Private Equity at Work

Eileen Appelbaum and Rosemary Batt tried to take an academic look at private equity firms and published their results in Private Equity at Work: When Wall Street Manages Main Street. The authors paint the world in black and white. They present the book as a question of whether private equity firms are (1) financial innovators that save failing businesses or (2) financial predators that bankrupt otherwise healthy companies and destroy jobs?

You can guess the answer from the first two paragraphs. The authors spend eight lines on the successful Aidells Sausage Company investment and 19 lines on the disastrous Mervyn’s Department Store investment.

The authors largely treat private equity firms as parasites and propose far-reaching and ill-thought out ideas to curb them. They reach their conclusions from a misunderstanding of private equity, poor comparisons, and a lack of data.

The authors chose to use the corporate-raiding barbarians of the 1980s leveraged buyouts as the origin of private equity instead of Bain Capital’s genesis of management consulting.

The authors routinely use public companies as a benchmark. They fail to note that public companies are merely a small fraction of the operating companies in the United States. It’s hard to get data on private companies, of course, because they are private.

In my mind comparing the bankruptcy rate of private equity-owned companies to the rate of public companies is not a true comparison of failure. I accept the premise that public companies typically carry less debt as a percentage of their capital structure. But I don’t accept the premise that the public company standard is true for non-public companies, whether they are operator owned or private equity-owned.

The authors get trapped in the idea that private equity is all about taking public companies private using high levels of debt. The LBO sector is only one part of the private equity world.

I was particularly annoyed at the authors for their failure to correctly describe the regulatory framework and background for private equity firms. Private equity firms were not subjected to SEC regulation by Dodd-Frank. The SEC always had the power to enforce the anti-fraud provisions of the various securities laws. Dodd-Frank removed a commonly-used exemption from registration as investment advisers. That old exemption was based the number of clients (i.e. funds) the firm managed, not size.

When it comes to performance, the authors have some good data, but much of it is admittedly flawed data on performance. Those flaws don’t keep them from reaching their conclusions. They note that a large chunk of private equity firms do not beat the S&P 500 or similar public company benchmark. They state that many investors would have been better off investing in an ETF. They fail to note that the same is true for mutual funds. The majority of which fail to exceed their respective benchmarks.

The authors also label private equity as focused on short-term shareholder value. They seem to forget that public companies are even more focused on short-term issues. A public company’s value is determined with every trade and the value swings up and down with the stock ticker wrapping around the tote board.

Eventually, the authors sprinkle in some positive stories of private equity. But the book is largely a hatchet job on private equity.

Eileen Appelbaum is Senior Economist at the Center for Economic and Policy Research. Rosemary Batt is the Alice Hanson Cook Professor of Women and Work at the ILR School, Cornell University.

A publicist sent me a copy to review. There were many times while reading the book that I wished he had saved the postage.