LIFEWORTH REVIEW OF 2007: SECOND QUARTER April to June
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Lifeworth Review of 2007 GOTO www.lifeworth.com Lifeworth Review 2007: The Global Step Change
Jem Bendell
Adjunct Associate Professor,

Griffith Business School, Australia

Founder, Lifeworth, Switzerland
Jonathan Cohen Jonathan Cohen
Research Associate,
Lifeworth Consulting, Switzerland

Private equity, public inequity


Another segment of the financial industry that received some heat in 2007 was private equity. Also in June, while more than a hundred bankers and investors attended a dealmaker conference at the New York Stock Exchange, two union groups protested the growing and, in their view, 'unchecked power of these well-heeled and secretive investment firms'. Andrew McDonald, director of the private equity campaign for the Service Employees International Union (SEIU), which represents 1.8 million workers, told Reuters that 'America is waking up to the fact that private equity is everywhere and it has a huge impact not only on the economy but workers and communities'. In April, the SEIU had unveiled a report highlighting its concerns about buy-outs, which can lead to job cuts, the elimination of pension plans and cuts in health coverage.9

9 Joseph A. Giannone, 'Unions vow to crank up the heat on buyout firms', Reuters, 27 June 2007; www.reuters.com/article/bondsNews/idUSN2742886220070627.

Buy-out firms have been active for more than 20 years, but in early 2007 scrutiny of them grew. The floating of the Blackstone Group, the takeover of iconic companies such as Chrysler, Hertz and Tommy Hilfiger, and the billions of dollars made by the dealmakers, have helped raise their public profile. Key to their recent growth has been an era of cheap debt. This has enabled many private equity firms to punch way above the weight of their own bank balance. Worldwide, the private equity industry is thought to have about $300 billion in cash, which might amount to $1 trillion in spending power when firms borrow against their capital, according to Ernst & Young.

Ben Schiller10 summarises the main criticism of private equity firms as being that 'after buying out companies, they load them with debt, take out the cash, and then sell the emaciated carcass a few years later. In Germany, private equity firms have famously been described as locusts for their asset-stripping activities.' Key here is the widespread use of leveraged buy-outs (LBOs), which involves borrowing other people's money to buy other people's companies in return for giving them your debts and demanding large dividends. For instance, the private equity partners who took over the British retailer Debenhams increased the company's debt from 100 million to 1.9 billion, paid themselves dividends of 1.3 billion, tripling their investment in just over two years.11 To the non-financier this sounds somewhat like getting a mortgage from a bank to buy a house and giving the existing tenants the debt and upping their rent. Nice 'work' if you can get it.

10 Schiller, op. cit.
11 John Russell, 'Private Equity: Humbling the Barbarians', Ethical Corporation, 1 April 2007; www.ethicalcorp.com/content_print.asp?ContentID=4981.

Unions are particularly concerned with job cuts. They cite the example of the Automobile Association (AA), where new owners Permira and CVC cut 3,400 jobs within months of taking it over.12 However, in April a study by the Financial Times suggested that the 30 largest private equity deals made between 2003 and 2004 in the UK have created 36,000 new jobs, many in the country. In response, Paul Kenny, general secretary of the union GMB, said, 'The FT finding that some companies owned by private equity grew jobs and turnover does not invalidate the GMB experience of job losses at the hands of private equity in the mature sectors of the economy like AA and Birds Eye, and the related tax breaks, asset-stripping, saddling of thriving companies with massive debts and culture of secrecy.'13

12 Ibid.
13 Andrew Taylor and Chris Bryant, 'Buy-out firms defy job-cutting reputation', Financial Times, 1 April 2007.

In addition, recent evidence suggests that short-term pressures on executives from these LBOs and hedge fund activity are limiting investment in various areas, not only employment. In a survey last year of 400 senior US executives by the Journal of Accounting and Economics, four-fifths of respondents said they would cut spending on research and development, advertising, maintenance and hiring to meet their quarterly targets.14

14 Schiller, op. cit.

Some commentators on corporate social responsibility argue that 'there is nothing inherent to the private equity model that should mean that privately owned businesses must be inherently less sustainable or less responsible than [publicly listed companies]', and see the issue merely as one of increasing the knowledge of private equity managers and their stakeholders about best practice.15 That is a convenient position to take if selling advisory services and seeing a major new market from the backlash against private equity firms. However, there can be no denying the 'tax breaks, asset-stripping, saddling thriving companies with massive debts and the culture of secrecy' that Kenny describes poses problems for how companies create value for society. 'When you have something in private equity you don't have the public visibility about corporate social responsibility activities in the same way as with public companies,' says Arthur Probert from Tomorrow's Company.16

15 Mallen Baker, 'Private Equity: Agents or Destroyers of Responsible Business?', Business Respect 110 (13 May 2007); www.mallenbaker.net/csr/CSRfiles/page.php?Story_ID=1856.
16 Taylor and Bryant, op. cit

Private equity managers themselves have differing perspectives on corporate social responsibility. On the one hand, there is evidence of progressive behaviour. Private equity firms made their $32 billion takeover of energy company TXU dependent on the firm cancelling 8 out of 11 coal-fired power stations on environmental grounds. David Russell, head of responsible investment at the Universities Superannuation Scheme, a pension fund with 29 billion assets under management, explained that that all of the fund's current private equity assets are invested in wind farms.17

17 Russell, op. cit.

However, some of the large PE investors take a dim view of how societal concerns relate to them. At a Treasury select committee in the UK, CVC Capital managing partner Donald Mackenzie said, 'A lot of public companies we speak to spent too much time on regulatory issues, social responsibility and corporate governance . . . And they forget their prime purpose-which is to grow the company as rapidly as possible.'18 One sector already causing concern is retailing. In May, Somerfield Stores, UK grocer, pulled out of the Ethical Trading Initiative after being bought out by private equity group Apax Partners. Mallen Baker of Business in the Community sees PE managers demanding a new rigour in corporate social responsibility thinking. 'They are skeptical, because flawed arguments based on wishful thinking are the sorts of things they pride themselves on being able to see through.'19 However, the idea that there can be a business case for voluntary corporate action on all social and environmental issues has already been shown up as wishful thinking and the agenda has moved on to focus on creating the right frameworks and drivers for business to be more responsible, accountable and sustainable. That requires a systemic view, appreciating the importance of value creation across the whole economy in the long term, and a sense of moral purpose to act beyond, but not in contest with, what is financially sensible for one's own company today. If the financial system empowers those who take no such long-term or broader view and seek to maximise short-term returns based on debt to equity calculations, then we have a problem that can not be resolved by Blackstone or Primera, for instance, hiring a corporate social responsibility manager and joining a few relevant membership organisations.

18 John Russell, 'Blog: Private equity bosses slam corporate responsibility', Ethical Corporation, 2007; ethicalcorp.com.
19 Baker, op. cit.

However, apart from some in the trade union movement, by mid-2007 the connections were not being clearly made between these new financial powerhouses and the interests of wider society. In Melbourne, Australia, the top business conference of the year was packed with seminars about social and environmental challenges. During a panel on Private Equity during this 'Future Summit' the audience sat hushed listening almost in awe to the millionaire dealmakers on stage and did not ask any questions about how PE is helping or hindering a sustainable Australian economy.20 In May, PE even made it into Vanity Fair's annual 'Green Issue'. Nearly all articles addressed crucial issues such as climate change. The one on private equity marvelled at the billions that PE firms are making by 'doing the math', mentioned some protests, but concluded 'just deal me in'.21

20 www.futuresummit.org
21 Michael Wolff, 'Serious Money', Vanity Fair, May 2007: 74-82.

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