Are Private Equity Firms Evil Doers?

Print
Wednesday, 11 January 2012 05:59

The NYT had an article discussing whether private equity firms are good or bad for the economy. The piece failed to focus on the real issues.

The focus of the piece is whether private equity increases or decreases the number of jobs in the firms it controls. This is not really a good measure of whether the industry is good or bad for the economy.

If private equity firms were successful in making companies more efficient and lowering prices to consumers, then it could lead to more jobs in the economy, even if there were fewer workers directly employed in the firms under its control. (This does not really apply in the current economy, where inefficiency means more workers are employed. This is good in the context of a poorly managed macroeconomy with high unemployment.)

However private equity firms do not profit just by making firms more efficient. Private equity also profits by financial engineering. For example, it is standard practice for private equity firms to load their firms with debt. This means that interest payments, which are tax deductible, are substituted for dividend payments, which are not tax deductible.

Private equity companies also often force firms into bankruptcy to offload debt. This can often include pension obligations, which are then taken over by the Pension Benefit Guarantee Corporation. Insofar as private equity companies are drawing their profit from this sort of financial engineering, it is not providing a benefit to the economy. In fact, it is a direct drain on the productive economy.

Clearly private equity companies engage in both practices (increasing efficiency and financial engineering). There is no definitive study showing which is more important to its profits and whether the efficiency gains exceeds the waste associated with financial engineering.

At one point the article quotes R. Glenn Hubbard, the dean of the Columbia Business School and one of Mr. Romney’s economic advisers (who also played a starring role in the movie Inside Job), saying:

"private equity firms have an impact on productivity ... That doesn’t mean that people don’t lose their jobs. But the question of whether private equity adds value? It’s settled among economists."

It would have been helpful to include the view of a less partisan economist who could have told readers that this is not true.