Podcast: Private Equity, Employment, and Management — Josh Lerner, Harvard Business School & PCRI (Part 1)

It’s an age old question across all types of investing: can you have it all?

In other words, can investors get the twin benefits of doing well and doing good? For the various private equity participants, the question has become more urgent over the last several years, particularly around ESG, Environmental, Social and Governance issues. As requirements around doing good increase from politicians, LPs, employees, even GPs, the need for GPs and LPs to deliver it all continues to rise. Put simply, what are the broad, social consequences of private equity investments?

These were just some of the topics covered in a recent round table that brought together LPs, GPs and academics sponsored by the Private Capital Research Institute, the Institutional Limited Partners Association and the Private Capital Project at Harvard Business School. The event was titled: The Consequences of Private Equity and Employment in Management.

What do the various players have to say? We spoke with one of the conference leaders, Dr. Josh Lerner, chair of the Entrepreneurial Management Unit and the Schiff professor of investment banking at Harvard Business School. He also serves as Director of the Private Capital Research Institute, a nonprofit devoted to encouraging access to data and research about venture capital and private equity.

Here’s Part 1 of our conversation:

Chris Riback: Josh, you held a conference on the social consequences of private equity investments with particular focus on the ESG, of course, environment, social and governance factors. Why do you have such a conference? How have the social consequences of private equity become such an industry concern?

Josh Lerner: Well, it’s certain the case but this is an area where there is much greater awareness and sensitivity than was the case even five years ago. Well, it’s certainly been the case that there have been criticisms offered of the private equity industry for its consequences on jobs that have appeared periodically in the political arena. We can think about the period in the late 1980s, then again right around the peak of the mid-2000s by outboom where these issues were very much in the frame of discussion.

They were largely external and focused in the sense that a lot of the criticisms and issues that were raised were really in the context of people outside the private equity ecosystem criticizing the industry rightly or wrongly for many of these aspects.

One of the changes that we’ve seen in the past few years has been much more of the discussion not being about responding to politicians. If anything, it seems the political pressures have eased on the industry, but rather in terms of responding to concerns within the industry in particularly from limited partners who are increasingly thinking about not just simply what the financial returns of those investments are, but also what the broader ESG type consequences of those investments are.

Chris Riback: I know that your conference brought together … That’s broadly speaking through different perspectives: the GPs, the LPs and the academics, and I’m going to ask you about each of them. At the highly level, that shift of focus maybe a call it from external to internal and the willingness to look from the inside, how much of … I mean, you just differentiated from the bottom line evaluation at least from the LP side on returns, but across the board, the LPs and GPs, is there a tie? Does it ultimately tie to the bottom line? I mean, it’s such a bottom line focused sector, right? I mean, on both the LP side and GP side. In the end, they’re all really judged so strongly based on returns and based on numbers, so was it … Even if it was an ESG focus, does that get tied to the bottom line?

Josh Lerner: Well, that’s a great question, which doesn’t have a clear answer to it, but I think that it’s fair to say that, particularly when it comes to European institutional investors, there is and certainly many high networth individuals that there really is that proverbial double bottom line that essentially, well, having good metrics on ESG considerations is not sufficient and maybe it’s not even primary. At the same time, it’s also necessarily that there is a sense that many of these pensions and families have people who are very concerned about the consequences and the impact of their portfolio. As such, certainly the comfort level with investing in groups that seem to have problematic ESG relationships is not really there.

I think with the US pensions in particular, it’s a somewhat different kind of consideration. There, perhaps, reflecting the fact that we’ve seen a number of instances of political leadership within states pressuring pensions to do various economically target investments, which have had a very mixed track record. In many cases, they were pressured to do investments that turned out to either be of rather dubious economic merits. In the worst cases, where there was political connectedness between the project sponsor and the political leadership of the state, there’s been still a lot of caution about broadening the evaluation criterion from anything other than the financial return. I don’t think you can paint it with a broad brush the entirety of the LP community.

Chris Riback: I do want to ask you about the evaluation criterion and how that’s looked at from multiple perspectives. On that point of multiple perspectives, you had, and this must have been fascinating, LPs, GPs and, of course, academics led by you, how different were the viewpoints? I found myself, in reading your study, I found myself thinking about that old story of the blind man and the elephant. Were the different private equity participants describing the same elephant?

Josh Lerner: I think that’s a great question, which is to say that certainly we saw a number of comments and desires on the part of the limited partners to really invest in groups that had a positive impact on the world, which is certainly a very laudable goal. I think what the academic research highlighted is that, while this was a certainly a terrific thing to aspire to, it also is the case that this is really hard to pull off, in a large part, because assessing many of these issues is extremely challenging.

In particular, what we saw in the academic side was a number of examples of studies that tried to look very carefully at the consequences of private investing but doing so by looking at real structured kinds of problems where you could actually figure it out. For instance, the paper that Shai Bernstein and Albert Sheen discussed, which essentially looked at health inspection data, [we] ended up to finding that the … When you looked at essentially fast food franchises, which were owned by private equity groups as opposed to the ones that were owned by independent owner operators that you ended up seeing that there was substantially better performance after the private equity guys came in in terms of the likelihood that there would be health or safety violations.

In some sense … They’re basically cleaner, they’re safer and they’re better maintained. Now, on the one hand, you can say this certainly benefits restaurants and consumers, right? That the private equity guys seem to be doing something right. But certainly compared to the broader goal of saying we really want to understand what the impact of a given investment is on the economy, it’s very challenging, right? It’s challenging for private equity. You might argue, it’s even more challenging for venture capital, right? You think about something like Uber, right? And you say, is this a good thing or a bad thing? It’s certainly making transportation cheaper, which is great in allowing people to get to places they might not be able to go otherwise. It’s certainly creating new jobs for people who want to do stuff in the gig economy. At the same time, it clearly is having detrimental effects on taxi drivers and maybe even contributing to congestion in cities like New York and Boston.

Really figuring out what the cost benefit calculus around these things is, which in many cases the limited partners seem to express their goal on this. I think, if one lesson that came out of the academic stuff was that this was really hard. Well, one can look at very narrow places and see some patterns. When you looked more broadly, it was quite challenge to figure out some of these issues.

Tomorrow: Part II