Entrepreneurial finance literature has highlighted that institutional investors are the main contributors to private equity funds. This paper complements these findings by documenting that institutional investors also invest directly in private equity. A major concern for such investments is the higher agency costs associated with private equity. We show that institutions invest in private firms with governance mechanisms that tend to reduce the expected agency costs and risk of minority expropriation. Good governance mechanisms further allow institutional investors to enjoy the benefits of syndication and thereby reduce idiosyncratic risk. In addition, we show that institutional investments tend to be followed by further improvements in corporate governance and tend to occur in high-growth firms within research and development intensive industries.

Empirical studies of large publicly traded firms have shown a robust negative relationship between board size and firm performance. The evidence on small and medium-sized firms is less clear; we show that existing work has been incomplete in analyzing the causal relationship due to weak identification strategies. Using a rich data set of almost 7000 closely held corporations we provide a causal analysis of board size effects on firm performance: We use a novel instrument given by the number of children of the chief executive officer (CEO) of the firms. First, we find a strong positive correlation between family size and board size and show this correlation to be driven by firms where the CEO’s relatives serve on the board. Second, we find empirical evidence of a small adverse board size effect driven by the minority of small and medium-sized firms that are characterized by having comparatively large boards of six or more members.