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?
Yesterday we ran Part 1 of our conversation with 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 — addressing 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. Here’s Part 2 of the conversation:
Chris Riback: On this question of jobs and job creation and, obviously again, the title of the report: the consequences of private equity on employment and management. There’s some real discussion there about management. I mean, you talked about the study on operations.
Josh Lerner: Right.
Chris Riback: There is also a study on injury rates and the downward trend for all firms.
Josh Lerner: Right.
Chris Riback: On this question of jobs, which is on the headlines every day. It’s front and center certainly in American politics and American discussion and the tax bill is coming up. What … I mean, I understand the core question of is private equity good for jobs? Maybe that can, in some level, depend on where you sit, how you define jobs, what aspects of jobs and what define good. You did a study that looked at 5,000 buy-outs and you looked at employment. I guess in the end, how would you characterize the responses that you got around that question and is it a communication issue? Is it a fact based issue? What was the takeaway on this question of private equity in jobs?
Josh Lerner: It’s a great question. I think that what one can say with real clarity is that when we looked at the sample of transactions between 1980 and 2003 and we’re not updating it to take it through the financial crisis and so forth, but when you looked at the historical data, what you did see is that private equity backed firms relative to their peer group did lose job … If you looked at who is working at the plants prior to the buy-out and what happened to those firms after the buy-out relative to their peer group, they did lose more jobs than the peer companies or they grew more slowly depending on which industry they were in.
There is a sense in which to … Looking at private equity in aggregate to claim that private equity has no impact on employment is indeed misleading. That being said, while they were also … Whether it was substantially more layoffs largely through plant closings at the existing plants, the private equity guys were also going through a process of opening up additional facilities: greenfield facilities, and these … We only looked at the United States so this wasn’t jobs in Bangalore or Shenzhen but jobs in other places in the United States that was much more active on the part of private equity than they were of the comparable companies. In other words that the churn associated with private equity both in terms of jobs destroyed as well as jobs created were substantially higher in both cases.
Net private equity still ended up leading to fewer jobs being created, but one of the consequences of the churn is that you had a substantial increase in terms of the productivity of the plants that in many cases we’re talking about old economy traditional metal bending plants. What we found is that … Which typically have baseline productivity growth that’s very modest, and we found that after the private equity guys came in, the rate of productivity growth often accelerated by on the order of 1% a year, which one percentage point a year, which is a big boost in terms of productivity, so let’s say from one percentage point productivity growth to two percentage point productivity growth.
Very much of a big impact, and in some sense, perhaps one of the challenges is it doesn’t really lend itself to a nice soundbyte saying private equity is wonderful in every respect or has no problem at or challenging consequences at all. On the other hand, it doesn’t lend itself to the story where private equity is terrible either, right? It just suggests that it’s slightly complicated.
Chris Riback: This relationship: the labor private equity relationship, the report notes that labor is wary of private equity and you’ve talked about it short term in nature focus on towards existing and you’ve talked a little bit about this. On the other side, I was very interested to see one of the conclusions from the GP panel seem to be the need to improve information and understanding among various stakeholders.
How likely is that to happen particularly given some labors concerns, and what specifically would you recommend? I know you focused quite a bit in your life and in your studies on the communications of GPs. What specifically would you recommend GPs do in terms of meeting that conclusion of improving the information and understanding among the various stakeholders?
Josh Lerner: It’s a great question. I think that one thing is clear is that private equity is an industry that is, perhaps as the name suggest, private, right? And that many of the groups legitimately feel like tipping their hand in terms of their strategy is something that’s potentially harmful to them and as a result play it very close to the vest.
While you can understand where they’re coming from in a business strategy perspective, right? Saying if we’re levered in a way that’s slightly vulnerable, we just certainly don’t want to be tipping our hand what we’re going to do in terms of pricing or other things so that competitors aren’t tempted to go after us. But at the same time, it’s also clear that that kind of secretiveness can reinforce some of the anxieties that perhaps very legitimately end up surrounding the industry in the eyes of many stakeholders and other parties who are involved.
I think this is an area where the industry has to do more. I think the answer is not in terms of dodging the facts and saying, “Everything is wonderful,” because I think those kind of arguments of saying we did a sample of 40 firms or here are seven case studies of things that worked out well end up not convincing anyone and make the industry, in some sense, look a little furtive in terms of its approach.
It seems like it is probably much more the essential thing to very much engage a boarder community about what the challenges faced by the business are, what the responses are likely to be and so forth. That’s likely to be a more painful and, in some cases, complicated process than would then would be the case with the status quo. But I think in the long run that’s likely to be essential for success.
Chris Riback: Josh, to close out the conversation, just back on the broader ESG question. The important notes that there are some 4,000 private equity firms, and as the ESG interest grow, which types of GPs does that help and hurt? I mean, do bigger GPs have more flexibility to maintain ESG standard even in economic downturns and how important … Do we need more level setting; more ESG standards, more accepted ESG standards?
Josh Lerner: Right. I think that certainly it is the case that this, to a certain extent, does favor larger groups, right? That essentially when you think about it, they’ve got more resources to gather information, to communicate that information and so forth. But I think that you can say that in some respects, that’s a short run effect. In the longer run I think we will see, across the private equity industry, there being more attention to these issues, and we’ll just see not just large groups but even middle market or lower middle market groups putting much more focus in terms of capturing what’s going on with their portfolio companies and then communicating it.
Chris Riback: Getting standards across the industry, too hard to do?
Josh Lerner: Well, that’s a very interesting question. As you know, there has been somewhat of a mixed track record in terms of these types of standards out there, but certainly I think that it has, if indeed the limited partners push hard for it and are coordinated which, of course, is a big if.
If they are, it is very possible we may see that.