We need more transparency in the private equity industry

20 June 2013

Geoffrey Wood

A team of academics have called on the private equity industry to be more transparent after their study found that a large section of it increases unemployment while actually worsening the performance of the company they take over.

In the first statistical analysis of the private equity’s institutional buy-outs (IBO), which made up nearly half of all public-to-private buy-outs during the researched decade, Geoffrey Wood, of Warwick Business School, Marc Goergen, of Cardiff University, and Noel O'Sullivan, of Loughborough University, discovered that when they compared 105 publicly-listed firms that went through a buy-out between 1997 and 2006 to a control group of their industry rivals they fell further behind after the takeover. The study found that four years after the buy-out the performance gap between the two groups had tripled, from £29,000 - as measured by turnover per employee – to £89,000. (Click here to see the original press release).

This was coupled with 59 per cent of the private equity IBO firms reducing the size of their workforce in the first year compared to 32 per cent in the control group.

The findings drew a response from the British Venture Capital Association (BVCA), who dismissed the paper as “partial” and “unrepresentative”, saying that by the time of the first year post-buyout the sample number of IBO companies had fallen to 68 and by year four to 56. (Click here to see BVCA press release)

Professor Wood responded: “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 havens 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 of shell companies. We encourage the BVCA to improve disclosure by the industry so that studies such as ours can be more representative.

“We do not claim that our study is representative of the whole private equity industry; the focus of our study is on 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.”

The BVCA also said the authors 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.

But Professor Wood said: “Our hypothesis is that one particular type of private equity, ie 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 (MBOs), 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 activity has mostly positive effects does not provide a justification for ignoring the mostly negative effects of certain expressions of that activity.”

The study looks only at the first four years after the buy-out, but the BVCA say the average private equity holding period tends to be five to seven years and the performance of 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”.

Professor Wood said: “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.”

The BVCA also pointed out that the reduction in employment is unsurprising as IBOs tend to involve underperforming firms so are likely to lead to restructuring and “divestment of underperforming segments of the business”.

“We agree that restructuring of the target could be beneficial,” said Professor Wood. “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 BVCA’s argument was 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.”

The BVCA cite a report from September 2012 by the Centre for Management Buyouts and the Credit Management Research Centre which found private equity-backed buyouts achieved superior economic and financial performance from 1995 to 2012 than “comparable non-private equity buyouts and listed companies”. They say the study was based on a dataset of 400,299 company-year observations and 30,736 observations of companies that experienced a private equity backed buy-out and accused the academics’ study of looking at a small section of private equity activity, .

“Again, the BVCA equate private equity with MBOs,” said Professor Wood. “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.”

Professor Geoffrey Wood teaches Global Business Strategy on MSc Marketing & Strategy and Global Integrative Project and International Business Strategy on the undergraduate courses.

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