New research on private equity surprises even some of the experts

Skeptics often content that private equity (and hedge fund) “locusts” are holding companies for ever-shorter periods of time in an effort to extract value and high-tail it out of an investment before things go south.  Some, particularly trade unions, also believe that private equity take-over targets are destined to lose jobs following an acquisition (see related posting).

But both of these contentions have been called into question by a new research report commissioned by the World Economic Forum and released in Davos on Friday.  The report was led by Harvard’s VC guru Josh Lerner, was advised by a group including hedge fund demigod David Swensen of Yale and, according to its introduction, represents “an unprecedented endeavour linking active practitioners, leading academics, institutional investors in private equity and other constituents (such as organized labour) and boasts involvement from many parts of the globe.”

The full report, “The Global Economic Impact of Private Equity”, is available here.  It’s highly comprehensive to say the least and weighs in at 189 pages.  But if you don’t have several hours to kill, you can always read the key findings in a press release available here.

Lerner told a panel audience in Davos on Saturday that academic research on private equity hadn’t been as extensive in recent years as it had back in the 1980’s (full 70-minute panel video, official summary).  Hence the impetus for this new round of papers and case studies.  Perhaps due to this dearth of contemporary research, Lerner said he was surprised by a few of the report’s findings.  Said Lerner:

“One of the studies looked at the demography of private equity firms…In that study, two surprises came out. The first had to do with holding period. My anticipation going in was that we would have seen that holding periods of firms by private equity groups had actually gotten shorter in recent years. But when we actually looked at the evidence from 20,000 transactions over the past 3 decades, we saw exactly the opposite. The time that companies are remaining held by private equity groupsactually has lengthened rather than shortened.

“Similarly, a surprise that came out of that study had to do with bankruptcy. When we looked into the details, the results were quite surprising compared to what I thought we were going to find. Essentially the bankruptcy rate per yearis in the order of 1.2%. If you look at corporate bond issuers of all types, the rate is around 1.6% a year.

“There were also a number of surprises from the study we did on employment.  We compared roughly 600,000 offices and factories owned by private equity firms and compared them to the roughly 6 million offices and factories elsewhere in the United States…We found the private equity-backed firms were already losing jobs in the two years before the private equity transaction. That pattern continued for two years afterwards.  So essentially in the couple of years afterwards, the establishments owned by the private equity groups actually created fewer jobs than the comparable firms or factories.

“However, it gets more complication.  At the same time, the same private equity owned companies were more active in creating new jobs by opening new factors and other facilities.  And in fact this Greenfield job creationseemed to largely offset the job losses at the existing facilities.”

The wide-ranging panel discussion that ensued covered topic such as the structural advantages of private equity, European resistance to private equity (“locusts” etc.), the globalization of private equity, and the reasons behind private equity’s reputation for, well, privacy.

On this latter point, the industry’s reputation for secrecy, one panelist made an interesting observation:

“In some ways, the industry has created some of its won problems by its very name. We says its private equity. But in many ways, we’re not private at all. The businesses we buy often end up with far more disclosure in our hands than they had with their previous owners. As a simple example, when we bought the Hertz Rent a Car business from Ford, Ford really did not have to disclose very much about Hertz. But now that it’s an independent company with publicly-traded bonds, we have filing requirements and there are far more disclosures about the economics of Hertz than when it was owned by Ford.”

Other panelists seemed to agree that the industry could do more to actively communicate its purpose.  Another lamented:

“If we make too much money, we are roasted for stealing companies from the public and if we don’t make enough money, people say we’re not really as good as we say we are.”

Regular readers may recall one group of people who simultaneously argue that private equity makes too much money, yet doesn’t constitute a good investment for their pension funds: The International Trade Union Congress (see related posting).  In a report last year called “Where the House Always Wins: Private Equity, Hedge Funds and The New Casino Capitalism”, the group said:

“Private equity companies generally aim at, indeed promise, returns of above 20 percent per year. They often fail to meet these aims…Don’t believe the hype..private equity has underperformed during the last decades…”

Yet the same report argued:

“With asset stripping, quick-flips and other ways of rapidly ensuring high returns as its main strategies, it has no interest in investing in its employees, no need for employer-employee partnerships, and no reason to provide anything but the minimum when it comes to wages, benefits and conditions.” (our emphasis)

In many ways this new report is a counter-balance to the ITUC report last June that constituted an indictment of the private equity industry.  However, this report contains a truly impressive amount of data and information – making it destined to be a well-cited contribution to the literature in this area.  Still, anyone who wants to get a comprehensive picture of the arguments on both sides of this often rancorous, and increasingly important, debate probably ought to read both.

  • “The Global Economic Impact of Private Equity”
    World Economic Forum, January 2008 (189 pgs.)
    (available here)
  • “Where the House Always Wins: Private Equity, Hedge Funds and The New Casino Capitalism”
    International Trade Union Congress, June 2007 (52 pgs.)
    (available here)
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