The realities of private equity
DAVID ROBINSONLambasting your political opponents is nothing new in a hardscrabble U.S. primary election. But lambasting your opponents because they are pro-business is a rather curious attack strategy in a Republican primary.
Yet this is exactly the attack Newt Gingrich is mounting against Mitt Romney as an attempt to fight back against the barrage of negative advertising aimed at Gingrich in the Iowa caucuses. Gingrich and others claim private equity is a form of “vulture investing” that destroys jobs and leaves behind broken companies like corpses in a roadside ditch.
The problem with Gingrich’s argument is not that it’s negative. Sadly, we’ve come to expect negativity in political discourse.
The real problem with his argument is that it has no basis in fact. Scientific research simply does not support the claim that the private equity activity associated with Romney’s Bain Capital firm destroys jobs, companies or economic value. In fact, the body of scientific research on private equity performance suggests exactly the opposite.
First, let’s look at private equity performance. Recently, I co-authored a study with Berk Sensoy of Ohio State University in which we examined the performance of roughly 60 percent of the known private equity funds in the United States in existence since the mid-1980s. Ours was the largest study on record to date to use detailed performance measures to track private equity performance over time.
We found very clear evidence that private equity creates value for investors. If you had invested a dollar in private equity, and at the same time invested a dollar in the public markets, you would have earned 18 percent more over the life of the average private equity fund than you would have earned in the public markets. And this was after paying the private equity firm its fees, and after splitting the returns with them (the so-called “carry” in industry jargon), so this is net performance, not gross performance. In short, private equity creates value for investors.
Our initial findings have been corroborated by more recent work using even larger samples of private equity returns. Researchers from the University of Virginia’s Darden School of Business, the University of Oxford’s Said Business School and the University of Chicago’s Booth School of Business found almost identical results to ours: private equity has outperformed public markets by around 18 percent over a fund’s life.
Some have argued that this sort of excess performance is the result of private equity funds borrowing enormous amounts of money, using the leverage to increase the returns to investors and ending up saddling the firms they purchase with untenable debt loads. Our work shows this is not the case. In our performance calculations, we explicitly accounted for the possibility that some of the performance could have been coming from leverage, and adjusted our comparisons to public market returns accordingly. Even if we attribute implausibly large amounts of performance to leverage, private equity still outperforms public markets by a wide margin.
It’s tempting at this point to say, “So what? Isn’t this just an example of rich people helping other rich people get richer?” The answer is no. The investors in private equity are in large part pension funds, university endowments and the like. It’s unionized carpenters, state employees and teachers who win when private equity creates value for investors.
What about jobs? Does private equity create value for its investors by swooping down like a vulture to scoop large chunks of value out of companies, handing it over to investors and leaving behind unemployment and damaged firms?
Once again, the data do not support this assertion. In a recent study, researchers from the University of Chicago, the University of Maryland, the U.S. Census Bureau and Harvard Business School examined what happens to jobs in companies targeted by private equity. They find that although jobs are cut in underperforming segments, the job cuts are more than offset by new job creation in these same firms. In other words, private equity may destroy jobs, but it also creates jobs. And it creates more jobs than it destroys.
This process of creative destruction is vital to our economy. That’s why it’s so strange – and so wrong – to attack a political opponent for being involved in private equity.
Private equity doesn’t destroy jobs, doesn’t destroy companies and doesn’t destroy the welfare of our society. So politicians and pundits should stop destroying knowledge by making claims to the contrary.
David Robinson is a Professor of Finance and the William and Sue Gross Distinguished Research Fellow at Duke University’s Fuqua School of Business.