Melvin: What People Are Getting Wrong About The Private Equity Buyout Study
The headlines all talk about adverse effects… what did the study actually say?
The Economic Effects of Private Equity Buyouts is a study generating a lot of headlines. These headlines would suggest that private equity has negative impacts on the companies they buy, especially the workforce. But just how accurate are those takeaways?
The Economic Effects of Private Equity Buyouts
If we actually look at what the study says we find: “Relative to control firms, employment at targets rises 13 percent in firms previously under private ownership (private-to-private buyouts) and 10 percent in secondary buyouts (sale from one PE entity to another). Employment falls by 13 percent in buyouts of publicly listed firms (public-to-private deals) and by 16 percent in divisional buyouts. The overall average employment impact of PE buyouts is a statistically insignificant -1.4 percent in our sample.”
The study’s authors are Steven J. Davis University of Chicago, Hoover Institution, Kyle Handley and Ben Lipsius of the University of Michigan, Josh Lerner from Harvard Business School, John Haltiwanger University of Maryland, and Javier Miranda U.S. Bureau of the Census. The professors looked at 9,800 PE buyouts of U.S. firms between 1980 and 2013.
When looking at productivity they found: “Employment at target firms shrinks 13% over two years in buyouts of publicly listed firms but expands 13% in buyouts of privately held firms, both relative to contemporaneous outcomes at control firms. Labor productivity rises 8% at targets over two years post buyout (again, relative to controls), with large gains for both public-to-private and private-to-private buyouts. Target productivity gains are larger yet for deals executed amidst tight credit conditions.”
Other Findings in the Report
They also find that the condition of the economy and the credit markets at any given moment in time greatly impact productivity improvements.
The study notes: “Our evidence that buyouts executed amidst easy credit conditions bring smaller productivity gains suggests that PE groups exercise some latitude in how they create value for their investors. When credit is cheap and easy, PE groups may select buyouts, or structure them, to deliver private returns via financial engineering rather than operating improvements. Many PE groups were founded and seeded by investment bankers that historically relied on financial engineering to create private value, employing strategies such as repeatedly re-leveraging firms and ‘dividending’ out excess cash (Gompers, Kaplan, and Mukharlyamov, 2016). In this light, it is unsurprising if PE groups place less emphasis on operating improvements when leverage and dividends deliver high private returns.”
In spite of the headlines that seem critical of Private Equity, the study makes no final declaration on the evil of private equity buyouts.
Instead in their conclusion, the authors note: “Our study takes up that challenge for private equity buyouts, a major financial enterprise that critics see as dominated by rent-seeking activities with little in the way of societal benefits. We find that the real-side effects of buyouts on target firms and their workers vary greatly by deal type and market conditions.”
Private equity has faced a significant amount of criticism from political candidates, mainly Elizabeth Warren. The Democratic frontrunner has proposed a new law that would significantly curb buyout practices. Some argue that the law would effectively end private equity as we know it.
– Tim Melvin
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