The Real Effects Of Private Equity Buyouts via SSRN

Joacim Tåg

Research Institute of Industrial Economics (IFN)

September 8, 2010

IFN Working Paper No 851

Abstract:

Private equity buyouts have become a common element in the industrial development process. I survey the literature on the real economic effect of buyouts: employment, wages, productivity, and long-run investments. Employment tend to marginally fall after a buyout in most countries studied, with the exception being France. There are clear evidence of productivity gains following a buyout, with part of these being shared with worker through higher wages. The evidence is mixed regarding effects on long-run investments.

The Real Effects of Private Equity Buyouts – Introduction

Private equity buyouts are acquisitions of established companies undertaken by private equity firms. They are partly financed with debt and partly with equity raised from institutional investors for private equity funds with a predetermined life span. Private equity buyouts are also known as leveraged buyouts or bootstrap acquisitions. When management participates, they are sometimes called management buyouts.

The private equity industry took off during the 1980s. As a large wave of takeovers swept across the U.S., buyouts became a new phenomenon that was much talked about and scrutinized. When the takeover wave receded at the end of the 1980s, so did the number of buyouts. But as illustrated in Figure 1, it only took three years for buyouts to make their comeback and break new records by spreading out from the U.S. During 2000 to 2007, a worldwide explosion in the number of buyouts occurred and a staggering 79% of all buyouts between 1970 and 2009 took place after 1999. In particular, there has been an increase in the number of buyouts outside the U.S. and the U.K. As illustrated by Figure 2, at the peak of the boom in the 1980s, 93% of all buyouts took place in the U.S. or the U.K. At the peak of the boom in the 2000s, 53% of all transactions took place in the U.S. or the U.K.

The spread of the buyout phenomenon has not escaped criticism (FSA, 2006; ITUC, 2007; PSE, 2007). Labor unions and worker representatives claim that buyouts, through layoffs and wage cuts, generate returns to investors at the expense of workers. Industry critics express some concern about the detrimental effects of short holding periods by citing examples of “quick flips”, in which companies are sold off within two years after the buyout. This has prompted the view that private equity firms are short-term investors that are always on the lookout for a quick exit at the expense of employees, productivity and long-run investments. The private equity industry has not sat idle. Responding with studies of its own, its interest organizations have refuted the accusations and claimed that buyouts create better companies, increase job creation and promote long-term productivity (Achleitner and Klöckner, 2005; BVCA, 2006).

But why should a buyout affect employment, productivity and long-run investments? And what are the empirically documented effects? This overview offers an answer by drawing on a literature in economics and finance stretching back to the 1980s when the industry first emerged. Throughout, the emphasis will be on real effects, omitting such aspects as the effect of a buyout on operating profitability, returns to investors and tax payments. Studies that cannot separate between the effects of venture capital and private equity investments will also be omitted. For complementary overviews of the literature on buyouts covering these aspects, see e.g. Cumming et al. (2007), Kaplan and Strömberg (2009) or Wright et al. (2009).

The real effects are important since a buyout has the potential of affecting static efficiency (e.g. productivity), dynamic efficiency (e.g. innovation) and imposing (positive or negative) externalities on stakeholders in the firm (e.g. the employees). Empirical and theoretical studies on employment, wages, productivity, innovation and bankruptcy provide us with hints on what the social welfare implications of an active private equity market are likely to be.

In sum, the literature has discussed several reasons why a private equity buyout could have real effects. They can be grouped into three categories: a buyout reduces agency problems, it introduces uncertainty and temporary owners, and brings in capital and knowledge to the organization. These changes affect employees, productivity and long-run investments.

Private equity buyouts

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