For proponents of the “leverage creates discipline” school of thought, this news should come as no surprise. Companies with a heavy debt load are quicker to close inefficient plants or abandon a money-losing strategy. But in the world of public relations, this doesn’t necessarily make PE pros out to be heroes, especially since the study found that greater productivity doesn’t translate to higher wages for employees. I think it’s more important to determine whether private equity creates greater productivity and better discipline, and therefore, better companies, in the long term. No one studies what happens to PE-backed companies two or five years after their PE backers exit. I asked Josh Lerner, a Harvard Business School professor and co-editor of the report: Did the study address whether this productivity is sustainable?
He said no, because exit dates are sometimes numerous and difficult to track. He conceded that would make sense to look at.
“It would be asking, ‘Is this like shock therapy?’” he said. “Like when you take someone into rehab and for the next two years they are clean and sober, but then they start sliding back to their old habits? Or is it a permanent change?” Not a perfect metaphor, but it works.
The study is an extension of last year’s study, which noted that leveraged buyouts destroyed many jobs but ended up creating around the same amount through growth. “One reaction we had,” Lerner said, “was, ‘That’s fine, but what is the economic impact?’” PE-backed manufacturing companies were 2% more productive than public, government-backed and privately managed manufacturing companies, the report stated. A third of that was driven by the willingness of a PE backer to shut down unproductive facilities; two thirds was driven by doing less with more.
The part of the study that interested me most is the focus on economic downturns. During times of economic turmoil, PE-backed companies are even more productive than their counterparts, the report states.
It’s perplexing given the idea that PE-backed companies are supposedly running the leanest possible ships during good times (the whole, leverage creates discipline thing again). So when it comes time to cut, the company should have no levers left to pull. It seems that the less productive, less disciplined companies could better use the downturn to trim fat and perhaps “streamline their operations.” A turnaround expert suggested the reason for this finding is that since PE firms are so intensely focused on their covenants and debt, they may be ahead of the game on pending issues in portfolio companies and better able to address them in advance than its public counterpart.