SPRING, 2014


Leveraged Buyouts: The Full Story

by Terry Kosdrosky

New research by Professor Kyle Handley shows there's more to private equity buyouts than the headlines.

Private equity leveraged buyouts took a beating during the 2012 presidential campaign — at the expense of Republican candidate and former Bain Capital CEO Mitt Romney — but the slings were nothing new. Leveraged buyouts, or LBOs, have often been blamed for unemployment and excessive levels of corporate debt. But U-M Ross Professor Kyle Handley suspected there was more to the story, and his new research digs deeper to get the full picture. LBOs can be dramatic and traumatic — with painful layoffs, plant closures, and major transitions. However, Handley's new research shows that there is another side to the LBO story, including evidence of job creation, acquisitions, and productivity gains. Handley and his co-authors put together a multitude of data in a new way to give a more nuanced view of the economic effects of LBOs. In the end, what they discovered can better inform both policymakers and those in the industry.

“Until now, it's been really difficult to estimate the true effect of these leveraged buyouts by private equity firms,” says Handley, assistant professor of business economics. “There's no question they tend to cut jobs, but they also open new operations. So unless you look at both of those things relative to a control group, you're not looking at the net effect.”

Handley was joined in researching the paper “Private Equity, Jobs, and Productivity” by Steven J. Davis of the University of Chicago's Booth School of Business, John C. Haltiwanger of the University of Maryland, Josh Lerner of Harvard Business School, and Ron S. Jarmin and Javier Miranda of the U.S. Bureau of the Census Center for Economic Studies. The paper has been accepted for publication in The American Economic Review.

A Deeper Dive

Besides anecdotal evidence, past attempts to study the phenomenon used surveys, didn't have control groups, or didn't always distinguish between companies backed by venture capital and by private equity. It also was hard to disentangle pre- and post-acquisition data. Handley and his co-authors overcame that by using U.S. Census Bureau data that tracks employment and earnings before and after buyouts at specific locations. They also used the Annual Survey of Manufacturers and the Census of Manufacturers to measure firm performance, such as labor productivity. They use data from Capital IQ and others to track private equity deals. They only looked at deals where private equity firms took a controlling stake in a company. Venture capital deals and management-led buyouts were excluded. The key was creating a control group of companies so they could estimate what would have happened at LBO companies had they not been bought out. The large number of firms and location-specific employment data the authors used allowed them to compare buyout targets matched to a set of control companies that were in the same industry, the same age, and the same size prior to the buyout. After controlling for these characteristics, they tracked the difference in concurrent changes at both groups. “You really need to know what would have happened to the company in the absence of a buyout to get any sense of the true effect,” he says.

The Net Effect

There's no doubt that private equity funds, in general, make fast changes when they take over a company and some of those changes are painful. Operations shut down and people lose jobs. Indeed, Handley's study found more job loss – 3 percent more over two years – at individual establishments, say a factory or plant, for bought-out companies compared to the control group. At five years out, that grows to 6 percent. But those same LBO target companies created more “greenfield” jobs – 2 percent more – in new locations than the control group. The numbers indicate private equity buyouts are a catalyst for creative destruction. Bought-out firms also are more active in making acquisitions and sales and see more gains in productivity than the control group. Since low performing operations may be shut down at the same time that a firm expands employment elsewhere, it's important to account for the total employment change at the firmlevel. Summing across each firm's entire operation, the study says the difference in job loss between LBO firms and control group firms is less than 1 percent. The study only follows firms for two years after a buyout because numerous ownership changes over longer horizons would narrow the sample size and make comparisons more difficult, a constraint not imposed on the establishment analysis.

“Private equity firms come in with capital and do things the previous management wouldn't do, or didn't have the know-how or resources to do,” he says. “There's a lot of activity in a short amount of time and some of it cuts jobs, and some of it creates jobs. There's a lot going on and not all of it is captured anecdotally.”

The new research shows some of the arguments for and against leveraged buyouts may be simplistic, and that policymakers and practitioners should take a wider view.

“I think in some respects the leveraged buyout industry has gotten a bad rap because when they do shut-down operations — and the effects on the people laid off are stark and real — it's front-page news,” Handley says. “But everything else that leads to the aggregate effect — opening a new plant someplace else in the country or making acquisitions — isn't in the news.” “My conclusion is that it's not causing substantial employment loss when you look at the net effect.”


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