KUHN CAPITAL Tuesday, March 20, 2018
Dispatches from the front

Are PE Firms Bad for Business?

Couple of years back, we heard some horror stories about big PE firms reportedly over-leveraging their acquisitions, then gutting the portfolio companies' balance sheets by awarding themselves fat dividends. These actions then led to bankruptcies when sales failed to climb as forecast. Poster boy for this sort of allegation was the case of KB Toys which went into Chapter 11 after Bain Capital LBO’d the venerable retail chain.

So we're not surprised that when the housing bubble burst, and lo the politicians were loosed upon the land looking for culprits, they thought of PE firms. (They’ve also been threatening big commercial banks, investment banks, broker/dealers, hedge funds, angel investors, etc. We have no idea why hedge funds and angel investors are in this unhappy catch-all bucket -- maybe because investors can lose money there too?)

Of course, our politicians here in the states have conveniently ignored the truth that their own monster creations, Freddy Mac and Fannie Mae, were the primary engines of the American housing bubble, churning out torrents of bad mortgage paper that Wall Street obligingly sliced and diced to feed gullible appetites around the world. In the process, millions of people lost billions of dollars.

Still, the hunt is now on for how to more heavily regulate virtually all lenders, investors and intermediaries, PE firms included. The Europeans actually bear an even greater animus towards PE firms than the US government, we suspect because of old-fashioned nationalism and protectionism.

But what evidence supports the argument that PE firms are bad for business and must be “reformed”?

Actually, according to a group of business school professors led by Harvard’s Josh Lerner, their research supports arguments to the contrary. As they write in the abstract to their paper "Private Equity and Industry Performance" published last January:

“Industries where PE funds have invested in the past five years have grown more quickly in terms of productivity and employment. There are few significant differences between industries with limited and high private equity activity. It is hard to find support for claims that economic activity in industries with private equity backing is more exposed to aggregate shocks. The results using lagged private equity investments suggest that the results are not driven by reverse causality. These patterns are not driven solely by common law nations such as the United Kingdom and United States, but also hold in Continental Europe.”

We suppose it won’t be the first time that facts fail to inform political debate.

Ryan Kuhn

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