Private equity buyouts are a polarizing financial prospect. One need only look at the name of the recent bill that Senator Elizabeth Warren (D-Mass.) introduced to regulate private equity in the United States—the “Stop Wall Street Looting Act”—to get a sense of the ire they cause.
Private equity firms often hunt for target companies they see as undervalued. By cutting costs or reorganizing, the acquirer can improve productivity and position the firm for profitable operations or a future sale. In some quarters, fears persist that private equity acquires companies for reasons that do not benefit society: asset stripping, short-term profit at the expense of workers, and long-term stability.
“There are certainly a lot of concerns around whether these kind of transactions are indeed fomenting inequality by getting rid of high-quality jobs—and concerns about systemic risk as well,” says Josh Lerner, the Jacob H. Schiff Professor of Investment Banking at Harvard Business School, who leads the Entrepreneurial Management Unit.
“Our paper reveals some very attractive and socially beneficial aspects of the private equity industry, but it also indicates some more problematic aspects in terms of the changes in jobs and wages.”
Research lacking
Despite such fears, there has been little concrete analysis of the impact private equity buyouts cause. In part, that’s because the financial transactions are so complex; it can be difficult to track the fate of the acquired entity over time.
A landmark National Bureau of Economic Research working paper by Lerner and five colleagues at the University of Michigan, University of Maryland, University of Chicago, and the US Census Bureau cuts through some of the fog to reveal for the first time how buyouts affect companies and workers. The paper was published in October 2019.
Simply put, the issue is complicated. “The regulations under consideration are all essentially a one-size-fits-all solution,” Lerner says. “But one of the things that comes out very strongly in our research is that there are quite a lot of differences in impact across different kinds of transactions and different time periods.”
In order to analyze private equity’s effects, Lerner and his colleagues had to overcome several hurdles. The data they analyzed comes from the US Census and Internal Revenue Service, which have legitimate concerns about confidentiality for private companies. The work had to be done by Census personnel to maintain the proper anonymity.
Once the researchers had job and performance data on different companies, however, they also had to match them across time. “When one has a buyout, one gets a whole series of holding companies up on top of each other,” Lerner says. “We spent literally years reconstructing the chains from one entity to the next, and from year to year.”
Finally, the researchers had to compare the acquired firms to other companies that hadn’t been bought out, matching size, industry, and other factors in order to show the buyout’s effect. In the end, they were left with 9,800 firms bought out between 1980 and 2013 and were able to follow 6,000 firms with a high-enough confidence to determine outcomes.
Stark differences
When they finally sorted through all the data, they found big differences between private acquisitions of public companies and private acquisitions of companies that were already private. In public-to-private deals, employment after acquisition falls by an average of 13 percent relative to similar firms that did not undergo a buyout; private-to-private deals see the exact opposite effect. Relative employment rises by an average of 13 percent.
Lerner surmises that public companies may have more “fat” to cut after the buyout, while private companies may be more cash-strapped to begin with, and so the infusion of cash allows them to add to their workforce and pursue new opportunities.
When all of the transactions were considered together, employment fell 1.4 percent—a statistically insignificant amount. Since this total includes jobs added when other firms are acquired by the bought-out firms, the researchers isolated the effects on employment of only the entity that was part of the original buyout. In that case, they found that the total job loss (again, relative to similar firms) was 4.4 percent.
A jolt of productivity
On the positive side, they found that far from being stripped and left for dead, companies saw a jolt of productivity after acquisition—experiencing an average annual growth of 4 percent for the two years after the buyout. “There is an enormous hunger for economic growth, and here we see dramatic productivity growth for these firms,” says Lerner. “That is potentially socially beneficial.”
Despite those gains, however, companies don’t seem to be sharing it with their employees. In the study’s most disturbing finding, employee wages actually dropped an average of 2 percent (again relative to peer firms) in the two years following the buyout.
“It seems essentially all of the pie is going to the private equity group and their investors,” Lerner says.
“It seems essentially all of the pie is going to the private equity group and their investors.”
Even within these numbers, the researchers found a lot of variation over time. In general, private equity buyouts mirror what is going on in the larger economy—but more so. “If GDP is up or down, then the employment at private equity-backed firms will go up or down even more dramatically,” Lerner says.
Next step in the research
Lerner and his colleagues are now drilling down into specific private equity firms to see what variation exists and whether some of them perform better than others. When it comes to figuring out how to regulate firms, however, there may not be a one-size-fits-all solution.
“Our paper reveals some very attractive and socially beneficial aspects of the private equity industry,” Lerner says. “But it also indicates some more problematic aspects in terms of the changes in jobs and wages.
“Starting with that framework,” he continues, “will hopefully lead to better policy discussions than ones that either demonize the industry on the one hand, or present it as completely beneficial on the other.”
About the Author
Michael Blanding is a writer based in Boston.
[Image: metamorworks]
Related Reading
- Is Greed Ruining Private Equity Firms?
- Research Paper Investing Outside the Box: Evidence from Alternative Vehicles in Private CapitalIt
- Many Executives Are Afraid of Finance. Here's How They Can Gain Confidence
