Jobs are in jeopardy and paychecks shrink when private equity firms take over public companies, according to a new study.
Employment falls 13 percent within two years of buyouts of listed companies and 16 percent in carveouts (deals for part of a company), researchers from Harvard University, University of Chicago, University of Michigan, University of Maryland, and the U.S. Census Bureau found in their study of U.S. private equity deals from 1980 to 2013.
Following a buyout, the average earnings per worker declines 1.7 percent.
The private equity industry is under scrutiny, with increasing concern that piling debt onto companies to increase buyout returns may do economic harm. Buyout firms typically finance their acquisitions partly with debt, sometimes directing companies they own to borrow and pay them dividends before the acquirer sells.
“Policymakers have enacted and proposed several initiatives in the past decade to address the perceived harms of private equity,” the authors wrote in the study. “Separating wheat from chaff in private equity requires a fine-grained analysis.”
The researchers looked at four types of deal-making: buyouts of privately-held businesses, takeovers of listed companies, acquisitions of a division of a company, and the sale of a company from one private equity firm to another. They found that employment doesn’t shrink across all categories.
For example, employment rose 13 percent in the two years after a typical private-company buyout, and increased 10 percent when firms were sold from one private equity firm to another, according to their research.
“We find striking and systematic outcome differences depending on buyout type, credit market conditions at the time of buyout, and the evolution of macroeconomic and credit conditions post buyout,” they wrote in the study. “This conclusion cast doubts on the efficacy of ‘one-size-fits-all’ policy prescriptions for private equity.”
U.S. Senator Elizabeth Warren, who is running for President, recently introduced the “Stop Wall Street Looting Act” to broadly regulate private equity, the authors noted. She announced the act in July, saying that “for far too long, Washington has looked the other way while private equity firms take over companies, load them with debt, strip them of their wealth, and walk away scot-free — leaving workers, consumers, and whole communities to pick up the pieces.”
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Warren’s efforts follow steps by regulators in Europe to curb aggressive buyout behavior, with the researchers noting that the European Union introduced the Alternative Investment Fund Managers Directive to prevent “asset stripping” from companies after acquisition.
“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,” the authors of the private equity study wrote. “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.”
According to Warren’s proposal, almost 5.8 million people work for private-equity-owned companies in the U.S. The bill points to recent bankruptcies in the retail and grocery store industries that followed buyouts, including Toys “R” Us, Nine West, Claire’s Stores, and Southeastern Grocers.
Last week, EP Energy filed for bankruptcy protection more than seven years after its $7.2 billion leveraged buyout by Apollo Global Management. The Houston-based oil and gas company’s full-time U.S. workforce was sharply reduced over several years leading up to its bankruptcy, regulatory filings show.
Though certain industries have struggled, U.S. companies are operating in the longest bull market ever. At this late stage of the credit cycle, Moody’s Investors Service has warned that buyout firms will make the next downturn worse.
As a result of private equity activity, the number of low-rated companies deemed highly vulnerable to default may jump “dramatically,” possibly exceeding levels seen in the financial crisis, Moody’s said last month. The pool of companies rated Caa in North America may now look “benign,” Moody’s said. But that group is poised to swell with new entrants from a historically high concentration of risky borrowers that are rated just one level higher — and mainly owned by buyout firms.
That might not bode well for take-private deals in particular.
“Public-to-private deals proliferate in advance of credit market tightening, and their targets exhibit large post-buyout employment losses and poor productivity performance during aggregate downturns,” the authors of the private equity study said in their paper.