Hire and Fire: How to Boost Performance

Losing staff is usually seen as negative for fund managers—just ask PIMCO—but research suggests that employee turnover can actually strengthen teams and performance.

“Some turnover might be optimal, especially in scenarios in which teams are operating in a changing environment that requires firms to adapt.”An analysis of private equity teams by Francesca Cornelli and Vikrant Vig of the London Business School, and Elena Simintzi of the University of British Columbia, found that turnover can “help eliminate” poor performers, update skillsets, and “adapt to changing business conditions.”

The researchers collected data from 138 private equity firms via a fund-of-funds manager, covering nearly 6,000 individuals over 20 years.

They found a “positive and significant relation” between staff turnover in the first five years of a fund’s operation and the internal rate of return generated.

“Contrary to the belief among private equity investors that turnover is disruptive, our results suggest that turnover has, on average, a positive effect on private equity performance,” the authors wrote. “Thus, this obsession with team stability may be unwarranted. All in all, our results provide a more nuanced view of turnover.”

The researchers said the importance of stable management teams was not as clear-cut as investors and practitioners might think, despite the emphasis placed on stability in marketing material and investment contracts.

“Stability allows members of the team to get a better knowledge of the team member’s abilities, which leads to an improved allocation of tasks within a team and allows firms to keep a competitive advantage based on tacit knowledge embedded in relationships among employees,” the authors wrote. “However, some turnover might be optimal, especially in scenarios in which teams are operating in a changing environment that requires firms to adapt. A very stable team may not be able to take advantage of the new opportunities.”

The top-performing private equity firms “fire a higher fraction of their underperforming employees,” the research found. Deal-level data showed that transactions linked to employees who subsequently leave are more likely to underperform than deals made by other employees.

The research suggested that a “narrow focus on team stability may not necessarily lead to optimal investment decisions,” Cornelli, Vig, and Simintzi concluded. “Moreover, such beliefs may exacerbate agency problems allowing (even the underperforming) employees to capture higher rents, in the presence of moral hazard. Such agency rents are particularly relevant for the private equity industry, given the opacity in the industry, which results in more severe information asymmetries between insiders and outside investors.”

Read the full paper, “Team Stability and Performance: Evidence from Private Equity.”

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