies in the current study are less likely to have female directors than boards across the US. Similar to the finding regarding director ages discussed above, this may be a feature of boards of newly-public companies. However – also similar to the study of director age – the findings are less dramatic as of December 31, 2007 and December 31, 2008 than immediately after IPO. For example, immediately after IPO, only 3.6 percent of the directors serving on the boards of companies in our study were female, compared to 9 percent of directors serving on boards across the US. By December 31, 2007 – one, two, or three years after IPO, depending on the company – the difference between the IPO companies and the companies in the national studies had decreased; 6.3 percent of directors serving on studied company boards were female. As of December 31, 2008 the figure was slightly higher, at 6.8 percent.

Immediately after IPO, the non-PE-backed companies were nearly twice as likely to have female directors as were the buyout-fund-backed companies. However, in the subsequent analyses (at 2007 and 2008 year-ends) minimal differences existed between the two IPO groups.

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Chart 8: Director Gender (Source: The Corporate Library)

Board Meetings

As we noted in our 2007 Governance Practices Report, the median number of board meetings for all companies we covered that proxy year was seven, and the most common number of board meetings was six. In the 2008 report, the median jumped to eight but the most common number remained at six.

Immediately after IPO, the buyout-fund-backed companies reported holding an average of 5.6 board meetings per year, while the non-PE-backed companies reported holding an average of 6.6 board meetings per year.

However, in proxies filed in 2007, the buyout-fund-backed firms reported holding an average of 8.3 meetings in the prior year and the non-PE-backed companies reported holding an average of 7.6 board meetings. As of December 31, 2008, the buyout-fund-backed firms held an average of 7.8 meetings and the non-PE-backed group averaged 8.0 meetings. The fact that both groups of companies increased the frequency of their board meetings is in line with general practice at US companies in this time frame, when many boards met more frequently as they implemented Sarbanes-Oxley and new listing exchange requirements.

Board Committees

For our study sample viewed as a whole, the median size of both the audit and compensation committees, both immediately after the IPO and at as of both December 31, 2007 and December 31, 2008 was three members. The average number of members on the audit committee was 2.9 immediately after the IPO, 3.3 as of December 31, 2007 and 3.2 as of December 31, 2008. The average size of the compensation committee was similar: 2.7 members immediately after IPO, 3.3 as of December 31, 2007 and still 3.3 as of December 31, 2008.

The number of directors serving on the audit and compensation committees of both the buyout-fund-backed and the non-PE-backed companies in the current study is presented in Table 6 below. Although the committees in the first group are somewhat smaller on average, it is not clear whether the degree of difference is significant.

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Table 6: Committee Size (Source: The Corporate Library)

Buyout-Fund-Backed Audit Committee Compensation Committee

After IPO As of 12/31/07

As of 12/31/08

After IPO As of 12/31/07

As of 12/31/08

Median 3 3 3 3 3 3

Average 2.9 3.3 3.2 2.8 3.5 3.4

Non-PE-Backed Audit Committee Compensation Committee After IPO As of

12/31/07 As of

12/31/08 After IPO As of

12/31/07 As of

12/31/08 Median 3 3 3 3 3 3

Average 3.9 4.1 3.2 3.8 4 3.2

Committee Composition

Analysis of the composition of the committees in the buyout-fund-backed group shows some noteworthy features. The Corporate Library classifies directors not merely as inside or outside; we also identify a subset of outside directors we call “outside related” because, although technically independent by listing standards, they have significant ties to a company that we believe could compromise their objectivity. For the purposes of this study, we have designated as “outside related buyout fund (ORBF)” any director with a significant employment or business relationship to the buyout fund backer. Immediately after the IPO, the audit committees at 33% of the companies brought public by buyout funds, along with the compensation committees at a striking 52% of these companies, had a majority of members who had ties of this kind to the buyout fund, and were thus labeled ORBF by our researchers. As of December 31, 2008 the percentages shrank to only 2% of audit committees and only 19% of compensation committees having a majority of ORBF directors.

Analysis of ORBF Chairs showed a different pattern. The chairs of the audit committees were ORBF at 15% of the buyout-fund-backed companies at IPO and at 13% as of December 31, 2008. The chairs of the compensation committees were ORBF at 52% of these firms at IPO and at 27% as of December 31, 2008. This data may lend additional support to the findings of Jerry Cao, in the study cited in our introduction, which suggested that buyout funds may retain strong influence over key committees at companies they take public, even as their ownership stakes decline.

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Chart 9: ORBF Committee Members and Chairs (Source: The Corporate Library)

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RELATED PARTY TRANSACTIONS

Summary Findings

Related party transactions involving company directors and officers were common throughout our sample of IPO companies. However, the type of transactions that were most common differed between the two groups under consideration. Firms backed by buyout funds were significantly more likely than the non-PE-backed companies to report consulting agreements with top management, shareholder rights agreements (which specify special voting rights or the ability of certain shareholders or shareholder blocks to designate one or more of the company’s directors) and registration agreements (which are often tied to a shareholder rights agreement, and typically require the company to register for sale shares privately held by one or more shareholders or shareholder blocks, at the shareholders’ discretion). Non-PE-backed companies were more likely than the buyout-fund-backed companies to have ongoing business contracts and relationships.

Discussion

Related party transactions (“RPTs”) involving the officers and directors of public corporations were specifically targeted for reform and heightened disclosure by the Sarbanes-Oxley Act of 2002. Certain types of transactions, such as corporate loans to executives for the purchase of company stock, no longer occur. While all public corporations are required to include a section in their proxies to disclose related party transactions, the majority of US corporations now have relatively little to report in this area. The most common exceptions are to be found among controlled corporations (those where a single shareholding block controls at least 51% of the company’s voting shares) which account for approximately 10% of the companies in our coverage universe. Reportable related party transactions can range from private management or consulting contracts or real estate and aircraft leases to ongoing business contracts between the company and various large shareholders, top executives or directors. Shareholder rights agreements, which formalize certain rights for specific shareholders, often including the right to elect one or more designated members of the board of directors, are common among firms with one or more large principal, but not controlling, shareholders.

Related party transactions were also common among the IPO companies included in the present study, so common, in fact, that they are the rule rather than the exception. Of the ninety firms included in our study, only two of the buyout-backed firms and just six of the remaining firms were able to report a complete absence of RPTs at IPO time, with only marginal improvement reported by December 31, 2008. The exact types, number and percentages of RPTs reported by each group as of that date, and any changes relative to each company’s IPO date, are shown in Table 7 below. As of year-end 2008 there were no significant changes to these percentages, except that two of the buyout-fund-backed companies had been acquired and were no longer trading independently, and three more had suspended proxy filings pending the outcome of M&A-related negotiations.

The most common related party transactions among the buyout-fund-backed companies are closely tied to continued ownership by pre-IPO backers, and help formalize and, in many cases, strengthen their continued involvement. As pre-IPO backer ownership percentages begin to decline and the companies begin to be traded more broadly, the incidence and relative importance of these transactions tend to decline. Registration and shareholder rights agreements, however, are likely to remain in effect and in full force until the shareholders concerned have exited the company entirely.

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Related Party Transaction Categories

Equity-Related Loans Equity-related loans are loans related to shareholder equity or other capital issues, used for maintaining relative ownership positions among key executives and other corporate officers, or for tax purposes. These loans many originate from a dominant shareholder, or from the corporate entity itself, but in most cases were simply reported in the company prospectus and generally repaid at IPO. For example, Builders FirstSource (a buyout-fund-backed company), loaned $50,000 to CFO Charles L. Horn to purchase shares of company stock under a company stock incentive plan; the loan was repaid in full prior to the company’s IPO. In a more typical example, at Warner Music Group (a buyout-fund-backed company) backers loaned the company $700 million to facilitate the IPO, which was paid in full on completion. At GateHouse Media (also a buyout-fund-backed company), a complex series of loan agreements incorporating specific covenants that directly influenced the company’s corporate governance were used for both capitalization and regular operating cash flow purposes both before and after the company’s IPO.

Other Loans Other loans are mostly housing-related and other non-equity-related loans to key executives, or loans related to ongoing business agreements intended to facilitate corporate cash flow. Alpha Natural Resources (a buyout-fund-backed company), for example, reported relocation loans of $100,000 and $79,600 to two different executives, both of which were repaid, with interest, prior to the company’s IPO. Similarly, XenoPort, Inc. (a non-PE-backed company), reported a $150,000 loan to Dr. Kenneth C. Cundy, its senior vice president of preclinical development, used by Dr. Cundy in the purchase of a primary residence. In this case, for as long as Dr. Cundy remains with XenoPort, the company will forgive any interest accrued on an annual basis. The Huntsman Corporation (a buyout-fund-backed company) reported a $25 million loan to the company from Horizon Ventures LLC, an entity controlled by Jon M. Huntsman, the company Chairman and father of company CEO Peter R. Huntsman; interest on the loan was set at 15% and was not intended to be paid in cash but rather accrued and added to the principal balance. The loan yielded a reported $25 million in interest, a gain of 100% for Mr. Huntsman over the two year life of the loan. This is a prime example of the way in which such arrangements can be structured to maximize returns for the company’s interested shareholders, but can disadvantage unrelated public shareholders.

Ongoing Business Relationships Ongoing business relationships are contractual or subsidiary-derived business agreements that are generally intended to survive the IPO and be sustained into the foreseeable future, including various supply chain, distribution or manufacturing agreements, and licensing and other intellectual property agreements. They may also include direct ongoing business relationships with individual officers and directors, particularly at financial service firms.

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At Crocs (a non-PE-backed company), the company reported entering into two different ten-year distribution and kiosk agreements with entities controlled by former CEO George Boedecker, agreements which generated $2.3 million in revenues for Crocs in 2006. Camden Resources reported ongoing contracts with its prior partners and backers that paid Camden $32.5 million in 2006. Western Alliance Bancorporation (a non-PE-backed company) reported a total of $27.1 million in loans to its “officers, directors and principal shareholders (and their associates),” but these were not loans related to these individuals’ involvement with Western Alliance. The loans were provided to these individuals in the bank’s regular course of business, “on the same terms, including interest rates and collateral on loans as those prevailing at the same time with other persons of similar creditworthiness,” and were loans which Western Alliance intended to continue to service post-IPO. Cerberus is a large buyout fund that frequently enters into business agreements with related parties. For example BlueLinx Holdings (a buyout-fund-backed company) reported three different arrangements with Cerberus affiliates in 2006, including the provision of temporary staffing totaling $2.0 million, real estate surveys and information technology consulting totaling $206,580 and rental car fees totaling $332,922. At Crosstex Energy (a non-PE-backed company) agreements set forth the precise terms whereby the company may or may not compete directly with the company’s pre-IPO backers and related entities.

Management and Consulting Agreements Management and consulting agreements are contractual agreements that allow for payments to company backers, key executives, or directors for the provision of ongoing administrative, management or professional services not related to specific salaried positions, including contracts with private entities held primarily or entirely by company executives or directors. Buyout fund Kohlberg, Kravis and Roberts (KKR) often employs such agreements with its holdings. Rockwood Holdings (a buyout-fund-backed company), for example, reported a management services agreement… with KKR and DLJMB to provide “certain management, business strategy, consulting and financial services to [Rockwood] and [its] subsidiaries…The aggregate annual fee under the management services agreement [was] $2.0 million, which amount was increased by 5% each year and was payable quarterly to KKR and DLJMB on a pro rata basis based on their respective percentage equity interest in [Rockwood].” Under the terms of this agreement Rockwood paid a transaction fee of $21.0 million to KKR and $9.0 million to DLJMB (or an aggregate fee of $30.0 million) in connection with the closing of its Dynamit Nobel acquisition. The agreement also included indemnification language intended to protect KKR from potential litigation or other disputes. While KKR has maintained such agreements with other firms post-IPO, in this case the agreement was terminated “for an aggregate consideration of $10.0 million,” although the company also notes that, “certain provisions in the management services agreement, including indemnification, survive such termination." Another buyout-fund-backed company, Accuride Corporation, had a similar agreement with KKR and Trimaran Fund Management L.L.C., (TFM) for management and consulting services, “of the type customarily performed by investment companies to its portfolio companies,” that involves annual fees of $665,000 to KKR and $335,000 to TFM, plus “all reasonable out-of-pocket expenses incurred in connection with such retention, including travel expenses and expenses of legal counsel.” In this case, the term of the agreement is tied to KKR’s and TFM’s continued involvement with Accuride through a Shareholder Rights Agreement with both parties, or in the event of a change of control “as provided in the

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Shareholder Rights Agreement." Cerberus and several other private equity buyout firms also commonly employ similar agreements.

Real Estate Leases and Agreements Real estate leases and agreements are typically leases for privately held offices, plants or other real estate assets directly or indirectly held by company backers or by individual company executives or directors. For example, Blackbaud, Inc. (a buyout-fund-backed company) reported on a ten year lease for its corporate headquarters in Charleston, South Carolina with an entity owned by a principal shareholder and two executives of Blackbaud. The lease payments are $4.3 million per year, terms the company believes to be “at least as favorable to us as could have been obtained from an unaffiliated third party.” Consolidated Communications Holdings (another buyout-fund-backed company) reported on a number of sale/leaseback arrangements involving entities affiliated with company Chairman and former CEO Richard A. Lumpkin. Beacon Roofing supply similarly reported a lease agreement worth $600,000 a year with an entity affiliated with company Chairman and former CEO Andrew R. Logie. H&E Equipment Services reported on leases for multiple facilities owned by various members of the Engquist family, including the company’s CEO and other members of the board. These are all very typical examples of this kind of agreement.

Aircraft Leases and Agreements Aircraft leases and agreements involve the corporate use of private aircraft either directly or indirectly owned by individual company backers, shareholders, executives or directors. H&E Equipment Services (a buyout-fund-backed company), for example, charters an aircraft from Gulf Wide Aviation, an entity owned by members of the Engquist family who represent the “E” in H&E Equipment and are related to H&E CEO John M. Engquist; in 2002, 2003 and 2004, payments “in respect of charter costs to Gulf Wide Aviation and salary to the pilot totaled approximately $294,000, $244,000 and $273,000, respectively.” Life Time Fitness (a non-PE-backed company) reported a similar arrangement, but noted that it has recently purchased its own aircraft and terminated that agreement. Advance America, Cash Advance Centers, Inc. (a non-PE-backed company), in a unique variation on this theme previously paid “approximately $1.1 million in 2001, $1.3 million in 2002, $1.1 million in 2003 and $829,000 in the first nine months of 2004” for airplanes leased from company board members. The company intends to purchase two of these planes from the same parties using company shares as valued at IPO, thus terminating its prior agreements.

Shareholder Rights Agreements Shareholder Rights Agreements are specialized agreements that can significantly impact the corporate governance of a firm, most often by specifying special voting rights or the ability of certain shareholders or shareholder blocks to designate one or more of the company’s directors. These agreements were the single most common – and important – type of agreement noted among the various related party transactions reported by these companies, particularly among the buyout-fund-backed companies. They

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are especially favored by the large buyout firms. KKR and Cerberus that often employ them to assert a degree of control over these companies post-IPO that is significantly greater than their economic exposure.

While all shareholder agreements share similar characteristics, some provide the pre-IPO holders with effectively total control over the affairs of the company for the foreseeable future, putting the company’s minority public shareholders at a significant disadvantage. By normal public corporation standards, these agreements could hardly be considered good corporate governance practices, but they are not uncommon among companies making the transition to public trading. At Rockwood Holdings, for example, the Stockholders' Agreement with Affiliates of KKR and DLJMB gives KKR the right to designate five, and DLJMB to designate two, of the company’s eight directors post-IPO. The agreement also restricts DLJMB’s ability to transfer shares, and includes drag-along rights that would allow KKR to force DLJMB’s participation in any sale of company shares as negotiated by KKR. The agreement also provides both parties with registration rights, which are often incorporated in these agreements. GateHouse Media reported on an Investor Rights Agreement with another large private equity firm, Fortress Investor Group. The Investor Rights Agreement provides Fortress with the ability to nominate a number of company directors proportionate to its holdings in the company. The agreement also includes a number of different registration rights arrangements and mutual indemnification language. At SMART Modular Technologies (a buyout-fund-backed company) a shareholders' agreement with “TPG, Francisco Partners and Shah Capital Partners and certain other shareholders… covers matters of corporate governance, restrictions on transfer of [the company’s] securities and information rights.” The terms of the agreement spell out the number of directors to be designated by each party, and goes on to severely limit the ability of the company to undertake various strategic options without the express approval of this particular group of shareholders.

Registration Rights Agreements Often tied to a related shareholder rights agreement, a registration rights agreement typically requires the company to register for sale shares privately held by one or more shareholders or shareholder blocks at some time after the initial IPO and at the shareholder’s discretion. This action has the effect of making the shares widely transferrable in the market. Registration rights agreements are common among both types of IPOs included in this study. A typical registration rights agreement reported by Assurant, Inc. (a non-PE-backed company) with Fortis Insurance, Assurant’s owner prior to IPO, grants registration rights to Fortis and its affiliates exclusively during the first year after IPO. As with the Shareholder Rights Agreements described above, KKR, Cerberus and other large buyout firms often employ such registrations rights agreements. This may be because buyout-fund-backed companies tend to have their backers retain a majority stake in the company post-IPO (49 percent of companies have this characteristic, according to the Ownership analysis section above). These backers may wish to decrease their ownership gradually to participate in share price appreciation once the company goes public. Registration rights agreements would facilitate this to happen and may therefore be in place at a higher rate at buyout-fund-backed companies.

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Indemnification Agreements Indemnification agreements indemnify one or more parties to the company’s IPO, placing the burden of defense on the company should legal action ensue. Such agreements typically involve the company’s backers, and are only slightly more common at buyout-backed firms than at non-PE-backed companies. Indemnification language may also be incorporated in Shareholder Rights or Registration Rights agreements. The language must be quite precise. For example, the “Indemnification and Expense Agreement” between EnerSys (a buyout-fund-backed company) and various Morgan Stanley firms states that:

to the fullest extent permitted by law, none of such stockholders, or any of their respective partners or other affiliates, or their respective members, stockholders, directors, managers, officers, employees, agents or other affiliates, or any person or entity who serves at the request of any such stockholder on behalf of any person or entity as an officer, director, manager, partner or employee of any person or entity (referred to as indemnified parties), shall be liable to us for any act or omission taken or suffered by such indemnified party in connection with the conduct of our affairs or otherwise in connection with such stockholder’s ownership of shares of our common stock, unless such act or omission resulted from fraud, willful misconduct or gross negligence by such indemnified party or any mistake, negligence, dishonesty or bad faith of any agent of such indemnified party. We have also agreed with each Morgan Stanley Fund that, to the fullest extent permitted by law, we will indemnify each of such indemnified parties for any and all liabilities and expenses (including amounts paid in satisfaction of judgments, in compromises and settlements, as fines and penalties and legal or other costs and reasonable expenses of investigating or defending against any claim or alleged claim) of any nature whatsoever, known or unknown, liquidated or unliquidated, that are incurred by such indemnified party and arise out of or in connection with our affairs, or any indemnified party’s ownership of shares of our common stock, including acting as a director, manager or officer or its equivalent; provided that an indemnified party shall be entitled to indemnification only to the extent that such indemnified party’s conduct did not constitute fraud, willful misconduct or gross negligence. We have also agreed to pay, or reimburse, each Morgan Stanley Fund for all such stockholder’s reasonable out-of-pocket fees and expenses incurred in connection with and related to such stockholder’s ownership of shares of our common stock.

While nearly all the types of RPTs examined were reported by at least one company in each group, the buyout-backed and non-PE-backed groups differed significantly in several key areas. Consulting agreements with top management and both shareholder rights and registration agreements were most common among the buyout-backed firms, while ongoing business contracts and relationships were dominant among the non-PE-backed companies.

Table 7: Related Party Transactions (Source: The Corporate Library)*

IPO As of December 31, 2007 As of December 31, 2008

Buyout-Fund-

Backed (#)

Non-PE-

Backed (#)

Buyout-Fund-

Backed (%)

Non-PE-

Backed (%)

Buyout-Fund-

Backed (#)

Non-PE-

Backed (#)

Buyout-Fund-

Backed (%)

Non-PE-

Backed (%)

Buyout-Fund-

Backed (#)

Non-PE-

Backed (#)

Buyout-Fund-

Backed (%)

Non-PE-

Backed (%)

Loans Equity 11 9 22.92% 21.43% 3 1 6.25% 2.38% 3 1 6.82% 2.44%

Loans Other 12 7 25.00% 16.67% 4 6 8.33% 14.29% 4 6 9.09% 14.63%

Business Relationships

16 24 33.33% 57.14% 12 19 25.00% 45.24% 11 18 25.00% 43.90%

Consulting 28 11 58.33% 26.19% 18 10 37.50% 23.81% 16 9 36.36% 24.39%

Real Estate 11 6 22.92% 14.29% 10 4 20.83% 9.52% 10 4 22.73% 9.76%

Aircraft 1 3 2.08% 7.14% 2 3 4.17% 7.14% 2 3 4.55% 7.32%

Shareholder Agreements

32 13 66.67% 30.95% 21 4 43.75% 9.52% 19 4 43.18% 9.76%

Registration Rights

21 12 43.75% 28.57% 13 9 27.08% 21.43% 13 9 29.55% 21.95%

Indemnification 9 4 18.75% 9.52% 6 5 12.50% 11.90% 8 5 18.18% 12.20%

No RPTs 2 6 4.17% 14.29% 3 8 6.25% 19.05% 3 8 6.82% 19.51%

* Note: The counts here reflect the number of each type of related party transaction present in the sample, not the number of companies that had each type of transaction.

Chart 10: 2008 Distribution of Related Party Transaction Categories (Source: The Corporate Library)

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TAKEOVER DEFENSES

Summary Findings

IPO companies backed by buyout funds had significantly stronger takeover defenses than companies brought public by non-private-equity sponsors. Companies backed by buyout funds were more likely than others to have classified boards, poison pills, and restrictions on director removal by shareholders. Non-PE-backed companies were more likely, as a group, to restrict shareholders’ ability to fill board vacancies, but this may be in compensation for the group’s lower rates of classified boards and director removal restrictions and does not contradict the conclusion that buyout-fund-backed companies are, in general, better defended than their IPO peers.

While these differences can be seen in the whole sample analysis, they appear even more starkly in our study of the matched pairs, which is intended to control for variations due to industry affiliation and market capitalization and to better isolate the effects of buyout fund backing. In that sample, buyout-fund-backed companies were more likely than others to restrict shareholders’ rights to fill board vacancies or amend a company’s bylaws, and were more likely to have the latter provision in conjunction with a classified board, which makes for a particularly potent takeover defense.

Moreover, companies with buyout fund sponsorship employed certain structural takeover defenses—those that are usually embedded in company charters and thus are most difficult to change—at a higher rate than that seen among the overall US market, according to our national studies. This difference may be due to the fact that the buyout-fund-backed companies we analyzed went public very recently, after the hostile takeover wave of the 1980s made the importance of takeover protections apparent and after institutional investor opposition made it much more difficult for companies to add anti-takeover provisions to their charters post-IPO. (The IPO dates of companies in the broader market, by contrast, span many decades.)

Somewhat surprisingly, however, buyout-fund-backed companies were less likely to have adopted a poison pill than companies in the US market. It is possible that companies in the broader group have adopted pills at a higher rate because the other, structural defenses are not easily added. It may also be the case that the ongoing ownership stake of buyout funds following the IPO is viewed as making a tender offer—the hostile takeover strategy against which the pill defends—less likely.

Discussion

We assessed the prevalence of certain takeover defenses among the companies studied; specifically, we determined whether companies had the following features:

• A staggered, or classified, board in which directors are divided into groups or classes, with only one class up for election at each annual meeting and requiring multiple successive elections to change control of the board

• A shareholder rights plan or “poison pill” – a device that makes a hostile takeover prohibitively expensive by massively diluting a bidder’s stake in the target

• Charter or bylaw provisions limiting shareholders’ ability to remove directors before the expiration of their term (including supermajority voting requirements for removal and requirements that removal be effected only for “cause”) or shareholders’ ability to fill board vacancies; these defenses are important because a hostile bidder seeking to change control of the board will seek either to remove incumbent directors and replace them with nominees aligned with the bidder or to enlarge the size of the board and fill the resulting vacancies with friendly nominees

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• Restrictions (including outright prohibition or a supermajority voting requirement) on shareholders’ ability to amend the bylaws, which make it more difficult for shareholders to change certain features, such as the size of the board

Certain defenses, however, are most powerful in combination. The antitakeover effect of a classified board, for instance, is blunted if shareholders continue to have the power to remove directors without cause and to fill the resulting vacancies. For that reason, we also evaluated whether the companies in the study had the following combinations:

• “Effective” classified board, which not only staggers director elections but also limits shareholders’ ability to remove and replace directors and to amend the bylaws

• Classified board and a poison pill, which prevents a hostile bidder from replacing a majority of the board in one year and precludes the bidder from acquiring control via a tender offer

Whole Sample Analysis

The whole sample analyzed with respect to takeover defense characteristics included 87 companies – 46 companies that were backed by one or more buyout funds and 41 companies that were not backed by any type of private equity funds. (Takeover defense data was not available for three IPO companies due to foreign domicile or organization as a limited liability company.)

Classified Board

IPO companies backed by buyout firms were, on the whole, somewhat more likely than companies without PE firm backing to go public with a classified board. Specifically, we found that 57.4% of buyout-fund-backed companies had a classified board, compared with 53.7% of the other IPO companies. This compares to the overall US market’s percentage of classified boards at 54% in 2007 and 53% in 2008, according to our national studies.

The percentages found at these IPO companies are notable for two reasons. First, the frequency with which classified boards were found in both groups of companies significantly exceeds that found in IPO companies (both those backed by buyout funds and those without such backing) that went public in the mid to late 1990s. In a study of companies that went public from January 1, 1994 through July 1, 1997, Robert Daines and Michael Klausner found that 47.2% of companies with LBO fund backing and 40.7% of companies that did not have buyout or venture capital fund sponsorship had classified boards.28 This sharp increase may reflect the fact that it is now nearly impossible at companies with substantial institutional ownership to move from an unclassified to a classified board midstream through a charter amendment or shareholder-approved bylaw amendment because institutional investors’ voting guidelines generally do not support such changes. As a result, companies that think that having a classified board might be advantageous would opt to include it at the time of the IPO.

Second, our findings show a narrowing of the difference between buyout-fund-backed and other companies in the rate at which they go public with a classified board. In Daines and Klausner’s study, companies backed by buyout funds were nearly 16% more likely to have a classified board than non-PE-backed companies. (That is, the 6.5% difference between the two groups was equal to nearly 16% of the 40.7% of non-PE-backed companies with this feature.) That differential was cut to just under 7% in the companies we studied. It is possible that IPO companies are getting more uniform legal advice about the desirability of installing a classified board than was the case during the 1990s, or that buyout fund sponsors now feel more pressure to stay in the mainstream with respect to IPO company charters (with that mainstream, however, moving in the direction of greater entrenchment).

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None of the companies in either category with classified boards declassified them between the IPO date and the end of 2008. This finding is unsurprising despite the intense lobbying by shareholders in the past several years for companies to declassify their classified boards. The relative brevity of the study period means that shareholders would have been hard-pressed to mount a proxy campaign in favor of declassification, in light of the one-year holding requirement to submit a shareholder proposal and the time required to submit the proposal, have it voted on and pressure the board (since declassification proposals are non-binding) to act on a favorable result. Moreover, the continuing significant share ownership on the part of the buyout fund sponsors following the IPO would deter the submission of a shareholder proposal, since the funds could be expected to vote against such a proposal.

Poison Pill

Poison pills stand on a somewhat different footing than the other defenses analyzed in this study, all of which are found in company charters (and, to a lesser extent, bylaws) or supplied by state law in the absence of relevant company-specific provisions and are, as a result, difficult to change. A poison pill, by contrast, can be put in place quickly and unilaterally by a company’s board, assuming the company’s charter has authorized the securities that give the pill its potentially dilutive effect. For that reason, it has been said that every company has a “shadow” pill29 and that the fact that a company has not adopted a pill does not affect how well-defended it is against a hostile takeover.

While that reasoning is persuasive, we studied the presence of a poison pill in this study for two reasons. First, we believe it likely serves a signaling function, communicating information to the market and potential bidders about the board’s likely negotiating stance in the event of an overture. Second, the adoption of a poison pill has been found to be correlated with lower firm value, at least as part of a six-variable entrenchment index.30

Companies with buyout fund backing were much more likely to have a poison pill in place at the time they went public than companies that did not have a PE fund sponsor, but the overall numbers were low. Of the IPO companies backed by buyout funds, 10.9%, representing five companies, had poison pills in place, compared with 2.4% of companies (one company) without PE fund sponsorship that did so. This compares to 34% of the US market that had poison pills in 2007 and 29% in 2008 according to our national studies.

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Chart 11: Select Takeover Defenses Immediately After IPO (Source: The Corporate Library)

The IPO groups’ numbers grew somewhat over the study period but the gap between the buyout-fund-backed and other companies remained: by the end of 2007, six buyout-fund-backed companies, or 13.0%, and two non-PE-backed companies, or 4.9%, had a poison pill. At the end of 2008, seven or 15.2% of the buyout-fund-backed companies had adopted a pill, while four or 9.8% of companies without a PE fund sponsor had done the same. The increase over time may indicate that companies in both groups believed they were more vulnerable to an unsolicited takeover in later years than they were at the time of the IPO, perhaps as a result of ownership becoming more dispersed as financial sponsors sold down their equity stakes.

Chart 12: Select Takeover Defenses As of December 31, 2008 (Source: The Corporate Library)

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Restrictions on Removal and Replacement of Directors

At the IPO, a significantly higher proportion of companies backed by buyout funds had restrictions on shareholders’ ability to remove directors before the end of their term, which could take the form of requiring “cause” for removal or of requiring that removal be approved by holders of a supermajority of outstanding shares. Among buyout-fund-backed companies, 67.4% had such limitations in place, while 56.1% of companies not backed by PE funds did. The proportions were unchanged as of the end of 2007; as of the end of 2008, one non-PE-backed company had added removal restrictions, increasing the percentage of such companies with removal restrictions to 58.5%, with the buyout-fund-backed companies’ proportion remaining the same.

Companies not backed by PE funds were significantly more likely to limit shareholders’ ability to fill vacancies than were buyout-fund-backed companies. Just over 54 percent of companies with buyout fund backing had such limitations at the IPO, and this proportion diminished somewhat to 50% by the end of 2007 and 2008. Among companies not backed by PE funds, 63.4% restricted shareholders’ ability to fill board vacancies at the IPO; that figure rose to 65.9% at the end of 2007 and 2008. This compares to only 39% of the US market with this restriction in 2007 and 40% in 2008 according to our national studies.

Both of these defenses tend to be seen in conjunction with classified boards, because many state statutes provide that, absent a contrary provision in the charter or bylaws, directors on a classified board can only be removed for cause and that vacancies on such a board can only be filled by the directors. The proportion of companies backed by buyout funds with these structural defenses, however, exceed the proportion with classified boards, suggesting that even companies with annual election of directors find it useful to limit shareholders’ ability to change the composition of the board outside of the normal annual meeting cycle. Indeed, of the 20 companies backed by buyout funds that did not have classified boards at the IPO, seven or 35% had restrictions on director removal and nine or 45% limited shareholders’ ability to fill vacancies.

Bylaw Amendment Restrictions

As with vacancy restrictions, companies that were not backed by PE funds were more likely to impose restrictions on shareholders’ ability to amend the bylaws than buyout-fund-backed companies, though the difference between the two groups was smaller. At the IPO, 54.3% of companies with buyout fund sponsorship limited shareholders’ power to amend the bylaws, compared with 58.5% of companies not backed by PE funds. There was a slight uptick during the study period in non-PE-backed companies with bylaw amendment restrictions: by the end of 2007, one company added them, making the proportion 56.5%. At the end of 2008, another non-PE-backed firm had limited shareholders’ ability to amend the bylaws, bringing the percentage to 61.0%.

“Effective” Classified Board

The concept of the “effective” staggered or classified board originated in an influential law review article: Lucian Bebchuk, John Coates & Guhan Subramanian, “The Powerful Antitakeover Force of Staggered Boards,” 54 Stanford L. Rev. 887 (2002). An effective classified board describes a group of defenses that not only stagger the election of directors but also prevent circumvention of that classification through (a) director removal and replacement or (b) enlargement of the board to an extent that a bidder can elect enough directors to constitute a friendly majority. We counted a board as “effectively” classified where the following was true: the board was classified, there were restrictions on shareholders’ power to remove directors, shareholders lacked the power to fill board vacancies, and shareholders’ power to amend the bylaws was limited.

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Surprisingly, in light of the findings with respect to classified boards standing alone, companies with buyout fund backing were somewhat less likely to have effective classified boards at the IPO than were companies not backed by PE funds – 28.3% and 34.1%, respectively. That gap widened by the end of 2007, when 26.1% of buyout-fund-backed companies and 36.6% of non-PE-backed companies had effective classified boards. At the end of 2008, those figures were unchanged. This compares to a US market percentage of only 13% of companies having an effective classified board in 2007 and 16% in 2008, according to our national studies. The overall number of IPO companies in both categories with effective classified boards was relatively low: 14 non-PE-backed and 13 buyout-fund-backed companies at the IPO and 12 buyout-fund-backed and 15 non-PE-backed at the end of 2007 and 2008. Compared to the number of companies with classified boards, the number with effective classified boards is relatively small.

Classified Board and Poison Pill

The combination of a classified board and a poison pill is considered particularly potent because the poison pill interferes with a hostile bidder’s ability to mount a tender offer for the target’s shares and the classified board precludes the bidder from changing control of the board in a single proxy contest; in other words, both of the major strategies employed by a hostile bidder are rendered prohibitively expensive or unavailable by this combination of defenses.

Very few companies in either of the two categories had both a classified board and a poison pill at the IPO, though companies with buyout fund backers were more than three times more likely to have this combination in place. Four companies (8.5%) backed by buyout funds had both a classified board and a poison pill at the IPO, compared with only one of the companies not sponsored by a PE fund (2.4%). The numbers increased somewhat by the end of 2007, when five buyout-fund-backed companies (10.6%) and two companies in the other category (4.9%) had a classified board and a poison pill. At the end of 2008, one more non-PE-backed company had the combination, bringing the percentage to 7.3%, while the proportion of buyout-fund-backed companies was unchanged. The low overall numbers are a logical consequence of the low number of companies in both categories with poison pills both at the IPO and the end of 2007 and 2008.

Matched Pairs Analysis

The matched pairs analysis for takeover defenses included nineteen pairs of companies matched with respect to industry classification and market capitalization. Comparing the governance of the two groups of companies—those backed by buyout funds and those without PE backing—using matched pairs eliminates some other factors that might affect the choice of governance structures. The matched pairs subsample, however, is smaller, with 19 companies in each of the two groups, compared with 46 and 41 in the whole sample. The 19 pairs include 16 of the 18 pairs analyzed in the other sections of this study and listed in Appendix B; of those 18 pairs, two (Copano Energy/Atlas America and Republic Airways Holdings/Macquarie Infrastructure) could not be analyzed because takeover defense data was not collected due to LLC status. Three matched pairs, all IPOs from 2006, were added only for purposes of takeover defense analysis: Aventine Renewable Energy Holdings/Delek US Holdings, Clayton Holdings/Home Bancshares and Obagi Medical Products/Alexza Pharmaceuticals.

Classified Board

Unlike the whole sample analysis, the matched pairs subsample shows a substantial difference between companies backed by buyout funds and companies not backed by PE funds in the rate at which they go public with classified boards. Almost two-thirds (63.2%) of companies with buyout fund backing had a

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classified board at the time of IPO, compared with only 42.1% of other companies. The difference is striking: in the matched pairs subsample, buyout-fund-backed companies are 50% more likely to have a classified board than companies in the other group, compared with a 7% greater likelihood in the whole sample. The data for the end of 2007 and 2008 were unchanged.

Poison Pill

As in the whole sample analysis, few companies in either group had adopted a poison pill at the time they went public. Two companies backed by buyout funds had a poison pill at the IPO (10.5%); one company added a poison pill between the IPO and end of 2007, bringing the proportion to 15.8%. Among companies without a PE fund sponsor, only one (5.3%) had a poison pill at IPO and at the end of 2007. At the end of 2008, however, three companies or 15.8% of this group had adopted a poison pill. Thus, although buyout-fund-backed companies were two times as likely to have a poison pill in place at the IPO and three times as likely to have a pill at the end of 2007, the small number of companies makes those differences seem less dramatic.

Moreover, the difference between the two groups of companies had disappeared by the end of 2008, perhaps due to common pressures caused by the troubled equity markets. A board tends to adopt a poison pill when the company’s stock price is depressed and the board as a result views the company as vulnerable to an opportunistic bid that does not reflect the company’s long-term value.

Limitations on Removal and Filling of Vacancies

Companies in the matched pairs subsample with buyout fund sponsors were somewhat more likely to limit shareholders’ ability to remove directors and fill board vacancies than were companies not backed by PE funds. A bit over two-thirds (68.4%) of buyout-fund-backed companies imposed limits on the removal right, compared with 52.6% of the companies in the other group. The gap was unchanged at the end of 2007 but had narrowed by the end of 2008, when 57.9% of the non-PE-backed companies limited removal rights. (The figure for buyout-backed companies stayed the same.)

Companies with buyout fund sponsorship were slightly more likely to restrict shareholders’ right to fill board vacancies at the IPO—68.4% of these companies did so, while 63.2% of companies not backed by PE funds imposed such limitations. By the end of 2007, however, those proportions had flip-flopped, with 68.4% of non-PE-backed companies imposing vacancy restrictions and 63.2% of buyout-fund-backed companies doing so. Those proportions continued through the end of 2008.

Bylaw Amendment Restrictions

Matched pair companies that were backed by buyout funds were more somewhat likely to limit or eliminate shareholders’ ability to amend the bylaws: both at the IPO and the end of 2007, 57.9% of these companies imposed such limitations, compared with 47.4% in the other group of companies. At the end of 2008, one company in each group had added bylaw amendment restrictions, bringing the percentages to 52.6% in the non-PE-backed group and 63.2% among companies with buyout fund sponsors. Here, the matched pairs showed a different pattern from the whole sample, where companies not backed by PE funds were more likely to limit the bylaw amendment right than buyout-fund-backed companies.

Effective Classified Board

Companies backed by buyout funds were more likely to have an effective classified board than companies without PE fund backing, which is inconsistent with the findings in the whole sample analysis, where the pattern was reversed. Of the buyout-fund-backed companies, 36.8% had an effective

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classified board at IPO, compared with 21.1% of the other companies. The difference narrowed by the end of 2007, when 31.6% of companies with buyout fund sponsors had an effective classified board, compared with 26.3% of the other companies. The proportions remained unchanged through the end of 2008.

Classified Board and Poison Pill

As one would expect given the paucity of poison pills among companies in both groups, very few companies had the combination of a classified board and a poison pill either at IPO or the end of 2007 or 2008. At the IPO, two buyout-fund-backed companies (10.5%) in the matched pairs had both a classified board and a poison pill, while one company without PE fund sponsorship (5.3%) had both defenses. By the end of 2007, the number of buyout-fund-backed companies with both defenses had increased to three (15.8%) whereas the number of companies from the other group stayed at one. The gap narrowed a bit by the end of 2008 because one non-PE-backed company added the combination, bring the total percentage to 10.5%, while the buyout-fund-backed proportion remained the same. These results are consistent with those found in the whole sample analysis.

Conclusion

In sum, companies that go public with backing from one or more buyout funds are more likely to employ a variety of takeover defenses, including the classified board and the poison pill (and the combination of those two defenses) than companies that go public without PE backing. With respect to certain other defenses, however, including structural defenses aimed at preventing shareholders from being able to remove and replace directors or amend the bylaws, the pattern is not so clear-cut because the whole sample analysis shows companies not backed by PE funds adopting these defenses at a higher rate.

Because earlier studies did not assess most of the defenses examined in this study (save for the classified board), it is not possible to compare the pattern over time. Extrapolating from the data on classified boards, however, it seems likely that not only that defense but the defenses associated with it—limitations on director removal and replacement—became more common in the period under study than they had been in the 1990s.

The results of our analysis show that the activist energy that has convinced many public companies to dismantle existing takeover defenses has not translated into positive change among companies at the IPO stage; indeed, the trend seems to be heading in the opposite direction. It may be the case that institutional investors are of two minds on defenses. Most institutions favor abolishing defenses when voting on shareholder meeting ballot items such as shareholder proposals to declassify the board, reflecting an assumption that takeover defenses in general are harmful to firm value. Those same institutions may not, however, accurately price (and thus not discourage the use of) defenses in the context of investment decision making.

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COMPENSATION—POLICY ANALYSIS

Methodology

For this section of our study, we first examined the compensation policies of 48 IPO companies, half buyout-fund-backed and half not backed by any type of private equity firm, with sixteen each from 2004, 2005 and 2006. Analysis was conducted by assessing compensation policy both pre-IPO and post-IPO. Most of the data was taken from compensation committee reports, compensation discussion and analyses, and compensation tables published in proxy statements, S-1s or 10-Ks.

Specific attention was paid to both the forms of compensation, as well as to any changes that might have been made subsequent to the IPO. It is an often-made contention that buyout-fund-backed companies have effective compensation policies that produce highly incentivized executives who have significant upsides if performance merits it, and lower levels of fixed pay and other forms of non-performance-based compensation. Our study sought to investigate this claim.

To this end, long-term compensation – all, notably, in the form of equity or equity-based instruments – was analyzed to look at the form and structure of the equity used. In addition, short-term incentives were assessed, paying close attention to the metrics used to assess performance and whether these changed after IPO. Base salaries, and any increase in such, as well as the provision of perquisites and benefits were also considered. Finally, it was noted whether the company utilized employment agreements to retain executives, particularly the CEO. It should be noted that we did not examine either operational performance or total shareholder return for the companies in this study, and we are making no claims about the actual achievements of their executives. However, our analysis carefully examines the structure of their compensation packages and assesses which are likely to align CEO pay with the interests of shareholders by incorporating structures that have been widely believed to link pay to performance.

Finally, we conducted an analysis of six matched pairs of IPOs from each of 2004, 2005, and 2006, investigating the same questions. This step was designed to control for the influence of industry and market cap on the type of governance characteristics present at the companies.

Summary Findings

Our analysis does not support the often-made claim that buyout-fund-backed companies excel at linking executive compensation to performance. Our research does indicate that buyout-fund-backed companies use a wider range of equity vehicles and incentive measures for executive compensation than do their non-PE-backed peers. These features give their compensation policies an initial appearance of greater complexity and sophistication. In addition, buyout-fund-backed companies were more likely to change compensation practices post-IPO or introduce a new form of compensation that had not been awarded in the past, while non-PE-backed companies concentrated on relatively simple and straightforward compensation practices pre-IPO and continued with them post-IPO. However, when the particulars of the policies are examined, there is little basis to conclude that the buyout-fund-backed companies’ policies are, in practice, more likely to be effective at linking pay to performance. Indeed, the simpler policies typically found at non-PE-backed companies may be at least as efficient in reaching this objective. The one area in which non-PE-backed companies’ policies displayed greater diversity was that of performance metrics. This is an additional indicator that these companies may be making more careful efforts to reward executives based on achievements beyond the narrow spectrum of earnings measurement.

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Furthermore, buyout-fund-backed companies displayed what we consider poor compensation governance in a number of respects. For instance, the use of tax gross-ups (a practice in which the company pays taxes on perquisites and other benefits received by the CEO, and which is not tied to performance in any way) was far more prevalent at buyout-fund-backed companies. Similarly, lucrative consultancy agreements for former executives, very generous employment agreements, and special bonuses were significantly more common at buyout-fund-backed firms. It seems reasonable to connect these practices to the presence of buyout fund backers, not only because the practices are either absent or much less common in the control group, but also because, as explained in our discussion of board committees above, buyout fund backers tend to retain control over many compensation committees immediately post-IPO. Although our study cannot speak conclusively to why this kind of compensation governance might exist at buyout-fund-backed firms, we speculate that buyout fund backers may be using compensation policy in the same way that Michael Klausner (2003) theorized they might use takeover defenses: as a means of rewarding company managers, acquiring a reputation for doing so, and ensuring their own access to future buyout deals.

These conclusions were supported both by the larger sample, and by the matched pairs analysis.

Discussion

Larger policy sample

Long-term compensation

As has already been indicated, all long-term compensation was offered in the form of equity (stock options, restricted stock, or performance stock) or equity-related vehicles (such as stock appreciation rights, or Class B Interests). Although a significant number of both buyout-fund-backed and non-PE-backed companies changed their approach to long-term compensation after their IPO, none moved to cash-based long-term compensation. The adoption of a long-term compensation policy post-IPO, when none had been in place before the public offering, was more common in buyout-fund-backed companies than in their non-buyout-fund backed peers.

Stock options were the equity compensation vehicle of choice pre-IPO in buyout-fund-backed companies, with 50% of the companies awarding them. Post-IPO, both stock options and restricted stock were equally widespread. In contrast, for non-PE-backed companies stock options were common and clearly dominant pre-IPO and remained so post-IPO. However, it should be noted that from pre-IPO to post-IPO, the number of buyout-firm-backed companies awarding restricted stock doubled, while the number of non-PE-backed companies using this equity vehicle stayed the same. These findings would not suggest that buyout-firm-backed companies have a very highly-incentivized executive group. Firstly, pre-IPO many executives did not receive any long-term incentives at all, and while there was a growth in the number receiving stock options this was exceeded by the growth in the use of time-vesting restricted stock – commonly regarded as a “pay-for-pulse” compensation vehicle which retains value whether a company has increased in value or not. In contrast, CEOs at non-PE-backed companies were far more likely to be in receipt of stock options than restricted stock.

On the other hand, buyout-fund-backed companies also were more likely to adopt performance-restricted stock than non-PE-backed companies, possibly indicating a greater tendency toward more sophisticated equity vehicles. Buyout-fund-backed companies are more likely to use restricted stock of both kinds – time-restricted only, and time- and performance-restricted, but the sample size for the latter is very low and therefore not necessarily significant. However, since buyout-fund-backed companies generally award restricted stock over stock options (a vehicle that requires a stock price increase for any profit to be

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available) compensation policy at these companies can be seen as less performance-based than at non-PE-backed companies. As a consequence of buyout-fund-backed companies awarding more performance-restricted stock, buyout-firm-backed companies had a more varied set of long-term performance measures than non-PE-backed companies. In at least two cases, though, the same metric was used in the long-term as was used to assess short-term performance, which tends to mitigate the impression of sophistication.

In addition to expanding the number of compensation vehicles being used, buyout-fund-backed companies were also more likely to increase the value of individual awards. (Please note that in our analysis, we have not recorded the introduction of a particular award post-IPO as an increase.) Buyout-fund-backed companies were also slightly more likely to introduce new equity plans post-IPO.

Short-term incentives

Two companies (both non-PE-backed) in the sample did not utilize short-term cash bonuses, apparently deciding that the pre-IPO grants of equity were sufficient continuing incentive. Of those companies that did award annual bonuses, a greater number of buyout-fund-backed companies increased the potential target value of these awards. Both the buyout-firm-backed companies and the others experienced approximately the same level of change in annual performance metrics pre- and post-IPO. Although earnings was the most common metric in both types of IPO, there was much more diversity of metrics in non-PE-backed companies. In four buyout-fund-backed companies, a more complex set of short-term metrics was adopted post-IPO. In contrast, most of the change to metrics in non-PE-backed companies was to reduce the complexity of measurement or to switch from one earnings metric to another.

Three buyout-fund-backed companies also awarded cash bonuses specifically related to the IPO event. Cash bonuses based on successfully managing the IPO are not related to the company’s ability to generate value for public shareholders.

Fixed pay

More non-PE-backed companies increased salary significantly post-IPO, in some cases in response to what were termed the “greater responsibilities” of running a public company. In contrast, it was buyout-fund-backed companies that saw an increase in the provision of executive-style benefits (such as club dues and use of corporate transportation), while pre-IPO they were at around the same level as those in non-PE-backed companies. In one instance this was in response to hiring a new CEO, but in others it represented an expansion of perks to an existing executive.

Employment agreements

The same number of companies in each group employed executives using employment agreements pre-IPO. Two buyout-fund-backed amended or signed new agreements with the CEO either at IPO or shortly afterwards and in each instance this led to a significant increase in compensation. This was not the case at the one non-PE-backed company that moved its CEO to an employment agreement.

The general level of complexity in compensation plans post-IPO appears to be higher in buyout-fund-backed companies, with a greater variety of incentives in use. However, not all of these are widely believed to actually lead to a closer tie between compensation and performance.

Indeed, along with this higher level of sophistication and incentivization come potential indicators of poor compensation governance. This includes higher levels of perquisites such as tax gross-ups and

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consultancy payments, as well as discretionary bonuses, executive chairmen sitting on compensation committees and over-generous employment agreements.

To illustrate this conclusion, we present examples of questionable compensation governance found at buyout-firm-backed companies below. While a smaller number of non-PE-backed companies did gross up some benefits for income tax, none provided examples of the other types of compensation practices included in the list below.

• Blackbaud, where option gains for former CEO had a tax gross-up element • Bluelinx Holdings, where, after his resignation in 2006, the former CEO started to receive

consultancy payments that were double his salary at the time of his employment • Wellcare Health Plans, where a post-IPO 5-year contract was signed that brought in significant

increases in almost every compensation element • Alpha Natural Resources’ post-IPO employment agreement led to significant increases in salary

and bonus opportunity • Consolidated Communications, where the executive chairman sits on the compensation

committee and the proxy contains many related party transactions involving him • GateHouse Media, where a substantial sign-on bonus was awarded to the CEO in 2006, the year

of IPO • ICF, where a Special Event Bonus generated a large cash bonus for all executives in the year of

IPO (2006) – the IPO being the special event • Dyncorp International, where retention bonuses were paid out that were supposed to retain

executives during the period of the IPO. Despite payment of these significant retention bonuses, three executives, including the CEO, left the year after the IPO

• Copano Energy, where debt forgiveness was offered to executives • FTD Group, where the CEO received a substantial severance payment pre-IPO despite

continuing as CEO In addition, tax gross-ups were prominent at the following six buyout-firm-backed companies:

• Accuride Corp both in fiscal 2005 and 2006 (this company grossed up income tax on any and every executive-level perquisite provided)

• Blackbaud in fiscal 2005 • Wellcare Health Plans in fiscal 2004 and 2005 • Alpha Natural Resources in fiscal 2006 • Consolidated Communications in fiscal 2006 • Huntsman Corp in fiscal 2005 and 2006

In contrast, at non-PE-backed companies, tax gross-ups were found at only three companies: CF Industries Holdings, Xenoport, and Assurant. The only non-PE-backed company with an extensive list of benefits was Venoco, which offered pre-IPO the following benefits: 401(k), profit sharing, insurance, health club dues, airplane use, watches, gift cards, parking, holiday lodging, personal use of company personnel and dividend equivalents. In 2007, the year after the IPO, however, this list dwindled to 401(k), insurance and health club dues. The types of special bonuses and consultancy agreements listed above were not found at other non-PE-backed companies.

Finally, the conclusion from the analysis of long-term compensation policies and compensation policies as a whole would suggest that far from emerging into the public sphere with effective compensation policies, buyout-firm-backed companies were more likely to change compensation practices post-IPO in an effort either to improve them or to bring them closer to those of more established companies, and not necessarily to those with the best governance practices. While some of these changes did create structures widely believed to be more in line with effective compensation governance (such as the

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introduction of performance share awards), many did not (such as the doubling of companies awarding restricted stock, and the increase in executive-style perks). In contrast, non-PE-backed companies concentrated on relatively simple and straightforward compensation practices pre-IPO and continued with them after the IPO.

Table 8: Analysis of Compensation Policy in Buyout-Firm-Backed and Non-PE-Backed IPOs 2004, 2005, and 2006 (Source: The Corporate Library)

Buyout-Fund-Backed Non-PE-Backed Differentials/conclusions Stock options

12 awarded stock options pre-IPO, though three not to the CEO

17 awarded stock options pre-IPO, though three not to the CEO

Stock options were more widespread pre-IPO in non-PE-backed companies

12 did not award stock options pre-IPO Seven did not award stock options pre-IPO

15 awarded stock options post-IPO, though two not to the CEO

19 awarded stock options post-IPO, though five not to the CEO

Following IPO, the differential was increased, with fewer buyout-firm-backed companies using stock options than non-PE-backed companies

Nine did not award stock options post-IPO

Five did not award stock options post-IPO

14 did not change policy, 10 did 19 did not change policy, five did

There was more change to option policy in buyout-firm-backed companies post-IPO

Restricted stock with time vesting only Six awarded restricted stock pre-IPO, 18 did not

Eight awarded restricted stock pre-IPO, 16 did not

Restricted stock was more widespread pre-IPO in non-PE-backed companies

12 awarded restricted stock post-IPO, though two not to the CEO, 12 did not

Eight awarded restricted stock post-IPO, 16 did not

Restricted stock was more widespread post-IPO in buyout-firm-backed companies

14 did not change policy, 10 did 18 did not change policy, six did

RS policy changed more often in buyout-firm-backed companies

Restricted stock with time and performance vesting No companies awarded performance-based stock pre-IPO

No companies awarded performance-based stock pre-IPO

Three awarded performance-based stock post-IPO

Only one company awarded performance-based stock post-IPO

More buyout-firm-backed companies introduced performance-based stock than did non-PE-backed

Three changed policy One company changed policy

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Table 8 (cont.) Buyout-Fund-Backed Non-PE-Backed Differentials/conclusions

Cash bonuses Cash bonuses and base salary were utilized by all buyout-firm-backed IPO companies both pre- and post-IPO. All offered a base salary

Two companies did not utilize a cash bonus either pre- or post-IPO, though two others did not award them to CEOs pre-IPO. All offered a base salary

Cash bonuses were slightly less prevalent in non-PE-backed companies

Perquisites Five companies had executive-style perks and benefits* pre-IPO, while eight did post-IPO

Four companies had executive-style perks and benefits pre-IPO, while five did post-IPO, though changes in practice were minor

Executive-style perks and benefits were slightly more prevalent in buyout-fund-backed companies pre- and post-IPO

* “Executive-style perks and benefits” are defined as exceeding typical provision of 401(k) contributions, insurance premia and/or auto allowance.

Compensation increases and changes (Note: Only those companies that awarded the relevant element of compensation both pre- and post -IPO are included in this portion of the analysis.)

Five out of 21 saw an increase in benefits

Two out of 21 saw minor increases in benefits

Five out of seven companies increased their stock option grants

Three out of 16 companies increased their stock option grants

A greater number of buyout-firm-backed companies increased the value of their stock option awards

Five out of 11 companies increased their restricted stock grants

Four out of nine companies increased their restricted stock grants

A greater number of buyout-firm-backed companies (though a smaller proportion) increased the value of their restricted stock awards

Seven companies out of 24 increased bonuses (not simply because of improved performance)

Five companies out of 24 increased bonuses (not simply because of improved performance)

A greater number of buyout-firm-backed companies increased the value of their potential bonus awards

Eight companies out of 24 increased salaries significantly (more than 10%)

12 companies out of 24 increased salaries significantly (more than 10%)

Fewer buyout-firm-backed companies awarded a significant increase in salary to their CEO post-IPO

Six out of 14 companies changed their annual performance metrics. Six did not change them.

Six out of 15 companies changed their annual performance metrics. Six did not change them

Both groups of companies experienced approximately the same level of change in annual performance metrics pre- and post-IPO

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Table 8 (cont.) Buyout-Fund-Backed Non-PE-Backed Differentials/conclusions

Compensation increases and changes (cont.) Earnings was the most common metric used, with a total of 16 instances pre-IPO and 19 post-IPO. The most common of these measures was EBITDA. The next most common metric was related to cash flow of some kind

Earnings was the most common metric used with a total seven instances pre-IPO and eight post-IPO. The next most common metrics were revenue and income with seven and nine instances respectively

While earnings was the most common metric in both types of IPO, there was far more diversity of metrics in non- PE-backed companies

Stock price, largely through stock options and/or restricted stock, was the most common long-term metric. The three companies that awarded performance-based stock used EPS, EBITDA and ROIC & operating income respectively and these were the only three companies that made any change

Stock price, largely through stock options and/or restricted stock, was the most common long-term metric. The company that awarded performance-based stock used TSR and was the only company that made any change

There was little or no variation in long-term metrics for non-PE-backed companies

Employment agreements Eight companies did not utilize employment agreements pre-IPO, and only two of these introduced their use post-IPO

Eight companies did not utilize employment agreements pre-IPO, and only one of these introduced their use post-IPO

Slightly more buyout-firm-backed companies moved to the use of employment agreements post-IPO

Matched Pairs Analysis – Compensation Policies

A matched pairs analysis of compensation policies was conducted based on six sets of buyout-firm-backed and non-PE-backed companies in each of 2004, 2005 and 2006. The matched pairs analysis does not reveal a completely consistent pattern of contrast between buyout-firm-backed and non-PE-backed companies. Sometimes the buyout-firm-backed company has the more performance-sensitive compensation policy, for example MWI Veterinary Supply (buyout-fund-backed) and LHC Group (non-PE-backed). MWI retained a very simple approach to compensation both pre and post-IPO, with effective annual performance metrics (EPS and RONA) and a single long-term equity grant made well before the IPO serving to incentivize over the long term. In contrast, LHC Group began its public career well but then made some unfortunate changes to its annual bonus plan, introducing quarterly EPS cash bonuses. While this was changed again in 2007 to introduce a range of other metrics, the change did not represent an improvement: Somewhat fortuitously, although the EPS target, which would have only accounted for a quarter of the bonus, was not met that year, all the other targets were met or exceeded.

On other occasions both companies in the pair have poor compensation policies. Such a pair would be Hornbeck Offshore Services (buyout-fund-backed) and Crosstex Energy (non-PE-backed). At Hornbeck the CEO’s compensation was increased significantly in the year following the IPO, largely through the introduction of a discretionary element to its bonus plan, in addition to the existing EBITDA target and the award of restricted stock. At Crosstex Energy all elements of compensation – salary, bonus (as a consequence of the salary increase), and restricted stock/stock units – increased in the year immediately following the IPO.

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A few pairs have similar and well-designed compensation policies. This was the case with Geomet (buyout-fund-backed) and Venoco (non-PE-backed). Indeed the two companies’ compensation plans are almost mirror images of each other, indicating that industry can have a significant effect on compensation policy design. Geomet has a well-designed annual incentive plan based on production, reserves, EBITDA and 3-year finding and development costs, although a discretionary element was added to this in 2007. The company makes moderate stock awards, though these are not tied to performance. Similarly, Venoco has a solid bonus plan based on almost precisely the same metrics: production, EBITDA, and growth in reserves. In addition, the company is making moves to tie long-term compensation more closely to TSR performance. Three other pairs also have similar and relatively well-designed compensation policies in both the buyout-firm-backed and non-PE-backed companies. These are: Blackbaud and Blackboard, Altra Holdings and American Railcar Industries, and Eagle Test Systems and Techwell. (The buyout-fund-backed company is given first in each pair here.)

On balance, however, the matched pairs analysis appears to bring out the theory offered in the whole sample analysis of compensation policy above: namely, that the higher complexity of compensation practices at buyout-firm-backed companies brings with it the increased risk of poor compensation governance. This leads, on balance, to there being slightly more matched pairs where the compensation policy has problems at buyout-firm-backed companies than at their non-PE-backed partners. A prime example of this is Bluelinx Holdings (buyout-fund-backed) and Portec Rail Products (non-PE-backed). At Bluelinx a very moderate compensation policy exploded in the second year after the IPO, with a substantial increase in the perquisites and benefits on offer and a former CEO receiving consultancy payments at double the level of his former base salary. In contrast, Portec has seen little or no change to its compensation policy, which remains simple and straightforward even three years out from the IPO, with a continuing focus on short-term operating profits and no employment agreement for the CEO.

Other matched pairs where the non-PE-backed company’s compensation policy would appear to be significantly more effective than the buyout-fund-backed company’s policy include: Alpha Natural Resources and Bois d’Arc Energy, Citi Trends and Volcom, Consolidated Communications and CBeyond, Dyncorp International and Stanley, and ICF International and Innerworkings. (Again, the buyout-fund-backed company is given first in each pair here.)

A detailed summary of the salient points of compensation policy for each matched pair is included in Appendix C.

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COMPENSATION—QUANTITATIVE ANALYSIS

Methodology

The quantitative analysis of compensation for the buyout-fund-backed and non-PE-backed IPO companies – like the qualitative analysis of compensation policy – concentrates on the structure of compensation at the two groups of IPOs. In particular, it attempts to identify whether one group or another has a more “highly-geared” or incentive-based compensation package. Fundamentally this was accomplished by looking at both actual and potential incentive payments in relation to both fixed compensation and total compensation, concentrating on the 2005-2006 period. This incentive compensation in turn is broken down into cash and non-cash (i.e. stock-based) incentive compensation to see if there is a greater reliance on equity in either of the groups.

The changes in SEC compensation disclosure regulations that took effect in 2006 make direct trend line analysis impossible for most companies over the full fiscal 2005-2006 period. The changes even prevent true comparisons between proportional pay calculations because of the new discrimination between equity and cash incentive disclosures. While a statistical analysis is not possible over the two-year period, a qualitative comparison can be made.

In addition, under the current disclosure arrangements, the new disclosures of “Stock Awards” and “Option Awards” allow us to assess the approach to equity compensation over a multi-year period because these accounting figures reflect compensation decisions over as much as five years (they represent the FAS 123R cost to the companies of all the stock and option awards that vested during the year and therefore could include tranches from up to five years of separate awards).

Because the claim to be tested is that one group has designed compensation more effectively than the other group, it appeared less important to look at pre-IPO and post-IPO practices and compare them, than to look at “outcomes” in compensation as well as “inputs” over as many years of data as was available in order to smooth out any one-off awards that might skew results. Outcomes are represented by the value of vested stock, cash bonus payments and value of exercised stock options. Inputs are represented by the face value of stock and option awards.

Compensation data was collected for fiscal 2005 and fiscal 2006. In fiscal 2005, approximately 70 IPOs are included in the analysis – the number of companies that had gone public in the sample at December 31, 2006 – while in 2006, the full sample was included except for the 10 companies that continued to file under the former disclosure regulations. A separate analysis of such a small sample would not produce meaningful results.

Finally, a side study of the stockholdings of CEOs was conducted to assess:

1. whether CEOs of buyout-fund-backed IPOs own more or less stock than their non-PE-backed IPOs, and

2. for companies with more than one year of compensation history, whether equity awards translate into greater stock ownership.

Summary Findings

In general, our quantitative analysis confirmed the impression gained from the qualitative study of compensation policies outlined above that buyout-firm-backed firms do not have more performance-oriented compensation structures than their non-PE-backed counterparts. CEOs of buyout-firm-backed

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companies tended to have higher total annual compensation than their peers at non-PE-backed firms, but this was more influenced by higher base salaries than by larger incentive-based compensation elements. Furthermore, non-PE-backed firms tended to utilize stock options – which reward executives only if the stock price rises – more than private-equity-backed firms. The latter focused more on restricted stock, which retains some value regardless of price movements. Thus, the equity packages of executives at non-PE-backed firms contained riskier elements.

The greater exposure to stock compensation – particularly stock options – for CEOs of non-PE-backed companies was clear in fiscal 2005, with higher levels of stock option profits and a greater proportion of incentive pay delivered as stock than for CEOs of buyout-firm-backed companies. Although these differentials were reversed in 2006, this was largely due to the higher value restricted stock awards vesting with CEOs of buyout-firm-backed companies and the post-IPO introduction of stock options, rather than a long-term commitment to performance-based equity compensation at the buyout-fund-backed companies.

Finally, the CEO stockholding study indicates that CEOs of non-PE-backed companies had much more significant shareholdings in their firms than the CEOs of companies backed by buyout firms.

Discussion

Fiscal year 2005

Annual compensation

In 2005, base salary, annual bonus and total annual compensation were higher at every aggregate (e.g., median, average and quartiles) for CEOs of buyout-firm-backed companies than they were for CEOs of non-PE-backed companies. While the slight differential in size – buyout-firm-backed companies had a slightly higher market capitalization than non-PE-backed companies – might explain some of this differential, it cannot explain all of it. At the median, for example, the base salary of the CEO of a buyout-firm-backed company was 147 percent higher than the non-PE-backed counterpart. Adding in perquisites and annual bonuses raised the differential to 165 percent. Only four CEOs in each group did not receive an annual bonus during fiscal 2005, but for CEOs of buyout-firm-backed companies, the bonus represented a slightly higher proportion of annual compensation (a median of 50 percent) than for CEOs of non-PE-backed companies (44.6 percent).

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Table 9: 2005 Base Salary, Annual Bonus, and Total Annual Compensation (Source: The Corporate Library) Base salary Annual bonus Total annual compensation

Buyout-Fund-Backed 2005 Number* 39 39 39 Maximum $1,469,000 $6,250,000 $7,250,000 Upper quartile $608,463 $925,000 $1,504,389 Average $534,324 $832,621 $1,412,139 Median $457,016 $500,000 $970,600 Lower quartile $340,000 $250,000 $734,615 Minimum $49,808 $0 $49,808

Non-PE-Backed 2005 Number* 31 31 31 Maximum $870,000 $3,864,838 $7,815,734 Upper quartile $390,507 $467,327 $958,624 Average $358,120 $424,056 $902,493 Median $310,000 $279,176 $589,176 Lower quartile $255,833 $98,665 $393,483 Minimum $10 $0 $10

*Number = number of companies evaluated for this table. Some companies were excluded because they did not provide compensation disclosure according to the new SEC regulations.

Summary

While higher base salaries have the consequence of higher compensation for buyout-fund-backed firms, the differential between the proportion of total annual compensation represented by cash incentives for the two groups of CEOs is not sufficiently high to suggest that there is a higher level of incentivization from cash incentives in either group.

Long-term incentive pay

There were only two payouts from long-term incentive plans (LTIPs) during fiscal 2005 and both were made to CEOs of non-PE-backed companies. Assurant’s LTIP payout represented profits from a stock appreciation rights (SARs) plan while CF Industries’ payout was the cash-out of a pre-IPO LTIP.

The same proportion of CEOs in each group exercised stock options during fiscal 2005, but the profits realized by CEOs of non-PE-backed companies far exceeded those made by CEOs of buyout-firm-backed companies at every aggregate level. For example, average and median profits for CEOs of non-PE-backed companies were $9,556,197 and $1,721,600 respectively, compared to $1,701,331 and $1,372,034 for CEOs of buyout-firm-backed companies.

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Table 10: LTIP Payout, Options Value Realized, Restricted Stock and Total Compensation 2005 (Source: The Corporate Library)

LTIP payout Option value realized Restricted stock Total compensation Buyout-Fund-Backed 2005

Number* 39 7 9 39Maximum $0 $4,948,267 $7,689,000 $10,785,526Upper quartile $0 $2,401,573 $2,969,641 $3,120,204Average $0 $1,701,331 $2,030,903 $2,485,377Median $0 $1,372,034 $994,500 $1,396,876Lower quartile $0 $190,262 $595,968 $836,538Minimum $0 $23,945 $520,594 $226,146

Non-PE-Backed 2005 Number* 31 5 10 31Maximum $1,367,466 $37,417,813 $5,224,500 $41,320,032Upper quartile $0 $22,302,113 $3,062,767 $2,881,933Average $83,412 $9,556,197 $1,606,343 $3,094,436Median $0 $1,721,600 $633,088 $691,633Lower quartile $0 $727,581 $183,199 $446,113Minimum $0 $405,168 $2,345 $10*Number = number of companies evaluated for this table. Some companies were excluded because they did not provide compensation disclosure according to the new SEC regulations.

Grant date values of stock option awards were also higher for CEOs of non-PE-backed companies and, more importantly, a greater number of them received stock option awards during the year. Median grant values of stock options for CEOs of non-PE-backed companies were $135,188, compared to zero for CEOs of buyout-fund-backed companies. Also 14 out of 31 non-PE-backed companies’ CEOs received option awards, compared to 14 out of 39 buyout-fund-backed companies.

On the other hand, CEOs of buyout-fund-backed companies retained greater value in unexercised vested and unvested stock options at the upper end, with higher maximum figures, higher upper quartile figures and higher average figures. Median values for unexercised vested, though not for unvested, stock options were higher for CEOs of non-PE-backed companies, though largely because a higher proportion of them had received stock options in the past.

The value differential for restricted stock awarded during fiscal 2005 indicated that CEOs of buyout-fund-backed companies generally received higher value awards; however, 32 percent of CEOs of non-PE-backed companies received restricted stock, compared to 23 percent of buyout-fund-backed companies.

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Table 11: Stock Options 2005 (Source: The Corporate Library)

Grant date value of stock

options Value of exercisable

options Value of unexercisable

options Buyout-Fund-Backed 2005

Number* 38 39 39Maximum $4,464,659 $29,628,473 $19,965,369Upper quartile $601,108 $4,573,578 $2,730,376Average $647,537 $3,544,647 $2,643,619Median $0 $277,672 $50,905Lower quartile $0 $0 $0Minimum $0 $0 $0

Non-PE-Backed 2005 Number* 27 32 32Maximum $6,507,864 $9,845,467 $6,418,116Upper quartile $1,095,300 $3,461,047 $1,373,327Average $821,838 $2,243,309 $1,121,041Median $135,188 $355,565 $294,213Lower quartile $0 $0 $0Minimum $0 $0 $0


Summary

Although the number of equity awards is relatively low, these findings would suggest that CEOs of non-PE-backed companies are being rewarded with a higher proportion of equity than their buyout-firm-backed counterparts as well as more frequently being in receipt of equity grants.

Pay ratios

Confirming the findings already noted, the average level of incentive pay received as equity – at 32.5 percent – for CEOs of non-PE-backed companies exceeds that for CEOs of buyout-firm-backed companies (22.5 percent). Incentive pay is made up of annual bonus, stock option profits, restricted stock and any payouts from any other long-term incentive plan. On the other hand, the figures for incentive compensation as a proportion of total compensation are heavily influenced by the greater numbers of CEOs receiving annual cash bonuses, and therefore CEOs of buyout-firm-backed companies have higher proportions of incentive pay as a whole: 53.3 percent compared to 43.4 percent for non-PE-backed companies.

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Table 12: Incentive Pay 2005 (Source: The Corporate Library) Incentive pay as stock Incentive pay as a proportion of total pay

Buyout-Fund-Backed 2005 Number* 39 39Maximum 100.00% 94.46%Upper quartile 55.05% 79.20%Average 22.52% 53.25%Median 0.00% 52.22%Lower quartile 0.00% 37.88%Minimum 0.00% 0.00%

Non-PE-Backed 2005 Number* 31 31Maximum 98.84% 97.70%Upper quartile 63.73% 76.23%Average 32.47% 43.38%Median 0.29% 39.31%Lower quartile 0.00% 8.27%Minimum 0.00% 0.00%*Number = number of companies evaluated for this table. Some companies were excluded because they did not provide compensation disclosure according to the new SEC regulations.

Fiscal year 2006

Cash compensation

As in 2005, base salaries for CEOs of buyout-firm-backed companies far exceed those of CEOs of non- PE-backed companies at every aggregate level. The same is true for bonuses, non-equity incentive compensation (NEIC), and total annual compensation, though maxima for all of these elements of pay are roughly the same in both groups. The differential for median base salaries is around 1.4 in favor of buyout-firm-backed companies, while median total annual compensation for CEOs of buyout-firm-backed companies is almost double that for CEOs of non-PE-backed firms. Again, while some of this differential is explicable through the slightly larger size of buyout-firm-backed firms as measured by market capitalization, it does not explain all of it.

Cash incentives were not only higher at buyout-firm-backed companies, but were more common. Only three CEOs of non-PE-backed companies did not receive either a bonus or an NEIC award, while seven received both types of payment. In contrast, six CEOs of non-PE-backed companies received neither a bonus nor an NEIC payment, while only two received both types of award. In addition, cash incentives made up a greater proportion of total annual compensation for CEOs of buyout-firm-backed companies, 47.4 percent, compared to 37.5 percent for CEOs of non-PE-backed firms. In addition, cash incentives represented 100 percent of base salary at the median for buyout-firm-backed CEOs, and just under 75 percent for non-PE-backed CEOs.

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Table 13: 2006 Base Salary, Bonus, NEIC, and Total Annual Compensation (Source: The Corporate Library) Base salary Bonus NEIC Total annual compensation

Buyout-Fund-Backed Number* 43 43 43 43Maximum $1,525,417 $1,400,000 $3,610,800 $12,158,964Upper quartile $650,000 $400,000 $700,000 $1,872,853Average $573,575 $231,060 $533,434 $1,715,351Median $500,000 $0 $344,750 $1,301,972Lower quartile $375,000 $0 $0 $749,185Minimum $300,000 $0 $0 $440,665

Non-PE-Backed Number* 38 38 38 38Maximum $870,000 $1,400,000 $3,864,838 $11,370,256Upper quartile $492,015 $44,919 $309,524 $926,038Average $392,552 $117,857 $320,163 $1,049,476Median $355,953 $0 $181,875 $643,679Lower quartile $300,000 $0 $0 $496,755Minimum $0 $0 $0 $10


Summary

Again, as in 2005, higher base salaries will inevitably lead to higher annual compensation, but in 2006, the differential between the levels of incentivization appears higher than in 2005, with larger proportions of annual compensation being represented by cash incentives for CEOs of buyout-firm-backed companies. While this differential is higher, it is still not more than 10 percentage points.

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Chart 13: Average Base Salary of IPO Groups Over Time (Source: The Corporate Library)

Chart 14: Average Total Annual Compensation of IPO Groups Over Time (Source: The Corporate Library)

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Long-term incentive pay

In contrast to 2005, a greater number and a slightly greater proportion of CEOs of buyout-firm-backed companies exercised stock options during 2006 with greater profits realized on the exercise. More than two-fifths of buyout-firm-backed CEOs exercised stock options compared to less than a third of non-PE-backed CEOs. While the value realized on the vesting of other equity (typically restricted stock) for CEOs of buyout-firm-backed companies was higher than their non-PE-backed peers, the proportion receiving awards was very similar. The consequence of this was a median total actual compensation for CEOs of buyout-firm-backed companies that was almost two and a half times higher than it was for CEOs of non-PE-backed companies.

Table 14: 2006 Option Value Realized, Value Realized on Vesting of Stock, and Total Actual Compensation (Source: The Corporate Library)

Option value realized Value realized on vesting of stock Total actual compensationBuyout-Fund-Backed

Number* 17 15 43Maximum $14,798,638 $12,286,832 $21,097,424Upper quartile $7,167,041 $1,874,988 $5,495,313Average $4,530,341 $1,700,188 $4,400,005Median $3,984,095 $962,162 $2,247,700Lower quartile $720,820 $212,925 $1,202,165Minimum $121,960 $42,191 $458,664

Non-PE-Backed Number* 10 12 38Maximum $9,769,917 $6,220,500 $12,230,523Upper quartile $5,078,063 $1,649,686 $3,204,050Average $3,428,894 $1,235,106 $2,380,010Median $2,664,084 $460,900 $937,802Lower quartile $647,912 $202,583 $625,175Minimum $149,532 $77,382 $10


Differentials in favor of CEOs of buyout-firm-backed companies continued in the analysis of the grant date value of equity awards, which measures the face value of stock awards made in fiscal 2006 but which vest over the coming years. Three-fifths of CEOs of buyout-firm-backed companies received some form of equity grant in 2006, with a median value of more than $1.8 million, compared to less than half of CEOs of non-PE-backed companies with a median of less than $1.5 million.

The higher value awards of restricted stock seen in 2005 continued to be seen in fiscal 2006 for CEOs of buyout-firm-backed companies. The median Financial Accounting Standard (FAS) 123(R) figure recognized as an expense in 2006 for buyout-firm-backed CEOs was $117,746, while it was zero for their non-PE-backed peers, as fewer than half of them received an award. Similarly, the FAS value of options vesting during the year reflects the higher level of such awards typically granted to CEOs of non- PE-backed companies. Median and upper quartile option awards were higher for this group. The higher level

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of option awards was not enough to compensate for the differential in stock awards, so CEOs of buyout-firm-backed companies were recorded as having higher total summary compensation values at all aggregate levels. (Total summary compensation is the total compensation figure that companies are required to disclose by the SEC in their Summary Compensation Table and includes the FAS 123(R) figures for stock awards and option awards. In contrast, the values realized from the exercise or vesting of such awards are used to calculate The Corporate Library’s total actual compensation figure.)

Table 15: 2006 Equity Awards and Total Summary Compensation (Source: The Corporate Library)

Grant date value of equity

awards Stock

awards Option awards

Total summary compensation

Buyout-Fund-Backed Number* 26 43 43 43Maximum $5,895,400 $5,209,125 $4,844,739 $17,937,206Upper quartile $3,289,988 $800,000 $517,328 $3,645,834Average $2,093,254 $653,506 $454,602 $3,085,150Median $1,840,600 $117,746 $56,564 $2,106,110Lower quartile $498,077 $0 $0 $1,201,600Minimum $202,590 $0 $0 $499,290

Non-PE-Backed Number* 17 38 38 38Maximum $5,999,994 $5,700,000 $2,983,812 $12,844,692Upper quartile $4,448,304 $351,906 $727,830 $2,102,431Average $2,218,488 $367,541 $408,673 $1,867,322Median $1,459,578 $0 $71,544 $989,168Lower quartile $569,828 $0 $0 $650,721Minimum $174,601 $0 $0 $10


Summary

While there was an increase in the value realized on the exercise of stock options and the number of CEOs conducting such an exercise in buyout-firm-backed companies, it remains clear that a higher proportion of the equity-based compensation received by these CEOs comes from restricted stock. While neither restricted stock nor market-priced stock options can be considered at the forefront of long-term equity compensation design, stock options are at least preferable to restricted stock because they contain at least some risk – since stock price must increase for any profit to be available. Restricted stock maintains some value in good times and bad. If buyout-firm-backed companies are alleged to have more highly incentivized pay packages it would be expected that the majority of this would be delivered through equity compensation that is truly at risk. This is not the case; indeed, the CEOs of non-PE-backed companies have more risk built into their compensation packages than their buyout-firm-backed peers.

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Pay ratios

Reflecting the findings already noted about option exercises and the vesting of restricted stock, the average level of incentive pay received as equity – at 44.6 percent – for CEOs of buyout-firm-backed companies exceeds that for CEOs of non-PE-backed companies (at 38.8 percent). This reverses the finding for fiscal 2005, when stock represented a higher proportion of incentive pay for CEOs at non-PE-backed companies. The figures for incentive compensation as a proportion of total compensation are more heavily influenced by the greater numbers of CEOs receiving annual cash bonuses. Therefore, CEOs of buyout-firm-backed companies have higher proportions of incentive pay as a whole: 57.3 percent compared to 52.0 percent. This represents an increase in incentive pay as a proportion of total pay for both groups of CEOs.

Table 16: 2006 Incentive Pay (Source: The Corporate Library)

Incentive pay as

stock Incentive pay as a proportion of

total pay Buyout-Fund-Backed

Number* 43 43 Maximum 100.00% 96.23% Upper quartile 85.93% 85.90% Average 44.55% 57.28% Median 40.30% 60.69% Lower quartile 0.00% 39.26% Minimum 0.00% 0.00%

Non-PE-Backed Number* 38 38 Maximum 100.00% 100.00% Upper quartile 90.72% 82.44% Average 38.79% 51.99% Median 22.26% 49.54% Lower quartile 0.00% 33.40% Minimum 0.00% 0.00%


CEO stock ownership

A comparison was also made of the value of CEO stockholdings – calculated as a multiple of base salary – for each of the two groups of companies.

The value of stockholdings was calculated by taking net stock held (excluding stock options and stock of which the CEO is not a direct beneficiary) and multiplying it by the year-end stock price. This amount was then divided by the CEO’s base salary for the year to create a stockholding as a multiple of base salary figure.

As can be seen from Table 17 below, at the end of fiscal 2005, CEOs of non-PE-backed companies were invested in far higher levels of stock than their buyout-firm-backed counterparts. While this may be marginally influenced by the lower levels of base salary for non-PE-backed CEOs (see aggregate compensation analysis elsewhere in this report), it cannot explain the very substantial differentials at every aggregate level. These findings would suggest either that the heavier concentration of equity-based

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compensation pre-IPO that was found at non-PE-backed companies (see compensation policy discussion above) resulted in higher levels of stockholding for CEOs of these companies, or simply that these CEOs invested in higher levels of stock using their own funds. This finding also may be influenced by the high percentage of non-PE-backed firms that are Founder Firms (43 percent) and Family Firms (12 percent), as discussed above in the Ownership analysis. Such companies either have CEOs or Chairs that are both the founder of the company and a principal shareholder or have family ties to a founder that play a key role in the company’s ownership. The figures for salesforce.com, whose CEO has a base salary of only $10, were excluded from this analysis.

Table 17: Stockholding as a Multiple of Base Salary (Source: The Corporate Library) Buyout-Fund-Backed Non-PE-Backed Difference

Fiscal 2005 Year End Number* 39 30 Maximum 288.97 618.96 (329.99)Upper quartile 58.84 183.07 (124.23)Average 48.55 121.13 (72.58)Median 13.84 55.19 (41.35)Lower quartile 3.70 10.50 (6.80)Minimum 0.00 0.78 (0.78)

Fiscal 2006 Year End Number* 43 37 Maximum 355.37 1168.34 (812.96)Upper quartile 33.28 194.18 (160.91)Average 36.99 150.29 (113.30)Median 10.80 55.61 (44.82)Lower quartile 2.88 3.67 (0.79)Minimum 0.00 0.00 0.00

*Number = number of companies evaluated for this table. Some companies were excluded because they did not provide compensation disclosure according to the new SEC regulations. As noted above, salesforce.com was also excluded due to the CEO’s nominal base salary.

As can be seen, the differential in favor of CEOs of non-PE-backed companies continued and increased at all aggregate levels above the median in 2006. This would indicate that the differential is neither a function of stock price, nor stock price growth, nor a one-off occurrence but rather a feature of non-PE-backed companies.

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CONCLUSIONS AND RECOMMENDATIONS

The present study finds that buyout firms do not, on average, implement superior corporate governance policies at the companies they take public. In particular, our research suggests that:

• The compensation governance of many of these companies does not create structures that tie executive pay more closely to performance than is the case at the average company.

• Buyout firms maintain control over audit and compensation committees at many of the companies they launch following the IPO.

• Buyout-backed firms engage in many related party transactions with their backers following the IPO.

• Takeover defenses are notably stronger at buyout-fund-backed firms than at IPO companies in general.

Future researchers may wish to examine, among other questions:

• Whether the conclusions of this study are borne out by examining companies over a wider time frame (e.g., how long past IPO dates these differences between buyout-fund-backed firms and IPO companies in general persist)

• Whether the governance practices of firms brought public by venture capital firms (which are often viewed together with buyout funds under the rubric of “private equity”) differ significantly from those identified in this study

• Whether the operational and stock market performance of buyout-fund-backed companies differ in any predictable way from those of other IPO companies, and whether these differences can be tied to any of the governance practices identified here

• Whether there is a higher incidence of securities class action lawsuits at buyout-fund-backed IPOs with the governance practices we describe than at IPO companies in general

Finally, we recommend that institutional investors may wish to engage with the buyout funds in which they invest to encourage them to improve corporate governance—in particular compensation policies and takeover defenses—at the companies they take public.

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APPENDIX A

Table A1: List of Companies in Sample – Buyout-Fund-Backed Company Name IPO Date

Accuride Corporation 4/25/2005

Alpha Natural Resources, Inc. 2/14/2005

Altra Holdings, Inc. 12/14/2006

Asset Acceptance Capital Corp. 2/4/2004

Aventine Renewable Energy Holdings, Inc. 6/28/2006

Beacon Roofing Supply, Inc. 9/22/2004

Blackbaud, Inc. 7/21/2004

BlueLinx Holdings Inc. 12/13/2004

Bucyrus International, Inc. 7/22/2004

Builders FirstSource, Inc. 6/22/2005

CB Richard Ellis Group, Inc. 6/9/2004

Citi Trends, Inc. 5/17/2005

Clayton Holdings, Inc.* 3/23/2006

Consolidated Communications Holdings, Inc. 7/21/2005

Copano Energy LLC 11/8/2004

Dresser-Rand Group Inc. 8/4/2005

DSW Inc. 6/28/2005

DynCorp International, Inc. 5/3/2006

Eagle Test Systems, Inc.* 3/8/2006

EnerSys 7/29/2004

FTD Group, Inc.* 2/8/2005

GateHouse Media, Inc. 10/24/2006

GeoMet, Inc. 7/27/2006

H&E Equipment Services, Inc. 1/30/2006

Hornbeck Offshore Services, Inc. 3/25/2004

Huntsman Corporation 2/10/2005

Huron Consulting Group, Inc. 10/12/2004

ICF International 9/28/2006

ITC Holdings Corp. 7/25/2005

Kenexa Corporation 6/23/2005

Knoll, Inc. 12/13/2004

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Company Name IPO Date

MWI Veterinary Supply, Inc. 8/2/2005

Nalco Holding Company 11/10/2004

NTELOS Holdings Corp. 2/8/2006

NYMEX Holdings, Inc.* 11/16/2006

Obagi Medical Products, Inc. 12/13/2006

Pike Electric Corporation 7/26/2005

Republic Airways Holdings Inc. 5/26/2004

Rockwood Holdings, Inc. 8/16/2005

Sealy Corporation 4/6/2006

SMART Modular Technologies (WWH), Inc. 2/2/2006

Susser Holdings Corporation 10/18/2006

Symmetry Medical Inc. 12/8/2004

Syniverse Holdings, Inc. 2/9/2005

TRW Automotive Holdings Corp. 2/2/2004

UAP Holdings Corp.* 11/22/2004

Warner Music Group Corp. 5/10/2005

Wellcare Health Plans Inc 6/30/2004 *This company ceased to trade publicly by the end of 2008. See Methodology section for further details as to the impact on each section of the study.

Table A2: List of Companies in Sample – Non-PE-Backed


Advance America, Cash Advance Centers, Inc. 12/15/2004

Alexza Pharmaceuticals Inc. 3/8/2006

Allegiant Travel Company 12/7/2006

American Railcar Industries 1/19/2006

Assurant, Inc. 2/4/2004

Atlas America, Inc. 5/10/2004

Blackboard, Inc. 6/17/2004

Blue Nile, Inc. 5/19/2004

Bois d'Arc Energy, Inc.* 5/5/2005

Build-A-Bear Workshop, Inc. 10/27/2004

Cbeyond, Inc. 11/1/2005

CF Industries Holdings, Inc. 8/10/2005

CombinatoRx, Incorporated 11/9/2005

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Crocs, Inc. 2/7/2006

Crosstex Energy, Inc. 1/13/2004

Darwin Professional Underwriters, Inc.* 5/18/2006

Delek US Holdings, Inc. 5/3/2006

eHealth, Inc. 10/12/2006

Global Traffic Network, Inc. 3/23/2006

Greenhill & Co., Inc. 5/5/2004

GTx, Inc. 2/2/2004

Heartland Payment Systems, Inc. 8/10/2005

Hoku Scientific 8/5/2005

Home Bancshares, Inc. 6/22/2006

InnerWorkings, Inc. 8/15/2006

IPG Photonics Corporation 12/12/2006

LHC Group Inc. 6/8/2005

Life Time Fitness, Inc. 6/29/2004

Macquarie Infrastructure Co Trust 12/15/2004

MarketAxess Holdings, Inc. 11/4/2004

National Interstate Corporation 1/27/2005

Portec Rail Products, Inc. 1/23/2004

salesforce.com, inc. 6/22/2004

Stanley, Inc. 10/17/2006

Techwell, Inc. 6/20/2006

Unica Corporation 8/2/2005

Universal Truckload Services, Inc. 2/11/2005

Venoco, Inc. 11/16/2006

Vocus, Inc. 12/6/2005

Volcom, Inc. 6/29/2005

Western Alliance Bancorporation 6/30/2005

XenoPort, Inc. 6/2/2005 *This company ceased to trade publicly by the end of 2008. See Methodology section for further details as to the impact on each section of the study.

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APPENDIX B

Table B: Matched Pairs

Buyout-Fund-Backed Industry Non-PE-Backed Industry 2004

ASSET ACCEPTANCE CAPITAL Diversified Financial Services

MARKETAXESS HOLDINGS INC

Diversified Financial Services

BLACKBAUD INC Software BLACKBOARD INC Software

BLUELINX HOLDINGS INC

Trading Companies & Distributors

PORTEC RAIL PRODUCTS INC Machinery

COPANO ENERGY LLC-UNITS* Oil, Gas & Consumable Fuels ATLAS AMERICA INC*

Oil, Gas & Consumable Fuels

HORNBECK OFFSHORE SERVICES

Energy Equipment & Services CROSSTEX ENERGY INC


REPUBLIC AIRWAYS HOLDINGS INC* Airlines

MACQUARIE INFRASTRUCTURE CO*

Transportation Infrastructure

2005

ACCURIDE CORP Machinery HOKU SCIENTIFIC Electrical Equipment

ALPHA NATURAL RESOURCES INC

Oil, Gas & Consumable Fuels BOIS D' ARC ENERGY INC


CITI TRENDS INC Specialty Retail VOLCOM INC Textiles, Apparel & Luxury Goods

CONSOLIDATED COMMUNICATIONS

Diversified Telecommunication CBEYOND INC

Diversified Telecommunication

HUNTSMAN CORP Chemicals CF INDUSTRIES HOLDINGS Chemicals

MWI VETERINARY SUPPLY INC

Health Care Providers & Services LHC GROUP INC

Health Care Providers & Services

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Buyout-Fund-Backed Industry Non-PE-Backed Industry 2006

ALTRA HOLDINGS INC Machinery AMERICAN RAILCAR INDUSTRIES Machinery

DYNCORP INTERNATIONAL INC-A Aerospace & Defense

STANLEY INC Aerospace & Defense

EAGLE TEST SYSTEMS INC

Semiconductors & Semiconductor Equipment

TECHWELL INC

Semiconductors & Semiconductor Equipment

GATEHOUSE MEDIA INC Media GLOBAL TRAFFIC NETWORK INC Media

GEOMET INC


VENOCO INC Oil, Gas & Consumable Fuels

ICF INTERNATIONAL INC

Commercial Services & Supplies

INNERWORKINGS INC Commercial Services & Supplies

2006 – for Takeover Defense Analysis Only

AVENTINE RENEWABLE ENERGY HLDGS


DELEK US HOLDINGS, INC Oil, Gas & Consumable Fuels

CLAYTON HOLDINGS, INC

Thrifts & Mortgage Finance

HOME BANCSHARES, INC Commercial Banks

OBAGI MEDICAL PRODUCTS, INC Pharmaceuticals ALEXZA PHARMACEUTICALS, INC Pharmaceuticals

*This company could not be included in Takeover Defenses analysis since such data was not collected due to LLC status.

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APPENDIX C

Matched Pairs Analysis – Compensation

2004 Pair One

ASSET ACCEPTANCE CAPITAL

MARKETAXESS HOLDINGS INC

Buyout-Fund-Backed

Did not use options in year of IPO, though the company had awarded them in the past along with SARs. The SARs vested and paid out at the time of the IPO. Option awards were made in the year following IPO. Short-term metric – EBITDA. CEO has employment agreement.

Non-PE-Backed

The company had a full complement of long-term incentives (options, restricted stock, cash bonus) in the year of and the year following IPO. Short-term metric not disclosed. CEO does not have an employment agreement.

2004 Pair Two

BLACKBAUD INC

BLACKBOARD INC

Buyout-Fund-Backed

As in Pair One, this company did not issue options in the year of IPO, though it had awarded options in the past. In the year following IPO it awarded options to the new CEO, introduced restricted stock and extended benefits. Short-term metric adjusted EBITDA and revenue pre-IPO and adjusted EBIT and revenue post-IPO.

Non-PE-Backed

Like its buyout-fund-backed partner, the company had history of stock option grants. Compensation was generally enhanced in the year after IPO, along with a new employment agreement for CEO. Short-term metric sales and pre-tax net income both pre and post-IPO.

2004 Pair Three

BLUELINX HOLDINGS INC

PORTEC RAIL PRODUCTS INC

Buyout-Fund-Backed

Compensation policy began very moderately without any equity element and then ballooned in the second year after the IPO. Short-term metrics were not disclosed. CEO has an employment agreement.

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Non-PE-Backed

In contrast to its buyout-fund-backed partner, there has been little or no change to compensation policy which remains simple and straightforward even three years out from IPO, with a continuing focus on short-term operating profits and no employment agreement for the CEO.

2004 Pair Four

COPANO ENERGY LLC-UNITS

ATLAS AMERICA INC

Buyout-Fund-Backed

An immediate transformation of compensation policy did not lead to large equity or cash awards but rather to a more focused, mature approach. Salaries increased largely because of an acquisition. Short-term metric not disclosed pre-IPO, post-IPO based on cash flow. The CEO does not have an employment agreement.

Non-PE-Backed

IPO led to significant increases in salary, bonus, and option awards. Other elements of compensation – benefits and phantom stock units, the ESOP – stayed the same. This increase may be largely due to the fact that executives were not directly compensated by the company until the completion of the IPO, but rather by the management company. CEO has an employment agreement.

2004 Pair Five

HORNBECK OFFSHORE SERVICES

CROSSTEX ENERGY INC

Buyout-Fund-Backed

Compensation was ramped up significantly in the year following the IPO with the introduction of discretionary element to bonus plan in addition to the existing EBITDA target and the award of restricted stock. CEO has an employment agreement.

Non-PE-Backed

All elements of compensation – salary, bonus as a consequence of the salary increase, and restricted stock/stock units – increased in year after IPO. Short-term metric – ROI. CEO has an employment agreement.

2004 Pair Six

REPUBLIC AIRWAYS HOLDINGS IN

MACQUARIE INFRASTRUCTURE CO

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Buyout-Fund-Backed

The company made a single grant of stock options in the year of IPO and no other equity awards were made until 2007, three years later. Other outstanding options were in existence. Short-term metrics not disclosed. The CEO has an employment agreement.

Non-PE-Backed

For a non-PE-backed company, the compensation policy is relatively sophisticated, but also more exacting than most buyout-fund-backed companies with performance-related stock options whose condition requires the company’s ROE to outperform median of S&P/ASX 300 Industrials over three years prior to exercise. Also 30 percent of the profit share cash bonus remains at risk and deferred over eight years of the IPO. CEO has an employment agreement.

2005 Pair One

ACCURIDE CORP

HOKU SCIENTIFIC

Buyout-Fund-Backed

Compensation policy very poorly designed pre-IPO. Even the positive move to partially performance-based long-term incentives is severely mitigated by continually rising base salaries, bonuses and continued payment of tax gross-ups on any and every executive-level benefit that is being provided. The CEO’s employment agreement appears to be the cause of much of this excessive compensation. Performance measured using EBITDA and free cash flow. Stock options were replaced with SARs, but nevertheless the amended equity plan more than doubled the number of shares reserved for award in the year after the IPO.

Non-PE-Backed

Changes in strategy post-IPO caused pre-set annual performance measures to be irrelevant so officers’ performance was evaluated using "other" measures, but these are not disclosed. In addition the compensation committee's constantly changing policy on what portion of the bonus will be delivered in cash and what in stock would suggest a certain lack of decisiveness. The CEO does not have an employment agreement. Pre-IPO the performance measures were revenue, net income and shareholder value. In the future, the company intends to test revenue, gross margin and net income.

2005 Pair Two

ALPHA NATURAL RESOURCES INC

BOIS D' ARC ENERGY INC

Buyout-Fund-Backed

Post-IPO introduced performance shares only make up small portion of long-term incentive opportunity but this step in the right direction goes some way to mitigating the very substantial

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increases in salary and bonus opportunity. Short-term performance measures are ROIC and EBITDA, while the performance shares also measure ROIC, along with net income. The CEO signed a new employment agreement post-IPO.

Non-PE-Backed

The compensation committee clearly considers that the initial stock and option awards made during the year of the IPO year are sufficient motivation as no other incentives are offered or contemplated. The CEO has an employment agreement.

2005 Pair Three

CITI TRENDS INC

VOLCOM INC

Buyout-Fund-Backed

Apart from a significant increase in stock option awards post-IPO, there was very little change to compensation policy except that the process of annual performance metric setting became either more rigorous or better disclosed moving from the vague “sales and earnings” to the more precise operating cash flow, same store sales, and EPS. The CEO has an employment agreement.

Non-PE-Backed

No long-term incentives are in use at the company because of a desire to keep dilution to a minimum. Post-IPO, however, the CEO received a significant increase in salary and consequently bonus. Annual performance is measured using EPS. The CEO does not have an employment agreement.

2005 Pair Four

CONSOLIDATED COMMUNICATIONS

CBEYOND INC

Buyout-Fund-Backed

Restricted stock awards were granted pre-IPO and fully vested at the time of the IPO. There have been no other long-term awards. Short-term performance is measured using EBITDA, dividend payout, and increases in subscribers. The executive chairman sits on the compensation committee and the company’s proxy statement is littered with related party transactions because of him. The CEO does not have an employment agreement.

Non-PE-Backed

There was very little change to this simple compensation policy post-IPO, with only a minor change in annual performance metrics, retaining revenue and EBITDA, but changing free cash flow to capital expenditures. The CEO has an employment agreement.

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2005 Pair Five

HUNTSMAN CORP

CF INDUSTRIES HOLDINGS

Buyout-Fund-Backed

Equity grants were only made on IPO status as the plan was not in existence prior to that. There was also major increase in bonus due to special cost reduction incentive plan when debt reduction and cost reduction were added as metrics post-IPO to EBITDA, compliance and board performance. Compensation continued to increase. The CEO does not have an employment agreement.

Non-PE-Backed

The pre-IPO equity plan was cashed out at the time of offering. The recruitment of a compensation consultant, Towers Perrin, led to several changes in compensation including the use of restricted stock in addition to stock options and a change from pre-tax ROE and individual targets to cash flow ROC post-IPO. The CEO has an employment agreement.

2005 Pair Six

MWI VETERINARY SUPPLY INC

LHC GROUP INC

Buyout-Fund-Backed

The company retained a very simple compensation policy with the only long-term incentive a one-off, slowly vesting pre-IPO (2002) stock option grant. No changes to the EBITDA, RONA performance metrics. The CEO does not have an employment agreement.

Non-PE-Backed

As with its buyout-fund-backed peer, this company retained same basic simple compensation plan except for a change to quarterly EPS cash bonuses. However this was changed in 2007, somewhat fortuitously as the EPS target was not met that year and would have only accounted for a quarter of the bonus, while all the other targets were met.

2006 Pair One

ALTRA HOLDINGS INC

AMERICAN RAILCAR INDUSTRIES

Buyout-Fund-Backed

No changes to simple compensation plans. Restricted stock was not awarded in the first year after IPO, but the committee intends to continue making awards. Short-term performance

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measured using EBITDA and working capital management. CEO has employment agreement.

Non-PE-Backed

New equity compensation plan and new employment agreement with CEO both introduced for the IPO. Short-term performance measured against EBITDA and, post-IPO, individual measures.

2006 Pair Two

DYNCORP INTERNATIONAL INC-A

STANLEY INC

Buyout-Fund-Backed

Long-term equity is offered through the form of Class B interests in the controlling stockholder. These function similarly to restricted stock. A significant increase in bonus was due to a retention bonus being paid that was supposed to retain executives over the IPO period. Despite payment of these significant retention bonuses, three executives including the CEO, left the year after the IPO. Short-term performance metric only disclosed after the IPO and was EBITDA. CEO signed an employee agreement after IPO.

Non-PE-Backed

The company moved to awarding stock options following IPO and will only make restricted stock awards for retention purposes to new hires. Short-term performance is measured using EBITDA, revenue, sales, EPS, and rate variance. CEO does not have an employment agreement.

2006 Pair Three

EAGLE TEST SYSTEMS INC

TECHWELL INC

Buyout-Fund-Backed

Stock options were granted to all executives except the CEO after IPO. Some options had been awarded to other officers prior to IPO. Short-term metrics were not disclosed pre-IPO, in the following year they were stated as operating income and individual targets. The CEO has an employment agreement.

Non-PE-Backed

The company retains moderate base salaries and bonuses, and does not appear to have made significant additional stock awards post IPO. Stock options were not awarded to CEO immediately prior to the IPO, but he already had significant number of vested options. Additional options were awarded subsequent to the IPO and in the fiscal year following. Annual performance was measured using revenue and non-GAAP operating income in the year following IPO, but performance metrics were not disclosed prior to this.

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2006 Pair Four

GATEHOUSE MEDIA INC

GLOBAL TRAFFIC NETWORK INC

Buyout-Fund-Backed

Apart from the insufficient disclosure related to annual performance metrics and a substantial golden hello to the CEO as part of his employment agreement, compensation appears moderate. Long-term incentives are delivered in the form of restricted stock only at present.

Non-PE-Backed

As with its buyout-fund-backed peer, this company also displays inadequate performance metric disclosure, although the compensation discussion & analysis from the 2008 proxy statement indicates that a formal incentive plan will shortly be established. Compensation remains moderate. The CEO has an employment agreement.

2006 Pair Five

GEOMET INC

VENOCO INC

Buyout-Fund-Backed

The company has a well-designed annual incentive plan based on production, reserves, EBITDA and 3-year finding and development costs, although a discretionary element was added to this in 2007, and makes moderate stock awards, though these are not tied to performance. The CEO has an employment agreement.

Non-PE-Backed

A solid bonus plan based on production, EBITDA, and growth in reserves, as well as moves to tie long-term compensation closer to TSR performance are somewhat undermined by a list of perks in fiscal 2006. Many of these perks were gone by 2007. The CEO has an employment agreement.

2006 Pair Six

ICF INTERNATIONAL INC

INNERWORKINGS INC

Buyout-Fund-Backed

The switch from time-restricted stock to options is a step forward and the redesign of the bonus plan is also helpful, but the guaranteed base salary increases for the CEO would appear to be unnecessary. Pre-IPO performance was measured using adjusted EBITDA, while post-IPO the following metrics will be used: earnings, revenues, backlog, strategic goals relating to

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acquisitions and technology initiatives and operational goals relating to expense management and people development. In addition, the Special Event Bonus that paid out substantial awards on completion of the IPO has now been discontinued. The CEO has an employment agreement.

Non-PE-Backed

The company’s unsophisticated incentive plans became yet more unsophisticated following IPO, as short-term metrics were reduced down from revenues, EBITDA and net income to simply net income. The CEO has an employment agreement.

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APPENDIX D

Related Party Transactions

The exact types, number and percentages of RPTs reported by each group of companies in our sample are listed below.

Related Party Transaction Categories

Equity Related Loans

Loans related to shareholder equity or other capital issues, used to maintain relative ownership positions among key executives and other corporate officers, or for tax purposes. These loans many originate from a dominant shareholder, or from the corporate entity itself, but in most cases were simply reported in the company prospectus and generally resolved at IPO.

Examples:

• Alpha Natural Resources, Inc. – “Loans from First Reserve - We were formed and wholly owned by affiliates of First Reserve, one of our Sponsors, in 2002. As part of our formation and our acquisition of our Predecessor in December 2002, First Reserve loaned us $24.0 million for which we paid First Reserve $0.3 million in fees in 2002 and for which we incurred interest expense of $2.6 million and $144,000 during 2003 and 2002, respectively. The loan was contributed to our capital in 2003.”

• Builders FirstSource, Inc. – “The Company loaned $50,000 to Mr. Horn to purchase shares of our common stock, under our 1998 Stock Incentive Plan, as amended, which loan, together with interest thereon, was repaid in full on February 25, 2004.”

• Warner Music Group Corp. – "On December 23, 2004, Holdings issued approximately $700 million of Holdings Notes. The proceeds from the issuance of the Holdings Notes were used to fund a return of approximately $681 million from Holdings to its shareholders and the shareholders of Warner Music Group through a combination of dividends on Holdings' preferred stock and repurchases of its common stock and preferred stock and dividends on Warner Music Group's common stock. Of the total of $681 million, approximately $631 million was distributed to the Investors with the remainder being held by Warner Music Group. We distributed $42.5 million of the remaining $50 million to the Investors on March 28, 2005 and intend to distribute the remainder of approximately $7.5 million to the Investors prior to this offering. We obtained an amendment to Acquisition Corp's senior secured credit agreement to provide for the Holdings' Payment to Investors, including the distribution of the remaining $50 million to the Investors."

• Huntsman Corporation – “Subordinated Loan - On July 2, 2001, we borrowed $25.0 million from Horizon Ventures LLC, an entity controlled by Jon M. Huntsman, and executed a note payable in the same amount. The note bears interest at a rate of 15% per year and is due and payable on the earlier of: (1) July 2, 2011, (2) repayment in full in cash of all indebtedness under the HLLC Credit Facilities and the HLLC Subordinated Notes, or (3) commencement of a voluntary case under Title 11 of the U.S. Code or any similar law for the relief of debtors or our consent to the institution of a bankruptcy or an insolvency proceeding against us, or the making of a general assignment for the benefit of our creditors. Interest is not paid in cash, but is accrued at a designated rate of 15% per year, compounded annually. As of September 30, 2004 and

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December 31, 2003, accrued interest added to the principal balance was $14.5 million and $10.5 million, respectively. We intend to use a portion of the net proceeds from this offering to repay this note in full.”

In the following example a complex series of loan agreements incorporating specific covenants that directly influenced the company’s corporate governance were used for both capitalization and regular operating cash flow purposes both before and after the company’s IPO:

• GateHouse Media, Inc. - "First Lien Credit Agreement. GateHouse Media Operating, Inc. (‘‘Operating’’), an indirectly wholly owned subsidiary of GateHouse Media, GateHouse Media Holdco, Inc. (‘‘Holdco’’), a wholly owned subsidiary of GateHouse Media, and certain of their subsidiaries are party to a first lien credit agreement, dated as of June 6, 2006, as amended on June 21, 2006 and October 11, 2006, with a syndicate of financial institutions with Wachovia Bank, National Association as administrative agent. The first lien credit facility provided for a $570.0 million term loan facility and a revolving credit facility with a $40.0 million aggregate loan commitment amount available, including a $15.0 million sub-facility for letters of credit and a $10.0 million swingline facility. The first lien credit facility is secured by a first priority security interest in (i) all present and future capital stock or other membership, equity, ownership or profits interest of Operating and all of its direct and indirect domestic restricted subsidiaries, (ii) 66% of the voting stock (and 100% of the nonvoting stock) of all present and future first-tier foreign subsidiaries and (iii) substantially all of the tangible and intangible assets of Holdco, Operating and their present and future direct and indirect domestic restricted subsidiaries. In addition, the loans and other obligations of the borrowers under the first lien credit facility were guaranteed, subject to specified limitations, by Holdco, Operating and their present and future direct and indirect domestic restricted subsidiaries.

Borrowings under the first lien credit facility bore interest, at the borrower’s option, equal to the LIBOR Rate for a LIBOR Rate Loan (as defined in the facility), or the Alternate Base Rate for an Alternate Base Rate Loan ( as defined in the facility), plus an applicable margin. The applicable margin was fixed at 2.25% (LIBOR Rate) and 1.25% (Alternate Base Rate). The applicable margin for revolving loans was adjusted quarterly and ranged from 1.5% to 2.0% (LIBOR Rate) and 0.5% to 1.0 (Alternate Base Rate).

The first lien credit facility contains financial covenants that require Holdco to satisfy specified quarterly financial tests, consisting of a total leverage ratio, an interest coverage ratio and a fixed charge coverage ratio. The first lien credit facility also contain affirmative and negative covenants customarily found in loan agreements for similar transactions, including restrictions on our ability to incur indebtedness, create liens on assets, engage in certain lines of business, engage in mergers or consolidations, dispose of assets, make investments or acquisitions, engage in transactions with affiliates, enter into sale leaseback transactions, enter into negative pledges or pay dividends or make other restricted payments (except that after the second lien credit facility has been paid in full and terminated, Holdco is permitted to pay quarterly dividends so long as, after giving effect to any such dividend payment, Holdco and its subsidiaries are in pro forma compliance with each of the financial covenants, including the total leverage ratio). The first lien credit facility contained customary events of default, including defaults based on a failure to pay principal, reimbursement obligations, interest, fees or other obligations, subject to specified grace periods; a material inaccuracy of representations and warranties; breach of covenants; failure to pay other indebtedness and cross-defaults; a Change of Control (as defined in the first lien credit facility); events of bankruptcy and insolvency; material judgments; failure to meet certain requirements with respect to ERISA; and impairment of collateral.

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In October 2006, GateHouse Media used a portion of the net proceeds from its initial public offering to pay down $12.0 million of the first lien credit facility, and to repay in full the outstanding balance of $21.3 million under the $40.0 million revolving credit facility. As of December 31, 2006, $558.0 million was outstanding under the first lien credit facility. For fiscal 2006, GateHouse Media paid $23.1 million in interest under the first lien credit facility.

Fortress purchased $87 million of the $610 million first lien credit facility on arms’ length terms in a secondary market transaction. As of December 31, 2006, Fortress continues to hold $85.8 million of the first lien credit facility. The first lien credit facility was amended and restated on February 27, 2007.

Second Lien Credit Agreement. Holdco, Operating and certain of their subsidiaries were party to a secured bridge credit agreement, dated as of June 6, 2006, as amended on June 21, 2006, with a syndicate of financial institutions with Wachovia Bank, National Association as administrative agent. This second lien credit facility provided for a $152.0 million term facility that matured on June 6, 2014, subject to earlier maturity upon the occurrence of certain events. The second lien credit facility was secured by a second priority security interest in (i) all present and future capital stock or other membership, equity, ownership or profits interest of Operating and all of its direct and indirect domestic restricted subsidiaries, (ii) 66% of the voting stock (and 100% of the nonvoting stock) of all present and future first-tier foreign subsidiaries and (iii) substantially all of the tangible and intangible assets of Holdco, Operating and their present and future direct and indirect domestic restricted subsidiaries. In addition, the loans and other obligations of the borrowers under the second lien credit facility are guaranteed, subject to specified limitations, by Holdco, Operating and their present and future direct and indirect domestic restricted subsidiaries.

Borrowings under the second lien credit facility bore interest, at the borrower’s option, equal to the LIBOR Rate for a LIBOR Rate Loan (as defined in the facility) or the Alternate Base Rate for an Alternate Base Rate Loan (as defined in the facility), plus an applicable margin. The applicable margin was fixed at 1.5% (LIBOR Rate) and 0.5% (Alternate Base Rate). For fiscal 2006, GateHouse Media paid $4.2 million in interest under the second lien facility.

Fortress purchased $37.0 million of the $152.0 million second lien credit facility on arms’ length terms in a secondary market transaction.

In October 2006, GateHouse Media used a portion of the net proceeds from its initial public offering to repay in full and terminate the $152.0 million second lien credit facility."

Other Loans

Mostly housing related and other non-equity related loans to key executives, or loans related to ongoing business agreements intended to facilitate corporate cash flow.

Examples:

• Alpha Natural Resources, Inc. – “Loans to Executives - In connection with the hiring in October 2003 of David Stuebe, our Vice President and Chief Financial Officer, we extended to Mr. Stuebe a $100,000 relocation loan bearing interest at a rate of 6%. Mr. Stuebe repaid all outstanding principal and interest on this loan on March 31, 2004. In connection with the hiring in February 2003 of Kevin Crutchfield, our Executive Vice President, we extended to Mr. Crutchfield a

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$79,600 relocation loan bearing interest at a rate of 6.25%. Mr. Crutchfield repaid all outstanding principal and interest on this loan during 2003.”

• XenoPort, Inc. – "On December 20, 2001, we loaned $150,000 to Dr. Kenneth C. Cundy, our senior vice president of preclinical development, under a full-recourse promissory note, which was secured by a deed of trust. This loan bears interest at an annual rate of 4.13%. So long as Dr. Cundy remains employed with us, on each anniversary of the date of this note, we will automatically forgive all interest then accrued pursuant to the terms of the note. The loan was made in connection with the purchase of a primary residence."

Ongoing Business Relationships

Contractual or subsidiary-derived business agreements that are generally intended to survive the IPO and sustained into the foreseeable future. Includes various supply chain, distribution or manufacturing agreements, and licensing and other intellectual property agreements. May also include direct ongoing business relationships with individual officers and directors, particularly at financial service firms.

Examples:

• Crocs, Inc. – "Under the terms of the separation and release agreement, on April 1, 2005, we entered into a distribution agreement with Crocodile Distribution, LLC, an entity controlled by Mr. Boedecker, which granted Crocodile Distribution the exclusive rights to distribute our products in Mexico, the Dominican Republic, Costa Rica and, to the extent it complies with United States law in the future, Cuba. The initial term of the agreement is 10 years from July 1, 2005 and it is renewable on a non-exclusive basis for an additional five year term. The exclusivity portion of the agreement may be terminated by us if Crocodile Distribution fails to purchase certain minimum amounts of our products. Crocodile Distribution will receive a discount from our standard wholesale list price for the purchase of our products. In addition, on July 1, 2005, we entered into a kiosk agreement with Crocodile Kiosk, LLC, an entity controlled by Mr. Boedecker, which granted Crocodile Kiosk exclusive rights to license or sell certain crocs-related franchises to third parties. The license or franchise rights will give the licensee or franchisee the right to establish retail kiosks in airport locations. The term of the license agreement is 10 years but the termination of the kiosk agreement will not have an effect on a licensee’s or franchisee’s right to operate the kiosk for a term of up to 15 years. If Crocodile Kiosk fails to license or franchise a minimum number of kiosks during the term, the agreement will become non-exclusive. In 2006, we recognized $2.3 million of revenue related to these agreements."

• Western Alliance Bancorporation – “During 2004, the Banks had, and expect to have in the future, banking transactions in the ordinary course of business with our directors, officers, and principal shareholders (and their associates) on the same terms, including interest rates and collateral on loans as those prevailing at the same time with other persons of similar creditworthiness. In our opinion, these loans present no more than the normal risk of collectibility or other unfavorable features. At December 31, 2004, our officers, directors and principal shareholders (and their associates) were indebted to the Banks in the aggregate amount of approximately $27.1 million in connection with these loans. This amount was approximately 2.3% of total loans outstanding as of such date. All such loans are currently in good standing and are being paid in accordance with their terms.”

• Crosstex Energy, Inc. – "Omnibus Agreement. Concurrent with the closing of the Partnership's initial public offering, we entered into an agreement with it, Crosstex Energy GP, LLC and the

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Partnership's general partner which will govern potential competition among us and the other parties to the agreement. We agreed, and caused our controlled affiliates to agree, for so long as management, Yorktown Energy Partners IV, L.P. and Yorktown Energy Partners V, L.P. and its affiliates, or any combination thereof, control the Partnership's general partner, not to engage in the business of gathering, transmitting, treating, processing, storing and marketing of natural gas and the transportation, fractionation, storing and marketing of natural gas liquids unless we first offer it the opportunity to engage in this activity or acquire this business, and the board of directors of Crosstex Energy GP, LLC, with the concurrence of its conflicts committee, elects to cause it not to pursue such opportunity or acquisition. In addition, we have the ability to purchase a business that has a competing natural gas gathering, transmitting, treating, processing and producer services business if the competing business does not represent the majority in value of the business to be acquired and we offer the Partnership the opportunity to purchase the competing operations following their acquisition. The noncompetition restrictions in the omnibus agreement do not apply to the assets retained and business conducted by us at the closing of the Partnership's initial public offering. Except as provided above, we and our controlled affiliates are not prohibited from engaging in activities in which they compete directly with the Partnership. In addition, Yorktown Energy Partners IV, L.P., Yorktown Energy Partners V, L.P. and any affiliated Yorktown funds are not prohibited from owning or engaging in businesses which compete with us or the Partnership.

• Camden Resources, Inc. – “The Partnership treats gas for, and purchases gas from, Camden Resources, Inc. and treats gas for Erskine Energy Corporation and Approach Resources, Inc. All three entities are affiliates of us by way of equity investments made by Yorktown Energy Partners IV, L.P. and Yorktown Energy Partners V, L.P., collectively, one of our major shareholders. The gas treating and gas purchase agreements we have entered into with these three entities are standard industry agreements containing terms substantially similar to those contained in our agreements with other third parties. During the year ended December 31, 2006, the Partnership purchased natural gas from Camden Resources, Inc. in the amount of approximately $32.5 million and received approximately $2.6 million in treating fees from Camden Resources, Inc. During the year ended December 31, 2006, the Partnership received treating fees of $1.3 million and $0.3 million from Erskine Energy Corporation and Approach Resources, Inc., respectively."

Management and Consulting Agreements

Contractual agreements that allow for payments to key executives or directors for the provision of ongoing administrative, management or professional services not related to specific salaried positions. Includes contracts with private entities held primarily or entirely by company executives or directors. Often tied to one or more large shareholders, both before and after IPO.

Examples:

• Rockwood Holdings, Inc. – "Management Services Agreement with KKR and DLJMB III: In connection with the Dynamit Nobel acquisition, we have entered into a management services agreement, dated as of July 29, 2004, with KKR and DLJMB III. Under the agreement, KKR and DLJMB III have agreed to provide certain management, business strategy, consulting and financial services to us and our subsidiaries. These services include (i) advice regarding the structure, distribution, and timing of debt and equity offerings, (ii) advice regarding our business strategy, (iii) advice regarding dispositions and/or acquisitions and (iv) other services of the type customarily performed by KKR and DLJMB III. The aggregate annual fee under the management services agreement is $2.0 million, which amount will be increased by 5% each year and is

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payable quarterly to KKR and DLJMB III on a pro rata basis based on their respective percentage equity interest in us. This annual fee is paid by our U.S. subsidiaries. Under the agreement, we paid a transaction fee of $21.0 million to KKR and $9.0 million to DLJMB III (or an aggregate fee of $30.0 million) in connection with the closing of the Dynamit Nobel acquisition. We also agree to indemnify and hold each of KKR and DLJMB III and their respective partners, executives, officers, directors, employees, agents, controlling persons and affiliates harmless from and against any losses and/or liabilities relating to or arising out of the services contemplated by the agreement or the retention of KKR and DLJMB III pursuant to, and such entities' or their affiliates' performance of the services contemplated by, the agreement. In connection with this offering, the affiliates of KKR and DLJMB III have agreed to terminate the management services agreement for an aggregate consideration of $10.0 million. Certain provisions in the management services agreement, including indemnification, will survive such termination."

• Accuride Corporation – "Management Services Agreement: In connection with the TTI merger, we entered into a management services agreement with KKR and Trimaran Fund Management L.L.C., or TFM, pursuant to which we retained KKR and TFM to provide management, consulting and financial services to Accuride of the type customarily performed by investment companies to its portfolio companies. In exchange for such services, we agreed to pay an annual fee in the amount equal to $665,000 to KKR and $335,000 to TFM. In addition, we will reimburse KKR and TFM, and their respective affiliates, for all reasonable out-of-pocket expenses incurred in connection with such retention, including travel expenses and expenses of legal counsel. We may terminate the management services agreement with respect to either KKR or TFM when one or both parties no longer has the right to appoint one or more members to our board of directors pursuant to the terms of the Shareholder Rights Agreement that we entered in connection with the TTI merger. Additionally, the management services agreement will automatically terminate upon a change of control as provided in the Shareholder Rights Agreement."

• Asset Acceptance Capital Corp. – "On September 30, 2002, we entered into a consulting services agreement with Quad-C Management, Inc., an affiliate of AAC Quad-C Investors LLC, the sole stockholder of AAC Investors, Inc. (which beneficially owns more than 5% of our common stock), that expires on December 31, 2003. The agreement will automatically renew for additional one-year periods unless terminated by either party. Under the agreement, Quad-C Management, Inc. receives a consulting services fee of $300,000 per year for consulting with and advising us on matters relating to financing, taxation and operations and development of the business, among other matters. Upon consummation of this offering, this agreement will be terminated. While Quad-C Management, Inc. does not have a contractual right to appoint any members of the board of directors, two of our board members will be affiliates of Quad-C Management, Inc. In 2002, we paid Quad-C Management, Inc., $1.0 million in investment banking fees in connection with our equity recapitalization in September 2002, and $75,000 for consulting services rendered. In 2003, we paid Quad-C Management, Inc. $300,000 for consulting services rendered and will pay an additional $75,000 per quarter through the Reorganization. Terrence D. Daniels and Anthony R. Ignaczak both serve on our board of directors and are Partners of Quad-C Management, Inc."

• BlueLinx Holdings Inc. – "Temporary Staffing Provider We use Tandem Staffing Solutions, or Tandem, an affiliate of Cerberus, as the temporary staffing company for our office located in Atlanta, Georgia. We incurred total temporary staffing expenses of $2.0 million for 2006.

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Other SG&A We use ATC Associates, Inc. and SBI Group, Cerberus affiliates, for real estate surveys and information technology consulting. These expenses totaled $206,580 for fiscal 2006. Rental Car Provider For fiscal 2006, we incurred expenses for car rentals in the amount of $332,922. These services were provided by Vanguard Car Rental USA Inc., an affiliate of Cerberus."

Real Estate Leases and Agreements

Ongoing leases of privately held offices, plants or other real estate assets, whether directly or indirectly held by individual company executives or directors.

Examples:

• Blackbaud, Inc. – "Lease agreement - We entered into a lease agreement dated as of October 13, 1999 with Duck Pond Creek, LLC to lease the space for our headquarters in Charleston, South Carolina. Duck Pond Creek is a South Carolina limited liability company, 60% of which is owned by Anthony E. Bakker, a stockholder who beneficially owns approximately 14% of our capital stock prior to this offering, and 4% of which is owned by each of Louis J. Attanasi and Gerard J. Zink, two of our named executive officers. Under this lease, we made payments to Duck Pond Creek totaling approximately $4.3 million in 2001, 2002 and 2003. The term of the lease is for 10 years with two five-year renewal options. The current annual base rent of the lease is approximately $4.3 million. The base rate escalates annually at a rate equal to the change in the consumer price index, as defined in the agreement. Based on publicly-available survey data on office space rental rates in our area at the time we entered into the lease, we believe that this lease agreement is on terms at least as favorable to us as could have been obtained from an unaffiliated third party."

• Consolidated Communications Holdings, Inc. – "LATEL Sale/ Leaseback - In 2002, in connection with our predecessor company’s acquisition of ICTC and several related businesses from McLeodUSA, each of ICTC and Consolidated Communications Market Response, Inc., or Consolidated Market Response, an indirect, wholly owned subsidiary of the Company, entered into separate agreements with LATEL, pursuant to which each of them sold to LATEL real property for total consideration of approximately $9.2 million and then leased the property back from LATEL. The sale prices for the properties sold to LATEL were determined based upon an appraisal of each property. LATEL is owned 50.0% by Mr. Lumpkin and 50.0% by Agracel. Agracel is the sole managing member of LATEL. Mr. Lumpkin, together with members of his family, beneficially own 49.7% of Agracel. In addition, Mr Lumpkin is a director of Agracel. The initial term of both leases was one year beginning on December 31, 2002. Each lease automatically renews for successive one year terms through 2013, unless either ICTC or Consolidated Market Response provides one year prior written notice that it intends to terminate its respective lease. On August 1, 2005, LATEL exercised its option in the leases to convert the term of the leases to a fixed term of six years. After the fixed term expires on July 31, 2011, the leases will revert back to the initial lease terms through 2013.

Collectively, the lease expense for 2005 was approximately $1.3 million, of which ICTC paid approximately $1.1 million and Consolidated Market Response paid the remainder. These lease payments represent 100.0% of the revenues of LATEL. The annual rent for each lease will increase by 2.5% upon each renewal. Currently, the leases are recorded as operating leases of ICTC and Consolidated Market Response.

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MACC, LLC In 1997, prior to our predecessor company’s acquisition of ICTC at the end of 2002, Consolidated Market Response entered into a lease agreement with MACC, LLC (“MACC”), an Illinois limited liability company, pursuant to which Consolidated Market Response agreed to lease office space for a period of five years. Agracel is the sole managing member and 66.7% owner of MACC. Mr. Lumpkin and members of his family directly own the remainder of MACC. The parties extended the lease for an additional five years beginning October 14, 2002. Consolidated Market Response paid MACC rent for 2005 in the amount of $138,508. These payments represent approximately 58% of MACC’s total revenues for 2005. The lease provides for a cost of living increase to the annual lease payments based on the “Revised Consumers Price Index, All Urban Consumers” published by the Bureau of Labor Statistics for the United States Department of Labor. Neither party has the right to terminate this agreement by the terms of the agreement.

SKL Investment Group, LLC Mr. Lumpkin, together with members of his family, beneficially owns 100.0% of SKL Investment Group, a Delaware limited liability company which is an investment company serving the Lumpkin family. Mr. Lumpkin and members of his family are the sole voting members of SKL Investment Group. SKL Investment Group paid to CCI $76,800 in 2005 for the use of office space, computers and telephones and for other office related expenses. The amount CCI charged SKL for the use of its office space, equipment and other office related expenses is based upon the amounts incurred by CCI. For example, in 2005 SKL paid $28,500 to rent approximately 1,677 square feet of office space, which is equivalent to CCI’s base rent per square foot plus SKL’s pro rata share of real estate taxes, utilities and maintenance. SKL’s use of equipment and other office related expenses was based on actual third-party charges or SKL’s estimated usage."

Aircraft Leases and Agreements

Ongoing leases of privately aircraft, whether directly or indirectly owned by individual company executives or directors.

Examples:

• H&E Equipment Services, Inc. – “We charter an aircraft from Gulf Wide Aviation, L.L.C., in which Mr. Engquist has a 62.5% ownership interest. Mr. Engquist's mother and sister hold interests of 25% and 12.5%, respectively, in this entity. We pay an hourly rate to Gulf Wide Aviation for the use of the aircraft by various members of our management. In addition, a portion of one pilot's salary is paid by us. In 2002, 2003 and 2004, our payments in respect of charter costs to Gulf Wide Aviation and salary to the pilot totaled approximately $294,000, $244,000 and $273,000, respectively.”

• Life Time Fitness, Inc. – "We leased one jet until June 2003, and two jets in 2001 and 2002, from an aviation company that is wholly owned by Mr. Akradi, our Chairman of the Board of Directors, President and Chief Executive Officer, and Mr. Rowland. Each month we were charged the equivalent of the debt service for the exclusive use of the jets. We also paid an hourly fee for the periodic use of other aircraft owned by the aviation company. Beginning in July 2003, we paid an hourly market rate for the periodic use of one jet owned by the aviation company. We were charged $1,052,700, $857,100 and $891,600 for the use of the aircraft in 2001, 2002 and 2003, respectively. We purchased one jet from the aviation company for fair market value of $4.0 million in January 2004 and, as a result, we will no longer lease any aircraft from this aviation company.

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The price we paid was determined based on the average of three independent appraisals. We may continue to pay hourly fees for the periodic use of aircraft owned by the aviation company."

• Advance America, Cash Advance Centers, Inc. – "In connection with the operation of our business, we have leased airplanes and hangar space from Wyoming Associates, Inc., a company owned by Mr. Johnson, and we leased an airplane from Mr. Buntrock. We paid approximately $1.1 million in 2001, $1.3 million in 2002, $1.1 million in 2003 and $829,000 in the first nine months of 2004 for the airplanes we leased from Wyoming Associates, Inc. Hangar lease payments totaled approximately $59,000 in the first nine months of 2004 and $79,000 in each of the three full prior years. We paid approximately $0 in 2001, $0 in 2002, $0 in 2003 and $504,000 for the first nine months of 2004 for the airplane we leased from Mr. Buntrock. We have agreed to acquire the two airplanes that we have leased from Wyoming Associates, Inc, a 1985 Canadair Ltd. Challenger aircraft and a 1994 Gates Learjet aircraft, simultaneously with the closing of this offering pursuant to a contribution agreement that contains representations, warranties and other provisions that are standard for such a transaction, taking into account our previous use of these aircraft. We intend to pay the acquisition price by issuing approximately 686,217 shares of our common stock, based on the initial public offering price of our common stock of $15.00 per share. This transaction has been approved by a majority of the disinterested members of our board of directors, after consideration of an appraisal of the aircraft performed by an independent firm with expertise in aircraft appraisals. Our aircraft lease with Mr. Buntrock was terminated effective as of September 1, 2004. We expect to continue to lease hangar space from Wyoming Associates, Inc. and believe that, at least for the near term, it is more favorable to us to lease such space rather than incur the expense of constructing our own hangar space. Similarly, we expect to continue to use Wyoming Associates' maintenance personnel to service the aircraft to be acquired by us. The financial terms relating to such maintenance arrangement have not yet been negotiated. Our corporate policy does not allow for personal use by our personnel of our aircraft, unless such personal use does not result in any incremental cost to us."

Shareholder Agreements

Specialized agreements that can significantly impact corporate governance, most often by specify special voting rights or the ability of certain shareholders or shareholder blocks to designate one or more of the company’s directors.

Examples:

• Rockwood Holdings, Inc. – "Stockholders' Agreement with Affiliates of KKR and DLJMB (includes Registration Rights Agreement): In connection with the Dynamit Nobel acquisition, we entered into a stockholders' agreement, dated as of July 29, 2004, with affiliates of KKR and DLJMB:

Board Representation. The stockholders' agreement provides that our board of directors will initially consist of eight directors, five of whom will be designated by affiliates of KKR, two of whom will be designated by DLJMB and one of whom will be our chief executive officer. At such time that DLJMB ceases to own at least 10% of our outstanding common stock, DLJMB will cease to have the right to designate directors to our board of directors. In connection with this offering, our board of directors may be reconstituted, subject to compliance with applicable law and the listing rules of the applicable securities exchange; provided that, DLJMB will be entitled to designate one director to our board of directors for so long as they continue to own at least 10% of our outstanding common stock after giving effect to this offering.

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Restrictions on Transfers. Prior to the fifth anniversary of the Dynamit Nobel acquisition, DLJMB may not generally transfer shares of our common stock, other than to certain permitted transferees (including distributions to their limited partners), pursuant to a registered sale or pursuant to drag-along rights described below. Following the fifth anniversary of the Dynamit Nobel acquisition, DLJMB may transfer their shares subject to drag-along rights described below and certain other restrictions. Subject to compliance with certain restrictions, affiliates of KKR may transfer their shares by any means at any time.

Drag-Along Rights. If at any time affiliates of KKR and any other holder of shares of our common stock receive a bona fide offer from any third party to purchase at least a majority of our outstanding common stock, and such offer is accepted, then DLJMB will, if required by affiliates of KKR, transfer to such third-party on the terms of the accepted offer such number of shares of common stock held by them as is proportional to the number of shares being sold by affiliates of KKR and other holders in relation to the number of shares then owned by them.

Registration Rights. Each stockholder party to the agreement agrees to be bound by the registration rights agreement dated November 20, 2000, as amended. DLJMB is entitled to make up to three separate written requests that we effect the registration under the Securities Act of all or some of their shares of common stock pursuant to the terms of the registration rights agreement; provided, however, DLJMB may not make any such request until the earlier of (i) the termination of any applicable "lock-up" period and the end of any period during which dealers must deliver a prospectus in connection with the sale of any shares of our common stock by any affiliates of KKR pursuant to the exercise of its second demand registration right and (ii) the sixth anniversary of the closing of the Dynamit Nobel acquisition if no affiliate of KKR has exercised its demand registration right to date. Affiliates of KKR are entitled to make an unlimited number of requests that we effect the registration under the Securities Act of their shares of common stock."

• GateHouse Media, Inc. – "Investor Rights Agreement - On October 24, 2006, GateHouse Media entered into an Investor Rights Agreement with Fortress. The Investor Rights Agreement provides Fortress with certain rights with respect to the nomination of directors to GateHouse Media’s Board as well as registration rights for securities owned by Fortress.

The Investor Rights Agreement requires GateHouse Media to take all necessary or desirable action within its control to elect to its Board so long as Fortress beneficially owns (i) more than 50% of the voting power, four directors nominated by FIG Advisors LLC, an affiliate of Fortress (‘‘FIG Advisors’’), or such other party nominated by Fortress; (ii) between 25% and 50% of the voting power, three directors nominated by FIG Advisors; (iii) between 10% and 25% of the voting power, two directors nominated by FIG Advisors; and (iv) between 5% and 10% of the voting power, one director nominated by FIG Advisors. In the event that any designee of FIG Advisors shall for any reason cease to serve as a member of the Board during his term of office, FIG Advisors will be entitled to nominate an individual to fill the resulting vacancy on the Board. Pursuant to the Investor Rights Agreement, GateHouse Media grants Fortress, for so long as it beneficially owns at least 5% of its issued and outstanding common stock, ‘‘demand’’ registration rights. Fortress is entitled to an aggregate of four demand registrations.

GateHouse Media is not required to maintain the effectiveness of the registration statement for more than 60 days. GateHouse Media is also not required to effect any demand registration within six months of a ‘‘firm commitment’’ underwritten offering to which the requestor held ‘‘piggyback’’ rights and which included at least 50% of the securities requested by the requestor to be included. GateHouse Media is not obligated to grant a request for a demand registration

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within four months of any other demand registration and may refuse a request for demand registration if, in its reasonable judgment, it is not feasible to proceed with the registration because of the unavailability of audited financial statements.

For as long as Fortress beneficially owns an amount of at least equal to 1% of GateHouse Media’s issued and outstanding common stock, Fortress also has ‘‘piggyback’’ registration rights that allow Fortress to include the shares of common stock that Fortress owns in any public offering of equity securities initiated by GateHouse Media (other than those public offerings pursuant to registration statements on Forms S-4 or S-8) or by any of GateHouse Media’s other stockholders that may have registration rights in the future. The ‘‘piggyback’’ registration rights of Fortress are subject to proportional cutbacks based on the manner of the offering and the identity of the party initiating such offering.

GateHouse Media grants Fortress, for as long as Fortress beneficially owns at least 5% or more of GateHouse Media’s common stock, the right to request shelf registrations on Form S-3, providing for an offering to be made on a continuous basis, subject to a time limit on GateHouse Media’s efforts to keep the shelf registration statement continuously effective and GateHouse Media’s right to suspend the use of a shelf registration prospectus for a reasonable period of time (not exceeding 60 days in succession or 90 days in the aggregate in any 12-month period) if it determines that certain disclosures required by the shelf registration statement would be detrimental to it or its stockholders.

GateHouse Media agrees to indemnify Fortress against any losses or damages resulting from any untrue statement or omission of material fact in any registration statement or prospectus pursuant to which Fortress sells shares of GateHouse Media’s common stock, unless such liability arose from Fortress’ misstatement or omission, and Fortress has agreed to indemnify GateHouse Media against all losses caused by its misstatements or omissions. GateHouse Media will pay all expenses incident to registration and Fortress will pay its respective portions of all underwriting discounts, commissions and transfer taxes relating to the sale of its shares under such a registration statement."

• SMART Modular Technologies (WWH), Inc. – "Shareholders' Agreement - We, TPG, Francisco Partners and Shah Capital Partners and certain other shareholders are parties to a shareholders' agreement. The shareholders' agreement covers matters of corporate governance, restrictions on transfer of our securities and information rights.

Corporate Governance. The shareholders' agreement provides that so long as they hold at least 10% of our outstanding shares, each of TPG and Francisco Partners may nominate two members of our board of directors; that as long as they hold at least 5% of our outstanding shares, each of TPG, Francisco Partners and Shah Capital Partners may nominate one member of our board of directors; that the principal investors have the right to nominate jointly with our President or Chief Executive Officer (who shall also serve as a member of the board of directors during his employment with us) three other directors to our board; and that the parties to the shareholders' agreement will vote their ordinary shares to elect the persons so nominated to our board of directors. Mr. Shah was nominated by Shah Capital Partners, Mr. Frantz was nominated by TPG, and Mr. Deb was nominated by Francisco Partners. In addition, Messrs. McKinney, Mercer, Park, Patel and Weatherford, each of whom are independent in accordance with applicable NASDAQ and SEC rules, were nominated jointly by our principal investors and our chief executive officer. These rights of our principal investors do not affect the rights of our other shareholders, under our

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articles of association, to nominate our directors. In addition, each of TPG, Francisco Partners and Shah Capital Partners have the right, voting collectively, to nominate our chief executive officer and have agreed not to vote their ordinary shares for any amendment to our memorandum and articles of association unless the other principal investors also approve of such amendment.

The shareholders' agreement and our articles of association also provide that we may not take certain significant actions without the approval of TPG, Francisco Partners and Shah Capital Partners, acting collectively, as long as they own in the aggregate at least 25% of our outstanding ordinary shares. These actions include:

• mergers, acquisitions or certain sales of assets; • any liquidation, dissolution or bankruptcy; • issuances of securities; • determination of compensation and benefits for our chief executive officer, president and chief financial officer; • appointment or dismissal of any of the chairman of our board of directors, chief executive officer, president, chief financial officer or any other executive officer in any similar capacity; • amendments to the shareholders' agreement or exercise or waiver of rights under the shareholder's agreement; • any increase or decrease in the number of directors that comprise our board of directors; • the declaration of dividends or other distributions or the recapitalization, reclassification, redemption, repurchase or other acquisition of any of our subsidiaries' securities; any incurrence or refinancing of indebtedness in excess of $10.0 million; • approval of our business plan, budget and strategy; and • modification of our long-term business strategy, the scope of our business or any of our material customer relationships.

In addition, the shareholders' agreement provides that so long as TPG, Francisco Partners and Shah Capital Partners own in the aggregate at least 25% of our outstanding ordinary shares we may not enter into certain related party transactions without the consent of each of TPG, Francisco Partners and Shah Capital Partners.

All of the provisions of the shareholders' agreement are expressly subject to any requirements as to governance imposed by rules of the SEC and of any exchange on which our securities are listed.

Information Rights. So long as each of TPG, Francisco Partners and Shah Capital Partners hold at least 5% of our outstanding ordinary shares, each has the right to receive from us financial information, monthly management reports, reports from our independent public accountants and such additional information regarding our financial position or business as it reasonably requests.

Registration Rights –

Demand Registration. The shareholders' agreement provides that at the request of TPG, Francisco Partners and Shah Capital Partners, acting collectively or individually, we can be required to effect, at our expense, additional registration statements, or demand registrations, registering the securities held by such shareholders. We are required to pay the registration expenses in connection with each demand registration. We may decline to honor any of these demand registrations if the aggregate gross proceeds expected to be received does not equal or

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exceed $5.0 million or if we have effected a demand registration within the preceding six-month period. If a demand registration is underwritten and the managing underwriter advises us that the number of securities offered to the public needs to be reduced, priority of inclusion in the demand registration shall be such that first priority shall be given to TPG, Francisco Partners and Shah Capital Partners and their respective permitted transferees.

Incidental Registration. In addition to our obligations with respect to demand registrations, if we propose to register any of our securities, other than a registration on Form S-8 or S-4 or successor forms to these forms, whether or not such registration is for our own account, the parties to the shareholders' agreement, including TPG, Francisco Partners and Shah Capital Partners will have the opportunity to participate in such registration. Expenses relating to these incidental registrations are required to be paid by us. If an incidental registration is underwritten and the managing underwriter advises us that the number of securities offered to the public needs to be reduced, priority of inclusion shall be such that first priority shall be given to us and second priority shall be given to TPG, Francisco Partners and Shah Capital Partners and their respective permitted transferees. We and the shareholders selling securities under a registration statement are required to enter into customary indemnification and contribution arrangements with respect to each registration statement."

Registration Rights Agreements

Often tied to a related shareholder rights agreement, requires the company to register for sale, and generally assume any costs related to such registration, shares privately held by one or more shareholders or shareholder blocks, at some time after the initial IPO, at the shareholder’s discretion.

Example:

• Assurant, Inc. – "Registration Rights Agreement - Concurrently with the offering contemplated by this prospectus, we will enter into a registration rights agreement with Fortis Insurance N.V. pursuant to which we will grant to Fortis Insurance N.V. and its affiliates that become our stockholders (collectively, Fortis Insurance) rights to request registration under the Securities Act to effect a public offering with respect to all or part of the shares of our common stock owned by them from time to time during the term of the agreement so long as the shares to be offered pursuant to the request have an aggregate offering price of at least $500 million (based on the then current market price) and, when the aggregate registrable shares held by the stockholder is less than or, after giving effect to the requested offering will be, less than 20% of the outstanding shares of our common stock, $250 million. We will be required to fulfill such obligation except in limited circumstances. The maximum number of shares to be included in any such public offering will not exceed the maximum number that the managing underwriter of such public offering considers to be appropriate. These rights may be exercised on an unlimited number of occasions with respect to registration statements on Form S-2 or S-3 and on not more than two occasions with respect to registration statements on Form S-1; provided that we will not be obligated to effect more than one registration in any 90-day period.

In addition, subject to limited exceptions, if we propose to register any shares of our common stock, other equity securities or securities convertible into or exchangeable for equity securities, whether or not for sale for our own account, we are required to provide notice to Fortis Insurance, and if requested by Fortis Insurance, we will include its shares in the registration statement. The maximum number of shares to be included in any such public offering will not exceed the

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maximum number that the managing underwriter of such public offering considers to be appropriate with priority given to securities sought to be included at our request.

During the term of the agreement, Fortis Insurance will agree not to sell, transfer or hedge any shares of our common stock or any securities convertible into or exchangeable for our common stock for 10 days prior to and 90 days after the effective date of a registration statement for an underwritten public offering of any of our equity securities (unless the underwriters of such offering permit a shorter period).

We are generally obligated to pay all expenses of the registration and offering of shares in connection with any such registration, other than underwriting discounts and commissions. In addition, we will agree to indemnify Fortis Insurance for damages relating to a material misstatement or omission in any registration statement or prospectus relating to shares of our common stock to be sold by Fortis Insurance. Fortis Insurance will agree to indemnify us, our officers and our directors on the same basis with respect to material misstatements or omissions relating to information about Fortis Insurance up to the amount of net proceeds received.

Generally, we may grant registration rights to other persons; however, any such registration rights cannot be exercised until after the second anniversary of this offering."

Indemnification Agreements

An agreement to indemnify one or more parties to the company’s IPO, placing the burden of defense on the company should legal action ensue.

Examples:

• EnerSys – "Indemnity and Expense Agreement - We have agreed with each of the Morgan Stanley Funds, in an indemnity and expense agreement dated March 22, 2002, that, to the fullest extent permitted by law, none of such stockholders, or any of their respective partners or other affiliates, or their respective members, stockholders, directors, managers, officers, employees, agents or other affiliates, or any person or entity who serves at the request of any such stockholder on behalf of any person or entity as an officer, director, manager, partner or employee of any person or entity (referred to as indemnified parties), shall be liable to us for any act or omission taken or suffered by such indemnified party in connection with the conduct of our affairs or otherwise in connection with such stockholder’s ownership of shares of our common stock, unless such act or omission resulted from fraud, willful misconduct or gross negligence by such indemnified party or any mistake, negligence, dishonesty or bad faith of any agent of such indemnified party.

We have also agreed with each Morgan Stanley Fund that, to the fullest extent permitted by law, we will indemnify each of such indemnified parties for any and all liabilities and expenses (including amounts paid in satisfaction of judgments, in compromises and settlements, as fines and penalties and legal or other costs and reasonable expenses of investigating or defending against any claim or alleged claim) of any nature whatsoever, known or unknown, liquidated or unliquidated, that are incurred by such indemnified party and arise out of or in connection with our affairs, or any indemnified party’s ownership of shares of our common stock, including acting as a director, manager or officer or its equivalent; provided that an indemnified party shall be entitled to indemnification only to the extent that such indemnified party’s conduct did not constitute fraud, willful misconduct or gross negligence.

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We have also agreed to pay, or reimburse, each Morgan Stanley Fund for all such stockholder’s reasonable out-of-pocket fees and expenses incurred in connection with and related to such stockholder’s ownership of shares of our common stock."

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ENDNOTES

1 See Bain & Co., Mergers & Acquisitions 2007 Newsletter at 1-2 (available at

http://www.bain.com/bainweb/PDFs/cms/Public/YearEnd2007_MA_Newsletter_External.pdf). 2 See http://www.usa.xorte.com/0,4,After-a-Record-Year-of-U-S-IPO-Activity-in-2007-2008-is-Off-to-a-

Sluggish-Start,5003.html 3 Qtd. in “Q1 Buyout Deal Drop,” private equityHUB, 14 April 2008 (citing Buyouts magazine statistic that

buyouts with only $46.1 billion in disclosed values closed in the first quarter of 2008, compared with $103 billion in disclosed values in the first quarter of 2007).

4 Cyrus Sanati, “Huge Drop in Private Equity Fund-Raising,” The New York Times (Dealbook), Feb. 5, 2009. 5 See http://www.bain.com/bainweb/Consulting_Expertise/capabilities_detail.asp?capID=2. 6 See, e.g., Michael C. Jensen, “Eclipse of the Public Corporation,” Harvard Business Review, Vol. 67, pp.

61-74 (1989); Michael R. Braun and Scott F. Latham, “The Governance of Going Private Transactions: The Leveraged Buyout Board of Directors as a Distinctive Source of Value,” Management Decision vol. 45 (2007); and Michael C. Jensen, “The Economic Case for Private Equity (and Some Concerns),” presentation to the American Enterprise Institute conference on The History, Impact and Future of Private Equity: Ownership, Governance and Firm Performance, Washington, DC, Nov. 27, 2007 (available on www.ssrn.com).

7 Ernst & Young, “US Record IPO Activity From 2006 Continues in 2007, According to a New Report from Ernst & Young,” (New York: Ernst & Young, June 20, 2007), (available at http://www.ey.com/global/content.nsf/US/Media_-_Release_-_06-20-07DC.

8 Michael J. de la Merced, “An IPO Glut Just Waiting to Happen,” The New York Times, July 15, 2007; and “Private Equity Firms Losing LBO Exit Strategy,” MoneyNews.com, Sept. 12, 2007.

9 Power Point presentation on the New York State Comptroller’s website, filed on EDGAR as PX14A6N on Apr. 12, 2004, at slide 21.

10 Council of Institutional Investors, Council of Institutional Investors Corporate Governance Policies, dated April 11, 2008, at 1.7 (available at http://www.cii.org/UserFiles/file/council%20policies/CII%20Corp%20Gov%20Policies%204-11-08%20Final.pdf).

11 See generally ibid. 12 See Michael Klausner, “Institutional Shareholders, Private Equity, and Anti-takeover Protection at the

IPO Stage,” at 13-14, dated October 28, 2003, University of Pennsylvania Law Review, Vol.152 (available at SSRN: http://ssrn.com/abstract=452722 or DOI: 10.2139/ssrn.452722).

13 Ibid. at 14-15. 14 Robert Gertner & Steven N. Kaplan, “The Value-Maximizing Board,” unpublished paper, dated

December 2006, (available at http://faculty.chicagogsb.edu/steven.kaplan/research/gerkap.pdf). 15 Ibid. at 4. 16 Jerry X. Cao, “What Role Does Private Equity Play When Leveraged Buyouts Go Public?” unpublished

paper, dated March 16, 2008, (available on www.ssrn.com/abstract=1107375). 17 Ibid. at 15. 18 Ibid. at 16, 29 (table 5). 19 Ibid. at 16. 20 Michael Klausner, “Institutional Shareholders, Private Equity, and Anti-takeover Protection at the IPO

Stage,” dated October 28, 2003, University of Pennsylvania Law Review, Vol.152 (available at SSRN: http://ssrn.com/abstract=452722 or DOI: 10.2139/ssrn.452722).

21 Ibid. at 12 (table 4). 22 Ibid. 23 Ibid. at 19-20. 24 The Corporate Library’s 2007 Governance Practices Report (Portland, ME: The Corporate Library, 2007)

and The Corporate Library’s 2008 Governance Practices Report (Portland, ME: The Corporate Library, 2008) 25 Ibid. 26 Ibid. 27 Ibid. 28 Robert Daines & Michael Klausner, “Do IPO Charters Maximize Firm Value: Antitakeover Protections in

IPOs,” 17 Journal of Law, Economics and Organization 17 (April 2001) 83-120. 29 John C. Coates, “Takeover Defenses in the Shadow of the Pill: A Critique of the Scientific Evidence on

Takeover Defenses.” Texas Law Review 79.2 (2000): 271-382. 30 Lucian Bebchuk, Alma Cohen and Allen Ferrell, “What Matters in Corporate Governance,” dated

September 1, 2004, Review of Financial Studies Vol. 22, No. 2, pp. 783-827. (available at SSRN: http://ssrn.com/abstract=593423 or DOI: 10.2139/ssrn.593423).

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