Private Equity Doesn't Deserve Its Bad Reputation
Capitalism is quietly changing. For the past century, market economies have been dominated by publicly listed companies. But in the last two decades, there has been a slow, steady shift toward private equity. PE firms can themselves be listed on public exchanges, but the companies they run -- which are mostly owned by limited partners, rather than the firms themselves -- are often vast in both size and number. In 2013, management consulting firm Bain & Co. found that private equity accounted for 11 percent of large U.S. companies and 23 percent of midsized companies. The industry is growing globally too:
The total number of PE firms has increased enormously, and total assets under management now stands at about $2.5 trillion.
This represents a major change in the way the business world operates. So it’s important to assess the effects of the shift to PE.
The industry certainly has its detractors. In 2009, Josh Kosman published a book called “The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis,” claiming -- among other things -- that PE tends to increase bankruptcies. Mike Konczal, J.W. Mason and Amanda Page-Hoongrajok of the Roosevelt Institute, a liberal think tank, allege that PE exacerbates corporate short-termism. And Paul Krugman has claimed that leveraged buyouts made inequality worse.
But there’s also a fair amount of research indicating that PE has salutary effects. A 2008 study by economists Steven J. Davis, John Haltiwanger, Ron Jarmin, Josh Lerner and Javier Miranda found that PE buyouts tend to increase productivity and wages, partly by improving operations and partly by shutting down underperforming companies and divisions. Other papers generally have similar findings.
Because the debate over PE is wide-ranging, covering a vast range of factors and dealing with long-term questions, there’s no chance that it will be resolved any time soon. Realistically, the shift from public to private ownership almost certainly will entail both some benefits and some costs. But a series of new papers continues to show positive effects of PE buyouts, including in some unexpected areas.
A 2011 study by economists Quentin Boucly, David Sraer, and David Thesmar looked at 839 leveraged buyouts in France. Three years after the deals, the buyout targets saw their profitability increase relative to a control group of similar companies. But this profitability didn’t come from downsizing -- the buyout targets also grew faster than their peers, and they invested more.
That appears to contradict Konczal et al.’s argument that PE exacerbates short-termism. Although three years is a relatively short period of time, the fact that PE-owned companies increased investment is a sign that they’re more focused on the future. It’s worth noting that PE may operate somewhat differently in France than in other countries -- the literature generally finds that the industry relies less on downsizing in France than elsewhere.
A more recent paper by economists Cesare Fracassi, Alessandro Previtero, and Albert Sheen investigates the question of whether PE buyouts raise prices. This is certainly a concern, especially in light of industry consolidation and the rise of common ownership in U.S. industries. If PE raises profits because it reduces market competition, capitalism’s shift toward private markets could be bad for consumers.
Fracassi et al. do find that a PE buyout leads a company to raise its prices relative to similar companies. But the hikes are very modest -- less than 1 percent. And they find that companies bought by private equity tend to introduce lots of new products. The small price rise might therefore be due to consumers’ willingness to pay slightly more for better variety, rather than from an increase in monopoly power.
Finally, a 2017 paper by Jonathan Cohn, Nicole Nestoriak, and Malcolm Wardlaw looks at a rather unorthodox angle -- workplace safety. This is an important issue, because even if PE firms don’t fire people when they buy out companies, they might increase profits by forcing workers to endure worse conditions.
But Cohn et al. find that by the fourth year after a buyout, workplace injuries per employee decline by a little more than 10 percent. Interestingly, this decline only happens for public companies that get bought out -- when a company is already private, its injury rate doesn’t go down. The lack of decline for private buyout targets suggests that underreporting probably doesn’t explain most of the result.
So there is some evidence that PE firms invest in worker safety. That’s another strike against the short-termism argument. If anything it suggests just the opposite, and the authors argue that public buyout targets increase workplace safety more than private ones precisely because public markets are too focused on short-term profits.
These recent bits of good news for PE don’t resolve the broader argument about the industry’s impact on the country. They don’t address the arguments that PE raises systemic risk and/or inequality. In addition, any of these findings could be overturned by subsequent research. But they do represent reasons to be slightly less anxious about the sea change that's underway in capitalism.
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James Greiff at email@example.com