burdensome costs when the firm is ready to be sold. The reason is that out-
siders will always accord a less transparent firm a higher risk resulting in a
higher cost of capital than a firm that is more transparent. This higher cost
of capital results in a firm with a lower value. Finally, having customers with
a well-known reputation for dealing only with firms that meet and exceed
certain credit and other performance standards means that the firm-
customer relationship is “sticky,” and the cash flow that emanates from it
will have a longer duration and therefore be worth more, which of course
translates into higher value.
While the vast majority of private firms are small, and issues of trans-
parency typically abound, the larger a private firm is the greater the degree
of transparency that is required. The reason is that a private firm’s stake-
holders—customers, suppliers, joint-venture partners, and creditors—have
a need to understand the extent to which management/owner decisions may
impact the contracting arrangements the firm has with each of its stake-
holders. The information these relationships require should not be confused
with the reporting requirements of public firms to accurately disclose.
Rather, the type, quantity, and quality of required information arises from
the need to properly assess the risks of doing business with private firms.
Creating and Measuring the Value of Private Firms 29
GOVERNANCE
RATINGGOOD BEHAVIORWell above
averageCompanies ranked highly for corporate
government outperformed businesses with
weak governance during the past three
years. A study of stock returns of 1,600 major
global firms by GovernanceMetrics
International shows that corporations with
bad governance cost investors money.Well below
average
Global universe
average
*Annualized return figures for the three-year period ended Aug. 12.Above averageAverageBelow average–1.76%+1.7%+5.37%–018%–6.23%STOCK
PERFORMANCE*–13.27%FIGURE 2.6 Good Behavior