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Private Equity 2012 02

Private Equity 2012 02

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Center for Economic and Policy Research
1611 Connecticut Avenue, NW, Suite 400Washington, D.C. 20009202-293-5380www.cepr.net
 
A Primer on Private Equity at Work
Management, Employment, and Sustainability
Eileen Appelbaum and Rosemary Batt
February 2012
 
 
CEPR A Primer on Private Equity in the U.S.
i
 About the Authors
Eileen Appelbaum is a Senior Economist at the Center for Economic and Policy Research in Washington, D.C. and Rosemary Batt is the Alice Cook Professor of Women and Work at CornellUniversity, ILR School, in Ithaca, N.Y.
 Acknowledgments
 The authors thank Jae Eun Lee for her very able research assistance and the Russell SageFoundation for financial support.
Contents
 
CEPR A Primer on Private Equity in the U.S.
1
Executive Summary
Private equity (PE) companies have engaged in two big waves of leveraged buyouts in the U.S. in thelast 30 years. The first was book-ended by the 1979 buyout by KKR of the Houdaille Corporation, aFortune 500 conglomerate employing 7,700 people and by another spectacular KKR deal
 – 
itsrecord-setting buyout of RJR Nabisco for $31.1 billion in 1989. The second wave began in the late1990s and peaked in 2006-2007, with aggregate transaction value in private equity buyout deals in2007 reaching $607 billion and the number of deals reaching 1,500.Private equity companies are investment firms that recruit private pools of capital from pensionfunds, endowments, hedge funds, sovereign wealth funds, and wealthy individuals. They useextensive debt financing to take ownership and control of relatively mature businesses in a leveragedbuyout. That is, private equity firms buy businesses the way that individuals purchase houses
 – 
witha down payment or deposit supported by mortgage finance. A critical difference, however, is thathomeowners pay their own mortgages, whereas private equity funds require the firms they buy fortheir portfolios to take out these loans
 – 
thus making them, not the private equity investors,responsible for the loans. The only money that the private equity firm and the investors in its fundshave at risk is the initial equity they put up as a down payment.Private equity is a lightly regulated financial intermediary that provides an alternative investmentmechanism to the traditional banking system. Among the financial intermediaries that have emergedas major players, it is the one that most directly affects the management of, and employmentrelations in, operating companies that employ millions of U.S. workers. This primer provides anintroduction to private equity 
 – 
the institutional environment in which it emerged, its size and scope,its business model, and how it operates in different industries. We are especially interested in privateequity 
s effects on jobs, management decision-making, and the sustainability of productiveenterprises in the U.S.Our examination of widely cited studies of private equity helps to illuminate some of the majorcontroversies over private equity. On employment impacts, for example, we examine the mostrigorous empirical evidence, the widely cited National Bureau of Economic Research (NBER) study of the effects of private equity on employment. It finds a
clear pattern of slower growth at [privateequity] targets post buyout
 
 – 
a differential that cumulates to 3.2 percent of employment in the firsttwo years post-buyout and 6.4 percent over five years (Davis et al. 2011:17). This slower growth, theresearchers note,
reflects a greater pace of job destruction
at firms taken over by private equity post-buyout than at comparable establishments (2011:18). They nevertheless conclude thatemployment growth at private-equity-owned firms is only slightly slower than at other similarcompanies. They reach this conclusion by calculating not only the net effect of employees hired andfired by the private equity owned company, but also by adding in any employees in businesses thatthe company acquired while it was owned by PE. The jobs of these acquired employees, however,are not new jobs in the economy and clearly were not created by private equity. The returns earned by pension funds and other investors in private equity funds is another debatethat we clarify in our review of academic research. The body of evidence raises serious questionsabout the pay-offs to pension funds and other limited partners (as distinct from the profits earnedby the private equity firm that sponsors the funds) due in part to the long time horizon to whichlimited partners must commit their funds regardless of whether the funds are actually invested. The

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