Saturday, 5 January 2013

IS PRIVATE EQUITY ALL GOOD OR BAD?

Ed Miliband thinks that all private equity investors are bad, "stripping assets for a quick buck ... [and that] they aren't the values of British business". So is he right or wrong?

Similar to most other politicians, Ed Miliband is right and wrong. In what follows, I shall focus on the effects of private equity acquisitions on employees as there is an existing body of academic research studying that particular link. This research suggests that, on the whole, private equity acquisitions are good for employees, resulting in increases in employee numbers as well as improvements in employment practices and employee voice. However, most of this research does not distinguish between the different types of private equity investors.

Nevertheless, I first want to define what I mean by private equity. Private equity involves the acquisition of a public firm or at least the facilitation of that acquisition. The firm is taken private in a so called public-to-private (PTP) transaction. Importantly, there is a change in management or at least a change in management style.

The three main types of private equity acquisitions are:
  1. management buy-outs (MBOs),
  2. management buy-ins (MBIs), and
  3. institutional buy-outs (IBOs).
MBOs are carried out by the existing management and the role of the private equity investor is typically limited to the financing of the acquisition. As there is no change in management the effects of MBOs on the employees are likely to be neutral or positive. In contrast, MBIs are undertaken by a new, outside management team that takes the firm private. As there is a complete change in management the effects for the employees are likely to be negative. The main reason for this is that so called implicit contracts, that is unwritten, verbal contracts that the existing management had with the workforce are more likely to be broken. Finally, IBOs are undertaken by private equity houses and other specialist investors. They involve the complete replacement of the management and, as in the case of MBIs, it is likely that the effects on employees will be detrimental.

Existing research has typically looked at samples of private equity acquisitions including MBOs as well as MBIs, and maybe also IBOs, but has not clearly distinguished between these three types. This may explain why the observed overall effects on employment is mostly positive, both in terms of employment growth and in terms of a wide range of human resource policies. I have conducted some research with Prof. Noel O'Sullivan at Loughborough University and Prof. Geoff Wood at Warwick Business School. We focused on IBOs rather than on MBOs/MBIs. We found that, after correcting for differences in productivity and differences in wage costs, there is a significant drop in employee numbers in IBOs. An equivalent drop is not observed in other non-acquired firms that operate in the same industry. The results of this study have been published in Corporate Governance: An International Review. A pre-publication version is available from SSRN. This paper won the Standard Life prize of the best working paper in finance in the paper series of the European Corporate Governance Institute in 2012.

A follow-up study on a larger sample, which also includes evidence from interviews and regression analysis, has been published in the 2014 April issue of the Human Resource Management Journal. This is the study which the British Venture Capital Association (BVCA) criticised in a press release. See also our response to the BVCA as well as a letter by Alex Barr from Aberdeen Private Equity fund in the Financial Times and our response to his letter.

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