Cardiff Business School News

Private-equity buy-outs reduces employment without improving performance

Publicly-listed companies bought out by private-equity firms do not become more productive after their acquisition, according to a new study.

Private equity raises money to buy a company, with the primary objective of improving the fortunes of an under-performing firm. The ultimate intention is to seek a re-flotation on the stock exchange or to sell the firm on at a profit to another purchaser.

But when researchers at Warwick Business School, Cardiff University and Loughborough University looked at 105 UK companies that had been bought-out by private equity investors between 1997 and 2006 and compared their performance against firms of a similar size in the same industry over 10 years they found that the productivity of the acquired firms failed to improve.

Geoffrey Wood, of Warwick Business School, Marc Goergen, of Cardiff University and Noel O’Sullivan, of Loughborough University, factored in variables, such as labour costs and employee productivity when calculating the performance of the companies bought in an institutional buy-out (IBO) by private-equity firms or funds.

Professor Goergen, who is Professor of Finance at Cardiff Business School, said: "Existing studies tend to focus on one particular type of private equity acquisition which is management buy-outs (MBOs). An MBO consists of the existing management taking the firm private, with the financial support of private equity houses. The management ends up owning the firm.

"Typically, these studies find mainly positive effects of private equity acquisitions, including improvements in firm performance and employment growth. We focus on institutional buy-outs (IBOs) which are carried out by specialist investors. In contrast to MBOs, IBOs normally result in a complete change in management.

"We found that the private equity targets suffered from relatively weak productivity before the acquisition. However, there was little evidence that their productivity improved after the acquisition. This was the case despite substantial downsizing and also despite substantial cuts in wages after the acquisition. We did not find that wages in the private equity targets were higher than in the control firms before the acquisition. Hence, reining in excessive wages, which is frequently cited as a reason for private equity acquisitions, did not seem to be an appropriate motive for the acquisitions we studied."

Professor Goergen added that "More importantly, there was no evidence of job creations in the target firms after the acquisition. In fact, employee numbers dropped after the acquisition and this drop was even observed after adjusting for differences in labour costs and productivity.

"Why do targets of IBOs not experience an improvement in their performance? We believe that the new management that is put into place typically undervalues the firm's human capital. Hence, they are more prone to excessive downsizing of the workforce, which may then harm future performance."

For a copy of the paper Private Equity Takeovers and Employment in the UK: some Empirical Evidence contact Professor Marc Goergen.

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