Study Questions Benefits of Private Equity Institutional Buy-outs

Many firms taken over by private equity buy-outs see their performance fall even further behind their industry rivals, according to a study by the UK’s Warwick Business School.

In a statistical analysis of the private equity’s institutional buy-outs (IBO), which made up nearly half of all public-to-private buy-outs during the 10-year period researched, Geoffrey Wood, of Warwick Business School, Marc Goergen, of Cardiff University, and Noel O’Sullivan, of Loughborough University, discovered that when they compared 105 publicly-listed firms that went through a buy-out between 1997 and 2006 to a control group of their industry rivals they fell further behind after the takeover.

Instead of improving following the shedding of jobs the firms’ performance gap against the control group – as measured by turnover per employee – widened.

Wood, Goergen and O’Sullivan factored in variables, such as market-wide trends in employment and the economy when calculating the performance of the companies bought in an IBO by private equity firms or funds.

Professor Wood said: “What we found was the promised productivity gains of a takeover rarely materialised. Rather, there was evidence of private-equity buy-outs reducing the number of workers and squeezing wages, without making the firm more efficient.

“A year before the firms were taken over the average gap between them and the control group in terms of turnover per employee was £29,000. Four years after the buy-out that had widened to almost £89,000.”

Professor Wood and his team of researchers found private equity buy-outs underestimate the importance of the workers they end up making redundant. “We find strong evidence of a higher incidence of downsizing in the firms in the year following the acquisition, even when we adjust for differences in wage costs and productivity,” he said.

“In the first year after the buy-out 59% of the acquired firms reduce the size of their workforce compared to 32% in the control group, which is a jump of 18% over the previous year.

“While the existing literature argues that one of the reasons for private equity acquisitions is to rein in excessive labour costs there is very little evidence of workers earning wages above the market rate ahead of the takeover. Yet after the acquisitions there is evidence of a drop in mean and median wages.

“Why do firms that are taken over perform worse? We believe that it is because outsiders find it more difficult to cost the worth of a firm’s human assets, and their combined knowledge and capabilities. Hence, they are more likely to lay off staff and less aware of the consequences this may have for future performance.

“It is not a universally toxic industry, unlike IBOs, those firms bought-out by the management do improve performance, because they understand and appreciate their human assets.”

Professor Wood added: “This is the first study focusing on IBOs in the UK in that it is based on objective company data, rather than perceptions, and compares firms taken over against a control group of comparable firms that were not. We look at a time period of 10 years: six years prior to a buy-out taking place and four years afterwards.”


Related reading