AEI Trustee George R. Roberts, one of the three founding partners of the investment firm Kohlberg Kravis Roberts & Co., spoke at an Amgen Forum at AEI on April 16. Mr. Roberts reviewed the broad developments in the U.S. economy that have created opportunities for KKR, outlined the methods used by the firm to restructure the finances of major corporations, and discussed the effects of those methods on business performance.

Although many people consider the pattern of corporate mergers and buyouts over the past two decades as a novelty, Mr. Roberts explained that the activity resembled a wave of corporate consolidation at the turn of the century. At that time, a drive to increase efficiency and to eliminate excess capacity in manufacturing and transportation led to numerous mergers, including the consolidation of eight companies to form U.S. Steel in 1901. The financing of that deal, arranged by J. P. Morgan, totalled $1.2 billion—7 percent of the U.S. gross domestic product. In an unusual move, Morgan placed his partners on the board to represent the investors and to ensure that the interests of management and the interests of stockholders were unified.

Over the next four or five decades, managerial capitalism—based on the idea that management interests should be divorced from ownership—took hold. Managers in those decades were typically paid a fixed salary and had no stock options.

KKR invests private money in corporate restructuring. Their capital is largely provided by a group of limited partners, including banks, university endowments, and pension funds. The premise behind KKR’s efforts is that corporate performance can be markedly improved if, as Morgan envisioned, the interests of a company’s managers are united with those of its owners. Drawing an analogy with home ownership, Mr. Roberts said, “You take a lot better care of a house you own than one you rent.”

Mr. Roberts listed five points essential for good corporate governance: (1) Directors should be paid in stock, not cash. They need to have a significant investment in the companies that they oversee. (2) The board of directors ought to be relatively small. Mr. Roberts recommended restricting a board to a half-dozen people outside the corporation and the CEO. (3) The directors must be able to get information directly from the chief financial officer, without having to go through the CEO. (4) Directors need highly detailed performance information. (5) Every year, the board should hire an outsider to review the company’s value and to list its strategic options, including selling divisions or the entire company.