When will we learn the lessons of Private Equity?


3:21 pm - February 23rd 2010

by Adam Lent    


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Rewind almost three years and the trade union movement was embroiled in a bitter media spat with the private equity industry.

In a portent of something much bigger, private equity firms were accused of playing fast and loose with high levels of debt to buy up companies they neither understood nor cared for in order to make a quick buck.

But the ridicule aimed at the unions in the Summer of 2007 was often intense. It reached its nadir when the Chair of the All Party Private Equity Group, Sion Simon, went Paxo on the TUC General Secretary at a hearing of the Treasury Select Committee.

Simon asked Brendan Barber six times in quick and testy succession to produce the evidence that private equity firms increased risk for the companies they acquired.

Well, the evidence is now here.

As Ian Griffiths and Nick Mathiason report in The Guardian today no less than four planned flotations by private equity firms have been abandoned in the last two weeks. The reason: investors are now scared off (rather than seduced as they once were) by the debt-driven private equity business model.

This is deeply worrying. The future of companies owned by private equity firms unable to raise enough cash to meet massive debt repayments is very uncertain. The possibility of fire sales or major restructuring become increasingly likely with all that can mean to the continued employment and conditions of those working in the firms.

Big mistakes were made in the early days of debt mania when the Government did all it could to lure the private equity boys to London by offering the most favourable tax and regulatory regime possible. When it became clear in 2007 of the risks involved, mistakes were made again when a limited voluntary code was introduced which did little more than improve reporting in the industry.

But the Government now has a chance to partly put right what it did wrong back then.

The Kraft takeover of Cadbury has shown that the large leveraged buyout is far from dead. Indeed we may be about to see yet another round of frantic mergers and acquisitions. As Brendan explains, Gordon Brown and Peter Mandelson need to seize this moment to radically change the way firms are bought and sold in the UK.

Extra disclosure and consultation with the workforce is good, changing rules to limit the most speculative shareholders voting on an acquisition might help. But the real redemption will only come by accepting that we need an objective, dispassionate body to judge whether a takeover is really in the long term interests of the company being purchased and of the people who work there.

The sad truth is that shareholders, even the longest term investors, will always sell if the price is high enough. Company boards, who often stand to benefit financially to the tune of millions, will also recommend a sale at the right price. No voluntary mechanism, no extra disclosure, no tweaking of share voting regulations will change this fact.

In the end, only a mergers and acquisitions commission can make the objective judgement about the benefits of a takeover.

This may not help the thousands of workers now facing uncertainty as a result of private equity irresponsibility but it will, at least, stop many thousands more finding themselves in the same position in the future.

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About the author
Adam is an occasional contributor, former Head of Economics TUC, Associate Fellow at IPPR and co-author of 'In The Black Labour'.
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Story Filed Under: Blog ,Economy ,Trade Unions

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Reader comments


I’m not sure if this qualifies as blurting out the sheer crassness of the lame-brained soft left, but it’s adjacent to the same kettle of ballparks. If you want to learn the lesson of private equity, take a look at the data

I wouldn’t argue for a second that everything is fine in the world of private M&A, but giving the power to approve takeovers to a “commission” is comically naive.

That must be the same Sion Simon who made a political career for himself by being the ultra-Blarite MP for Birmingham Erdington as well as writing for the Daily Telegraph, Daily Express and News of the World.

Look how regenerated the Labour movement looks after 13 years of people like him representing Labour voters!

Ah yes, of course, we need the all-knowing all-seeing wise Government to make decisions that we are incapable of making correctly ourselves. How stupid of me to ignore this plainly obvious truth.

If being a shareholder is so easy, may I suggest that you enter the fray and start buying shares yourself? If you did, you would soon realise that sometimes shareholders lose money – no, really, it’s true – but when they make money, they are perfectly entitled to take their gains and move elsewhere. No need for a Government to step in, no need for a Government to utter a single word.

Perhaps, by your logic, we also need the Government to tell us when we are allowed to sell our car, or our house or our own businesses to make sure that the ‘benefits’ of a sale are properly considered?

“In the end, only a mergers and acquisitions commission can make the objective judgement about the benefits of a takeover.”

Based on something along the lines of the public interest argument? Like the one Brown scrapped?

LfaT: this is unusually lacking in awareness for you.

If being a shareholder is so easy, may I suggest that you enter the fray and start buying shares yourself?

Do you have any idea how staggeringly unrealistic that is? I work full time + about 20 hours most weeks and have a struggle to buy bread when it runs out.

The reason there is a vast social anger about the activities of capitalists is that Tories plutocrats, those who can just go out and buy shares in a volatile stock market, as a learning experiment, because someone on a blog told them to, are a very small number of people. They have all the money already, and nearly all of them are over 40 and have middle-class or above backgrounds.

Very, very few people in my generation believe they will ever own debt (a mortgage), let alone equity or savings in five figures. In this trite response, you have displayed (unusually, for you) exactly that disconnection from economic reality, as experienced by 80% of Britons, that your party are famous for.

Leaving all of that aside and engaging with the topic at hand for a moment; asset companies create nothing and add no value. They are a very clever legal mechanism for concentrating money in the hands of those who already have lots of money. Banks, at the very least, actually do something (provide commercial capital and lubricate the action of actual businesses who do real things). Private equity is a private casino with the taxpayer as the bank.

Here’s the thing though: ‘Inefficiency’ in a publicly listed company is pretty much shorthand for ‘excess employees’, where excess is whatever the PE firm decides it is.

However we feel about achieving business efficiency and international competitiveness, it’s sensible to weigh it against the plain fact that it means turfing a lot of people out on the street to find other jobs. Between 1997-2007 there was enough growth to cover it, but these days I’m not so sure. Kraft likely doesn’t need all of Cadbury’s Marketing, IT and Legal staff – how does competitiveness help those people?

Re: 5

PE isn’t casino capitalism in the same way as floor trading, it’s more like a license to print money. You use your money (or leverage) to buy another company, integrate/sell/downsize whatever’s duplicated, and pay back the money with your new improved profit margins.

The lending firms get a heavy chunk of interest, the PE shop gets a fat consultancy fee, the new conglomerate has doubled its profits without really doing anything. It’s genius from a finance point of view.

What can be done about it if anything is a slightly different issue. I don’t see where the author is claiming that private equity ownership has led to badly run companies. The issue is the debt that is sitting on the company balance sheets and bodes badly for future investment
‘ This is deeply worrying. The future of companies owned by private equity firms unable to raise enough cash to meet massive debt repayments is very uncertain. ‘

Many of the buy-outs were completed in the credit bubble and have massive debts that begin to mature 2012. It was always the intention to repay the debts by IPO floats. Selling the asset to others instead of an IPO means the debt remains on the balance sheet. It does not matter how well run the company if its debt burden prevents investment and hinders its growth prospects.

The private equity IPO window is closing because the companies burdened with debt are not worth the private equity valuation. Blackstone in recent weeks have postponed a number of listings. Another private equity-backed float (Promethean) is going ahead because they have no debt. Moreover, it should be borne in mind that the postponed sales will be their best-performing assets. What are the rest like if they can’t even float their good assets. The IPO market is there to finance long-term investment not to bailout the bad investments of private equity. Quite simply there is too much debt sitting on the balance sheets. The author is correct to highlight this as a ticking time bomb for the companies involved.

“But the real redemption will only come by accepting that we need an objective, dispassionate body to judge whether a takeover is really in the long term interests of the company being purchased and of the people who work there.”

Please tell me where we can find these objective, dispassionate people? Might as well add in a little omniscience and ineffability as well.

@ Tim Worstall

We’ll I’d say a move towards a more stakeholder model of capitalism where Unions have a larger say in what happens to the businesses they work in, after all greater workplace democracy is something I think we can all support.

I think Adam Lent might be suggesting something a little more top down – a commission sort of sounds like something the Rt. Hon. Frank Field would sit on, talking crap, stopping takeovers of companies with good PR like cadbury and letting the other ones go hang. I could be wrong of course (About Adam of course. Not Field, oh no)

@9

Ooh! ooh! That’s me! I could do that! What’s the pay like?

Y’ know, I first read, “When will we learn the lessons of Private Eye?” when I saw the headline. Its a combination of wishful thinking and failing eyesight.

10
You might not remember ‘The Crossman Diaries’ (‘Yes Minister’ was supposed to be based on this book) in it, Richard Crossman described a meeting between Harold Wilson and Henry Ford jnr, just after the 1964 election in which labour won, Labour’s manifesto promised new laws to enable Unions to have a greater say in board decisions with regard to future business plans.
Ford advised Wilson that if this went ahead, he would transfer all receipts of Ford cars,sold in the UK, to the European branches. At that time, Fords held the largest share of the UK market:- Wilson didn’t implement the promised legislation.
Not only does this indicate the nature of our democracy, I really don’t believe that large corporations and, in particularly multi-nats have really changed that much

@13

Quite.

Now that’s an area for discussion.

“We’ll I’d say a move towards a more stakeholder model of capitalism where Unions have a larger say in what happens to the businesses they work in, after all greater workplace democracy is something I think we can all support.”

Amusing…linking unions with democracy for a start. What happened to “the workers” rather than yet another bureaucracy?

But “greater workplace democracy” being something “we can all support”?

Nope, not me.

The people who get to decide over ownership are the people who do the owning. You put up your capital you get to decide on the disposition of that capital. You put up your labour you get to decide on the disposition of that: if you don’t like what’s on offer at one place, offer it elsewhere.

As those offering their capital have to do.

This is nothing at all to do with whether worker owned companies do better: I’m absolutely delighted if they do and sometimes they actually do do.

My point here is, you offer your labour for wages then wages you get. You offer your capital then the rights of capital to ownership you get. Want to do both? Then cough up matey.

See what I mean

Tim,

What a charmingly simple world you ultra-orthodox economists inhabit. Selling labour is just like selling shares – straightforward market relationships governed by the fundamental and perfect principles of supply and demand.

A whole understanding (and sadly a large proportion of a whole academic discipline) that pretends that rigidities of political, cultural and social power plus a whole host of other human foibles and frailities have no bearing on market outcomes. Or even worse recognise that they do and think that there is some utopia where they can be banished.

I really think that one day (maybe not too far off) we will look back on that whole academic edifice and wonder how anyone ever came to believe it.

It seems like something of a defeat when an alleged head of economics has to condemn economics to make a consistent case. It’s as if a think-tank of a different disposition had its head of climate science condemn the ultra-orthodox climate change consensus.

“What a charmingly simple world you ultra-orthodox economists inhabit. ”

I do have to keep saying this. I’m not an economist. Just an interested amateur. I have no advanced degrees in the subject, have never worked as an economist and couldn’t do a multiple regression to save my life.

I would also argue against my being “ultra-orthodox”. Many of my views tend towards the Austrian which is certainly not mainstream. Recessions as a period of recalculation for example. I’m also heavily invested in public choice economics (essentially, politicians and bureaucrats do what benefits politicians and bureaucrats, not anything so charmingly beneficial as what might do the rest of us some good).

“A whole understanding (and sadly a large proportion of a whole academic discipline) that pretends that rigidities of political, cultural and social power plus a whole host of other human foibles and frailities have no bearing on market outcomes.”

Eh? I argue endlessly that political, cultural and social power affect market outcomes. At least in part the gender pay gap is exacerbated by long maternity leaves as just one example. That the majority of said gap is caused by the gender assumptions we make as a society about who should care for young children.

I would even agree that where there is a monopsony then labour markets are not as I describe in outline above. Like, perhaps, when a union is running a closed shop (now thankfully illegal) or in a company town (now, given modern mobility, not really possible).

Or perhaps you’d prefer the example of national pay scales and the truly vile effects they have on the private sector in low income areas and the similarly vile effects they have on the public sector in high income ones? (several papers have recently pointed out that the NHS national pay scale for nurses leads to shortages of nurses in high income areas, to inconsistent care and thus to avoidable deaths). Such national pay scales caused by the social, political and cultural power of bodies like the TUC screaming that the same job is worth the same pay anywhere in the country….entirely ignoring that job markets work better when they are indeed based upon local supply and demand.

No, I don’t think that it is I who is ignoring such distortions imposed upon markets. Motes and beams come to mind.

Edward, I’m not attacking economics just a certain branch of economics which I think is wrong-headed.

Tim, I wasn’t sure about your particular leanings, so I was careful to distingusih between those economists who analyse markets as though they lack power relations and those who hold the utopian view that markets work best when non-market power relations are banished. I guess you fall into the latter.

I just don’t believe such market utopias can exist. That Austrian notion that you give, for example, that recessions are some sort of healthy restructuring mechanism and should be left to their own devices is naïve. Firstly, recessions might create new economic arrangements but these are based on revised power relations not a refreshed market. But more importantly humans simply don’t separate their economic lives from their political, cultural, social lives in the way many economists would like them to. If recessions are allowed to let rip, there will inevitably be a non-economic backlash of some form which will itself affect the economy. You can’t expect people to see themselves their families and their communities devastated and not take some form of action. That’s not a moral point. It’s an easily observed historical fact.

That’s why all those Austrian inspired Republicans who called for the banks to be allowed to go to the wall to allow the market to resolve the problem came across as so naïve and dogmatic to many European ears.

“That Austrian notion that you give, for example, that recessions are some sort of healthy restructuring mechanism and should be left to their own devices is naïve.”

I say “tend towards the Austrian”, not that I swallow the whole thing hook line and sinker.

Your own views, as laid out in that recent paper also tend towards the Austrian (“tend!”).

Think of what it is that you actually say: that the economy was over invested in financial services and that now we need to rebalance it. An Austrian (ish) view would be, OK, so if that is so then we’ve a period when we’re all sitting around scratching our heads wondering how to do this rebalancing. This is known as a recession.

Where I pick up the idea is that, starting from that point, how do we achieve that rebalancing? We need to be producing new industries, new compaies, looking at new sectors of the economy to be providing the future growth. This necessarily involves entrepreneurs. For that’s the name we give to people who take extant productive resources and combine them in new ways to produce new goods and or services.

That’s a very Austrian view indeed.

It also has a corollary: that if we reduce the amount of unused resources, by, for example, propping up the current structure of the economy (and we can posit this as the banks, or car companies, whatever) then we reduce the incentive for such entrepreneurs to do the experimentation which leads to those new industries and thus that future growth.

Longer outline of the argument here.

http://www.theregister.co.uk/2008/12/29/economic_models_and_upturns/

Left Outside@10,

I must say I’ve been hearing about this stakeholder model of capitalism for decades, but I’ve yet to hear the manifesto laid out in anything other than a pretty feeble way. So you want, for example, workers reps on the board. Meh. It might do some good if your labour relations are very good to begin with. And some harm if not. And it could be worked around. It’s hardly earth-shattering. It wouldn’t make businesses fundamentally any different to what they are.

What it seems to boil down to is that we want the people who control all the money to have the right values. Wish is just wishful thinking.

Gwyn@6,

To answer your question on efficiency, I think it is a mistake to resist it, even if there are lay-offs. The unemployment is temporary, and the benefits to all of us are permanent. Had the seed drill been resisted for the lay-offs it caused, we would all still be dirt poor. Efficiency brings us all lower prices and therefore effectively higher wages.

@22

Seed drills, spinning jennies, silicone chips: all these technologies had the potential to liberate working people. Remember Michael Rodd on Tomorrows World telling us silicone chips would mean menial jobs would vanish and we’d all have to learn to fill our leisure time? I took up slacking there and then.

Well it didn’t happen and I’m still pretty pissed off with Michael. That’s a side issue. The point is, why didn’t it happen? Was it naive to think it could? Did we even have a choice?

The vested interests of the ruling elite seem to have been well served by the way things turned out. The rest of us just have to get on as we always did, incrementally improving our lot while the plutocrats try to turn back the clock.

I’d like to see this forum spend less time debating with closed-minded righties and more time analysing how capitalism has used technology. I’d like to see ideas in place to try to ensure that any future technology benefits us optimally, not just a bit of trickle-down.

” Remember Michael Rodd on Tomorrows World telling us silicone chips would mean menial jobs would vanish and we’d all have to learn to fill our leisure time? I took up slacking there and then.

Well it didn’t happen and I’m still pretty pissed off with Michael. That’s a side issue. The point is, why didn’t it happen? Was it naive to think it could? Did we even have a choice?”

Well, to an extent, it actually did. Not since Tomorrow’s World was on our screens to be sure.

But look at it this way. Average full time wages in 1900 were 1 pound 8 shillings a week. That’s the average of everyone.

So, what do you have to earn now to get that living standard today? Retail price index says 113 pounds a week now. That’s overstating it a bit (we get free health care now, they didn’t then etc).

How much work do you have to do to get 113 pounds a week nowadays?

Nothing, not an hour, is I think the answer. Dole plus housing benefit is almost certainly more than that. Even if it ain’t we’re not far off it.

So, over a century and ten years of capitalism we’ve managed to make the entirely idle (yes, I know, many involuntarily so) as well off as the average person at the start of the period.

Not a bad record really.

And the reason people don’t intinctively get it is because they fail to realise quite how absolutely poor our forefathers were.

@24

Well I don’t fancy living on the dole. I’ve done it and it stinks. Its not the nirvana righties suggest it to be.

Of course, all those benefits you describe were achieved thanks to a grateful owning class deciding to share things a bit more fairly. That’s why, during my grandfather’s lifetime, his working week went from 12 hour days six days a week to 8 hour days five days a week?

Nothing to do with organised labour, industrial strife and real hardship to slowly win the gains you describe over decades.

Yurrzem, be fair to Tim, he didn’t suggest being on the dole was any good, rather that living in 1900 was a stinker by today’s standards.

You would have a better defence if you argued that the gain was due to technology rather than capitalism. That would be an interesting debate.

Joe,

I wasn’t arguing that the improvements working people have gained over the last century were due to capitalism! I don’t know where you got that from.

Working people have been regarded as just another resource to be used or discarded as required. Improvements have been won by organisation and activism, the bread and butter of the labour movement.

All too often technology has put people out of work, which is why there has been a mistrust of it by the left. However, progress requires that we adopt new technologies or be overtaken by others who have adopted them. The issue of the left has been how to adopt new technologies that replace working people while retaining a fair society and a functional economy.

Sadly recent decades have seen a decline in manufacturing in this country and a de-skilling of large sectors of the workforce. This is an issue I’d like to explore from a left wing perspective. It seems to me that exporting our manufacturing base was a small price to pay for the benefit to the owning classes of the damage it did to the trades union movement and thus the left as a whole.

Where do we want to be in ten or twenty years time? Upskilling and developing a sustainable manufacturing base would help us to withstand some of the ebbs and flows of the global economy (look at Germany today, hurting but still pretty good). We’ll also need to pay a lot more attention to food production as the oil-hungry system we use today becomes less viable and the problems of soil degradation and an unpredictable climate start to bite.

It is interesting that none of you seem to have noted that Nigel Doughty (a big player in Private Equity) was one of the biggest political donors last quarter according to the electoral commission. Wonder which party he gave money to…..

Tim,

It distresses me greatly that I can’t find anything I would fundamentally disagree with in your last two posts. I think I’d be less sanguine about the heroic role of entrepreneurs, so I’m not sure a simple release of resources is automatically beneficial.

But I definitely agree that many ignore how unimaginably better life is now than one-hundred years ago thanks of course in considerable part to post-war social democracy and collective bargaining but also to the wealth generating power of capitalism.

But I’ll check out the link and hope the natural state of antagonism can be restored!

Tim @15:

My point here is, you offer your labour for wages then wages you get. You offer your capital then the rights of capital to ownership you get. Want to do both? Then cough up matey.

This is the same mistake as LfaT. It presupposes that everyone in the system has capital. To employ capital for personal gain you have to already have some. To already have some when you start means you inherited it, or someone else gave it to you; i.e. if you come from the vast majority of the population, that paragraph can only have one sentence.

This is the foundational conceit of civilised society over the last 6-8 thouand years.


Reactions: Twitter, blogs
  1. Liberal Conspiracy

    When will this government learn the lessons of Private Equity? http://bit.ly/8Zke7h

  2. ToUChstone blog

    When will we learn the lessons of Private Equity? Adam has a guest post on Liberal Conspiracy http://ow.ly/1alN8

  3. Paul Sandars

    RT @libcon: When will this government learn the lessons of Private Equity? http://bit.ly/8Zke7h

  4. Corey Faustin

    Liberal Conspiracy » When will we learn the lessons of Private Equity? http://bit.ly/a4LhUQ





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