Do takeovers by ‘private equity’ firms destroy jobs?

Private equity firms are investment funds that tend to focus on buying companies that are undervalued or poorly managed, in order to turn them around and sell at a profit. To do that, they combine their own capital with borrowed money. This can work, if the firm that’s been bought out can earn money fast enough to pay the interest on the borrowed money.

The accusation leveled at the private equity industry is that it simply goes through “quick flips” - stripping company assets and axing jobs before selling firms or closing them down. They have come under fire during the past two or three years because of the high returns they generate for their investors, and the fact that their managers tend to earn huge amounts of money while being very successful at avoiding high tax bills.

But in the BBC article Private equity defends job record - BBC there is reference to research, conducted by Josh Lerner of Harvard Business School, which goes a long way in making a strong case in favour of the private equity business.

View BBC article here

Key points include:

The time that private equity firms hold on to their investments is growing, and currently stands at a bit more than five years.

Their management changes seem to be making an impact. In the United States, every year just 1.2% of private equity-owned firms are being forced into bankruptcy. In contrast, about 1.6% of firms issuing bonds go bankrupt. It is worse for troubled firms that have to issue so-called junk bonds; 4.7% of them tend to fail.

In the two years before being taken private, companies tend to lose 4% more jobs than their peers - an indication that these firms are in serious trouble to start with. In the two years after the takeover, these companies cut 7% more jobs than rivals. After that, employment levels are comparable. However, the sharper job cuts are partially offset by the fact that private equity-owned firms are growing faster and create 6% more jobs at new factories than their rivals. More importantly though, these figures do not take account of the jobs saved because private equity-controlled firms are less likely to go bankrupt.

It does seem true that the big job losses in the US had not happened in companies run by private equity, but industries like steel and car-making. “We get criticised if we make too much money,” said one private equity boss, “and if things [in an acquired company] don’t work we get criticised as well”.

This whole issue ties in very closely with the whole Corporate Social Responsibility debate that is currently raging.