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Private equity has often suffered from a poor image. A decade ago the industry’s players were vilified in Germany as “locusts”, accused of over-zealous cost-cutting and brutal job losses. They were charged with generating huge returns by loading the companies they bought with too much debt — and making their money by financial engineering rather than management expertise. The intervening years have seen hostilities tail off, along with a rising demand from companies for new types of finance. German companies have been at the centre of some of the industry’s largest deals this year.
In the US, however, buyout funds are back in the political crosshairs. Democratic presidential hopeful Elizabeth Warren has described private equity groups as “vampires” and proposed making firms liable for the debt of the portfolio companies they buy. It would be easy for buyout groups to dismiss such attacks. They would be wrong to do so.
Politicians’ interest in the more dubious tactics employed by private equity increases in line with its expanded role in the economy. The industry owns assets in every sector, from critical infrastructure to retailers. Persistent low interest rates have helped funds raise large sums of money; recent figures show they have up to $2.5tn to spend. At the same time, the number of public companies is shrinking.
With this greater power should come greater accountability. As Ms Warren has made clear, politicians cannot be happy when private equity funds are in essence making a one-way bet: risking a thin sliver of their own money as equity and providing the rest of the finance their companies need with debt, then walking away from investments that go wrong. In some cases critics claim private equity companies have deliberately exploited the limited liability company regime to pay themselves big dividends from increased debt before an investment collapses.
One way forward is for the underlying investors in private-equity funds to demand to know more. Pension funds and others often pay high fees in exchange for what they are told is better management. But that is difficult to measure.
A recent report by researchers from institutions including Harvard University found there are significant differences in performance based on the type of buyout, so there is no one-size-fits-all prescription. The same report found that private equity ownership typically results in significant job and wage losses for incumbent workers on the one hand but gains in productivity on the other.
Another report, by the Milken Institute, studied the performance of a small group of companies after private equity sold them via an initial public offering. It found that, on average, PE-backed companies created more returns than their non-PE owned peers after their initial listing. In the industry’s defence, many companies have flourished under private equity ownership. Listed companies often have to deal with fickle investors that may not have the longer-term view that a private equity fund can bring.
Clearer evidence is needed to show it is indeed better management by private equity that delivers superior results, not financial engineering. In some cases, such as the water industry in the UK, regulators have made moves to limit leverage and curtail dividend payouts. Ms Warren’s call for change has resonated at a time of wider debate about the purpose of business. It is time for private-equity barons and their investors to show greater accountability, or face drastic change.
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