Private Equity at Work

Private Equity at Work: When Wall Street Manages Main Street

Eileen Appelbaum
Rosemary Batt
Copyright Date: 2014
Published by: Russell Sage Foundation
Pages: 396
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  • Book Info
    Private Equity at Work
    Book Description:

    Private equity firms have long been at the center of public debates on the impact of the financial sector on Main Street companies. Are these firms financial innovators that save failing businesses or financial predators that bankrupt otherwise healthy companies and destroy jobs? The first comprehensive examination of this topic,Private Equity at Workprovides a detailed yet accessible guide to this controversial business model. Economist Eileen Appelbaum and Professor Rosemary Batt carefully evaluate the evidence-including original case studies and interviews, legal documents, bankruptcy proceedings, media coverage, and existing academic scholarship-to demonstrate the effects of private equity on American businesses and workers. They document that while private equity firms have had positive effects on the operations and growth of small and mid-sized companies and in turning around failing companies, the interventions of private equity more often than not lead to significant negative consequences for many businesses and workers.

    Prior research on private equity has focused almost exclusively on the financial performance of private equity funds and the returns to their investors.Private Equity at Workprovides a new roadmap to the largely hidden internal operations of these firms, showing how their business strategies disproportionately benefit the partners in private equity firms at the expense of other stakeholders and taxpayers. In the 1980s, leveraged buyouts by private equity firms saw high returns and were widely considered the solution to corporate wastefulness and mismanagement. And since 2000, nearly 11,500 companies-representing almost 8 million employees-have been purchased by private equity firms. As their role in the economy has increased, they have come under fire from labor unions and community advocates who argue that the proliferation of leveraged buyouts destroys jobs, causes wages to stagnate, saddles otherwise healthy companies with debt, and leads to subsidies from taxpayers.

    Appelbaum and Batt show that private equity firms' financial strategies are designed to extract maximum value from the companies they buy and sell, often to the detriment of those companies and their employees and suppliers. Their risky decisions include buying companies and extracting dividends by loading them with high levels of debt and selling assets. These actions often lead to financial distress and a disproportionate focus on cost-cutting, outsourcing, and wage and benefit losses for workers, especially if they are unionized.

    Because the law views private equity firms as investors rather than employers, private equity owners are not held accountable for their actions in ways that public corporations are. And their actions are not transparent because private equity owned companies are not regulated by the Securities and Exchange Commission. Thus, any debts or costs of bankruptcy incurred fall on businesses owned by private equity and their workers, not the private equity firms that govern them. For employees this often means loss of jobs, health and pension benefits, and retirement income. Appelbaum and Batt conclude with a set of policy recommendations intended to curb the negative effects of private equity while preserving its constructive role in the economy. These include policies to improve transparency and accountability, as well as changes that would reduce the excessive use of financial engineering strategies by firms.

    A groundbreaking analysis of a hotly contested business model,Private Equity at Workprovides an unprecedented analysis of the little-understood inner workings of private equity and of the effects of leveraged buyouts on American companies and workers. This important new work will be a valuable resource for scholars, policymakers, and the informed public alike.

    eISBN: 978-1-61044-818-5
    Subjects: Economics, Political Science, Sociology

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. List of Illustrations
    (pp. ix-x)
  4. About the Authors
    (pp. xi-xii)
  5. Acknowledgements
    (pp. xiii-xiv)
  6. Chapter 1 Private Equity: Investors as Managers
    (pp. 1-14)

    Aidells Sausage Company was founded by Bruce Aidell in 1983. A microbiologist and foodie, he developed an artisanal line of chicken sausage products that were widely popular in the San Francisco Bay Area. In 2007 private equity firm Encore Consumer Capital bought the company, provided financial management and operational and marketing expertise, and dramatically expanded its market reach. The company had grown from 140 to 350 employees by 2010, when it was sold to Sara Lee.

    Mervyn’s Department Store chain was another well-known and popular brand serving the Bay Area and other cities throughout California when it was acquired by...

  7. Chapter 2 Institutional Change and the Emergence of Private Equity
    (pp. 15-40)

    The private equity business model of the 2000s emerged out of the shareholder-value revolution and the leveraged buyout (LBO) movement of the 1970s and 1980s. Shareholder-value maximization represents a fundamental shift in the concept of the American corporation—from a view of it as a productive enterprise and stable institution serving the needs of a broad spectrum of stakeholders to a view of it as a bundle of assets to be bought and sold with an exclusive goal of maximizing shareholder value. Investor takeovers of corporations through leveraged buyouts—in which a small number of investors buy out other investors...

  8. Chapter 3 The Business Model: How Private Equity Makes Money
    (pp. 41-92)

    This chapter unpacks the business model that private equity firms use to make money. The model operates at two levels—the level of the PE firm and the level of the portfolio companies it acquires. The extensive use of debt to take over operating companies lies at the core of the private equity business model at both levels: the higher the use of debt at the portfolio level the higher the potential profits at the firm level.

    Most private equity firms are partnerships. The firms sponsor investment funds that buy out operating companies using high levels of debt—so-called leverage....

  9. Chapter 4 The Effects of the Financial Crisis, 2008 to 2012
    (pp. 93-126)

    The bursting of the housing bubble in 2006, the onset of recession in December 2007, and the financial crisis that erupted in 2008 led to the most serious contraction of the U.S. economy since the Great Depression. In a technical sense, the contraction ended during June 2009 with the upturn in the country’s gross domestic product. On other measures, however, such as slow economic growth and continued high unemployment, the U.S. economy was still mired in the doldrums during 2013, with limited prospects for rapid improvements in job creation. Median household income adjusted for inflation fell during the recession from...

  10. Chapter 5 The Middle Market—Increasing Focus After the Crisis
    (pp. 127-160)

    The private equity business model has several unique characteristics that distinguish it from the way that public corporations do business. As discussed in chapter 3, these attributes include the promise of outsized returns to the limited partners, the short time horizon for achieving higher-than-average returns, the greater use of leverage and financial engineering to increase returns, the active involvement of the PE firm in the business decisions of portfolio companies, the lower tax liabilities, and the lack of transparency when companies are taken private.

    The ability of private equity firms to execute this business model, however, varies with different market...

  11. Chapter 6 How Well Do Private Equity Funds Perform?
    (pp. 161-192)

    Whether private equity investments deliver on their promise of returns that are substantially above the stock market has been a controversial issue, with industry participants publishing very positive reports and finance economists providing more modest empirical results. Central to this controversy is the fact that private equity’s lack of transparency makes independent analyses of its data all but impossible. And as we saw in chapter 4, limited partners became disgruntled in the postcrisis period over excessive management fees and the poor performance of funds; as a result, they slowed their commitments to new funds. They also signaled their preference for...

  12. Chapter 7 Private Equity’s Effects on Jobs and Labor
    (pp. 193-238)

    Earlier chapters examined the private equity business model, how PE makes money, and how different types of PE firms influence the management of organizations across a wide spectrum of industries and markets. We have argued that the classic private equity model is different from that of public corporations in its debt-heavy capital structure, light legal oversight, lack of transparency and accountability, and higher risk-taking. We have also shown that the PE market is segmented, with buyouts of small and midsize companies offering less collateral for leveraging debt and more opportunities for operational improvements than larger companies with values of $500...

  13. Chapter 8 Dilemmas for Pension Funds as Limited Partners
    (pp. 239-264)

    Public and private employee pension funds—so-called workers’ capital—contribute over one-third of all money committed to private equity for investment. As such, these limited partners deserve careful attention. They particularly deserve attention because they face unique dilemmas in their roles as limited partners in PE funds. Managers of pension funds have the fiduciary responsibility to act in the best interests of their members. That is, they need to make investments that ensure the long-term stability of the fund as well as its short-term ability to meet payment obligations to members who are retirees. Allocations to higher-risk alternative investments, such...

  14. Chapter 9 Regulating Private Equity
    (pp. 265-306)

    As we saw in earlier chapters, private equity firms recruit investors—pension funds, hedge funds, sovereign wealth funds, endowments, wealthy individuals—and accumulate large private pools of capital. They use these funds in leveraged buyouts, at undisclosed prices, of operating companies that they acquire for their portfolios, typically taking control of them. Private equity is a financial intermediary that allocates the savings of its limited partners to financial investments. It is part of the so-called shadow finance sector and provides an alternative financing mechanism to the more highly regulated and transparent traditional financial system.¹

    Among the new financial intermediaries that...

  15. Notes
    (pp. 307-352)
  16. References
    (pp. 353-364)
  17. Index
    (pp. 365-381)