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Success breeds scrutiny. As private equity firms have snapped up swathes of corporate Europe and America – making some very quick and very large fortunes in the process – they were bound to find their activities under the microscope. But is the industry focused on the wrong area of regulatory risk?
So far, the Financial Services Authority in the UK – which fears the risk of “excessive leverage” and insider trading – has said it will step up scrutiny of big firms. In the US, regulators have focused on the supposedly “clubby” relationships between funds. One suspicion is that, when financial sponsors link up to buy companies, they keep an artificial lid on the prices paid to shareholders. Or that there is simply an unwritten rule not to muscle in on each other’s deals – remember KKR’s thin returns after the 1980s battle for RJR Nabisco.
Proving such collusion would be tough without a “smoking gun” such as incriminating e-mails. But even if those do not exist, private equity should not rest easy. A bigger regulatory risk could emerge if some high-profile buy-outs blow up. Regulators and lawmakers could focus more on the damage buy-outs can do to companies and employees – rather than whether the selling shareholders were short-changed.
It would be surprising if no buy-outs did collapse, given increasingly exuberant leverage levels and the risk that the economy will get weaker. In that case, jobs, healthcare and pension benefits at previously solid companies could be jeopardised because of over-aggressive capital structures. The idea of governments having to bail out pension plans, or of businesses in Europe and America being brought to their knees by excessive debt, could easily cause a backlash. That might include calls – admittedly hard to implement – for caps on leverage levels or limits on the levels of interest payments that are tax-deductible.
Regulators, or even lawmakers, are more likely to intervene if buy-outs cause real damage to businesses and their staff than because they see a few individuals get massively wealthy.