BVCA response to Warwick Business School report
In what follows, I and my co-authors respond to criticism voiced by the British Private Equity and Venture Capital Association (BVCA) about a study we conducted. The original BVCA press release can be found here.
A new paper by Geoffrey Wood of Warwick Business School, Marc Goergen of Cardiff University and Noel O'Sullivan of Loughborough University - 'The Employment Consequences of Private Equity Acquisitions: The Case Of Institutional Buy Outs' - looks at the changes to employment and productivity in companies that have been the subject of institutional buyouts (IBOs) compared to matched companies that did not receive such a buyout.
The paper looks at an initial total of 106 IBOs undertaken over the period 1997 to 2006. This is in the context of 2,200 management buyouts (MBOs) and 500 management buy-ins (MBIs) taking place in the UK over the same time period.
As it makes explicit, the study focuses "exclusively on the employment consequences of institutional buyouts (IBOs), as these are more likely to lend themselves to the type of negative employee consequences politicians and trade union representatives are most concerned about".
Rather than ensuring that the report overcomes the difficulties of recognising the heterogeneity of private equity investment and providing "greater empirical clarity" to the issue, this simply means that the report is a partial and unrepresentative look at private equity. The study concerns itself with a very small subsection of private equity deals and therefore any claims that this represents the private equity industry as a whole are erroneous.
We do not claim that our study is representative of the whole private equity industry; the focus of our study is institutional buy-outs (IBOs). IBOs are acquisitions by private equity houses of publicly quoted UK companies. Hence, contrary to some of the existing studies we do not include relatively small, unquoted private companies. Some of the companies covered by our study include Debenhams, Pizza Express and United Biscuits.
It appears that the authors have begged the question - they have started with the hypothesis that private equity is damaging to employment, wages and productivity, and sought to examine only those deals which they believe are most likely to prove this hypothesis.
Our hypothesis is that one particular type of private equity, i.e. IBOs, is damaging for employment. In contrast to previous studies, we do not amalgamate very different types of private equity. Few would disagree that management buy-outs, which do not involve a change in management, are bad for employment. By amalgamating MBOs with other types of private equity, one would equally bias outcomes toward positive employment effects. This is something we have gone out of our way to avoid.
The fact that one actitvity has mostly positive effects does not provide a justification for ignoring the mostly negative effects of certain expressions of that activity.
Of the 106 IBOs the report claims to examine, by the time of the first year post-buyout this number has fallen to 68. By year four, the number is just 56 - an ever smaller sample size than the one originally stated.
The drop in our sample is a reflection of the secretiveness of the private equity industry and the difficulty of tracing target firms after their acquisition. We have made a colossal effort to trace firms after their acquisition, but in some cases a lack of disclosure, often combined with a move of the target firm’s headquarters to tax heavens such as Nassau or Luxembourg, has prevented us from obtaining data post-acquisition. The cynic would state that some private equity houses make a huge effort to hide their target firms within a chain a shell companies. We encourage the BVCA to improve disclosure by the industry so that studies such as ours can be more representative..
Of further note, the report looks only at the first four years post-buyout. The average private equity holding periods tend to be five to seven years. As such, it provides an incomplete view of the impact of private equity backing. In addition, a significant number of the companies in the IBO sample (40 of 106) are from 2005 and 2006 - meaning the performance of both these and the comparator companies is likely to have been impacted by the global financial crisis and the attended economic uncertainty.
This criticism is not founded. We adjust for industry-wide as well as period-specific trends in the data. In any case, our study compares the private equity targets with two control samples of non-acquired firms. We cannot think of any reason why the global financial crisis would have hit the private equity targets, but not the non-acquired control firms of a similar size and operating in the same industries.
Despite acknowledging the fact that the companies undergoing an IBO tend to be underperforming (with productivity statistically significantly lower for the IBO companies), the report fails to acknowledge that this is likely to lead to restructuring and the divestment of underperforming segments of the business. The reduction in employment numbers that the study points towards is therefore unsurprising in this context.
We agree that restructuring of the target could be beneficial. However, we observe a statistically significant drop in employment after adjusting for differences in productivity and labour costs between the private equity targets and the non-acquired firms. If your argument were correct, we would not find any differences in employment growth between the target firms and the non-acquired firms as such differences would be entirely explained by the lower productivity and the higher wage costs in the target firms.
As indicated above, a more typical form of private equity investment is via management buyout, in which the existing management team of a company acquires a controlling equity stake in the business with private equity support.
Studies in this area are far more encouraging and find that companies that have been the subject of an MBO outperform comparable companies that have not. Indeed, Wood et al acknowledge this point in their own report.
For example, in September 2012 a report by the Centre for Management Buyouts and the Credit Management Research Centre found private equity-backed buyouts achieved superior economic and financial performance over the period 1995 to 2012, which includes the economic downturn, than comparable non-private equity buyouts and listed companies. This was a far larger study than Wood et al as it is based on a dataset of 400,299 company-year observations and 30,736 observations of companies that experienced a private equity backed buyout.
Private equity's positive impact on productivity has been well-established in a number of similar academic reports (a sample of which can be found below). By looking at such a small section of private equity activity, the paper produced by Warwick Business School is of minor relevance to the wider debate about how the private equity industry creates value in the companies in which it invests.
Again, the authors of this reply equate private equity with MBOs. The point of our study is that amalgamating IBOs and MBOs is not justified. While there may be fewer IBOs than MBOs the former concern large public firms whereas the latter concern smaller, frequently private held firms. If this makes our study irrelevant then we are happy to accept this criticism.