Private Equity Is a Force for Good

January 23, 2012

The recent flurry of criticism against Mitt Romney's tenure at Bain Capital compels a questioning of the role of private equity firms in the economy.  Seeking to understand their niche and their net effect on the job creation, researchers have attempted to define their primary functions and measure their impacts empirically, say Kevin Hassett, director of economic policy studies at the American Enterprise Institute, and Steven J. Davis, an economics professor at the University of Chicago.

Private equity firms, including Bain Capital, engage in three primary fields of investment:

  • Leveraged buyouts (LBOs), in which a firm uses debt to buy out a controlling stake in a company.
  • Turning around distressed companies.
  • Providing capital to new startups, offering growth capital to promising existing ventures.

The final function has significant potential as a job creator and almost certainly creates more jobs than it destroys, but LBO and turnaround specialists are more difficult to assess.  This is because, in attempting to make businesses profitable and maximize their sale value, private equity firms often reduce production costs by cutting workers.  The end goal of this, however, is hopefully the creation of a thriving business that saves jobs and creates more jobs in the long run.

A recent study circulated by the National Bureau of Economic Research uses a research approach specifically designed to addresses this issue.

  • Compared to similar firms, employment at buyout targets shrinks, on average, by about 2 percent over two years after coming under the control of private equity.
  • The loss is even smaller, about 1 percent of initial employment, when accounting for the purchase and sale of existing facilities.
  • However, the target firms also create new jobs more rapidly than otherwise comparable firms, with the extra job loss and extra job creation summing to 13 percent of initial employment -- much bigger than the net employment effect.

This empirical evidence suggests that while employment at bought-out firms may initially decrease, private equity firms aggregately aid employment in the long run.  This lends credence to the argument that these firms' role in the economy is that of creative destruction: eliminating inefficiencies to boost production in the long run.

Source: Kevin Hassett and Steven J. Davis, "Private Equity Is a Force for Good," The Atlantic, January 16, 2012.

For text:

http://www.theatlantic.com/business/archive/2012/01/is-private-equity-a-force-for-good/251419/

For study:

http://www.nber.org/papers/w17399

 

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