October 23, 2019
Let’s unpack the E&Y study.
E&Y touts that the private equity industry supports 8.8 million jobs. You could mistakenly think this means that PE created 8.8 million jobs or that PE increased employment at the companies it took over. That may be the industry’s intention, and E&Y seems happy to create this misimpression, but it’s not true.
A careful study of “The Economic Effects of Private Equity” by economists at Harvard and the University of Chicago looked at what happens to jobs when a PE firm buys out a Main Street company with offices, stores, warehouses, supermarkets, or other establishments and takes it over. The study found that, overall, when private equity takes over companies, employment in the establishments of those companies goes down by 4.4 percent in the first two years following the buyout. When private equity buys out big companies with lots of employees that trade on a stock market, the job loss is even more dramatic – 13 percent in the first two years.
If you are a worker at a company that has been acquired by a private equity firm, these are the numbers that matter to you – these numbers reflect the probability that you or some of your colleagues will lose their jobs.
So, what is E&Y talking about?
PE firms today are sitting on a huge pile of cash (what they call dry powder) that they are having a hard time spending. When there is a promising target company to buyout, the competition is keen. Companies today are being bought for 12 times earnings – an incredibly high price. It won’t be easy for private equity to sell these companies at a profit. So, what does PE do?. It buys up lots of smaller companies that it can acquire cheaply and adds them onto the original target company. These smaller companies can also be expected to lose on average 4.4 percent of employment over their first two years in PE hands. But if you look at the original target company, it will have acquired the workers at these “add-on” companies, and its total employment will have gone up.
E&Y, as they report, has taken a snapshot of a moment in time, so their analysis can’t address questions of job creation vs. job destruction. The rosy picture they paint is not of much use to workers in companies acquired by private equity or to policy makers interested in attracting businesses that will create jobs.
The E&Y study found that. “The average US private equity sector worker earned approximately $71,000 a year in wages and benefits in 2018.” This will certainly come as a surprise to the millions of workers employed by hotels, coffee shops, restaurants, retail stores, supermarkets, warehouses, and other businesses owned by private equity firms. E&Y makes it clear that they did not collect data about wages paid to workers from any PE firm or any portfolio company. The sleight of hand employed in calculating this earnings figure is egregious.
There are two big problems with E&Y’s analysis. The first reminds me of the old joke that when Bill Gates walks into a bar, the average earnings of all the customers in the bar will be millions of dollars. In this case, E&Y includes private equity firms and their employees – including $230 million paid to Stephen Schwartzman and four other top executives at Blackstone, $172 million paid to KKR’s top five executives, $138 million paid to Apollo’s top five executives, and $104 million to Carlyle’s top five – in figuring out the average earnings of private equity sector workers.
The second problem is that E&Y uses industry compensation to calculate the average earnings of private equity sector workers. But industry averages include the earnings of CEOs and top managers at PE-owned companies along with their hourly employees. It ignores the huge disparities in pay for workers in different occupations.
E&Y could have easily avoided this problem by reporting the median earnings of private equity sector workers instead of the average earnings. Median earnings indicate what the typical worker earns. This figure is not distorted by the high earnings of workers at the top – including private equity moguls who are a big part of the 1 percent.
Workers are not fooled. The legions of hard-working, hourly-paid workers employed in companies owned by private equity have no expectation of earning $71,000 in pay and benefits any time soon.
As with wages, E&Y makes no effort to collect data on actual taxes paid by PE-owned companies. Here they simply look at the historical relationship between each type of tax “to the level of economic activity” – presumably national income or GDP. Of course, historical data does not yet reflect the Trump tax cuts, which lowered taxes for wealthy people and for many businesses, and cut into tax receipts at every level of government. So, the E&Y estimates of different categories of tax receipts exaggerate what was paid to government last year.
Private equity firms are notorious for hiring an army of tax accountants and tax lawyers to push the envelope on tax avoidance and lower the taxes PE firms pay, PE firm employees pay, and the companies owned by PE pay. Furthermore, the loss to the economy from tax avoidance goes way beyond the lost tax revenue. It also includes the fact that some of the smartest people in the country are busy figuring out how wealthy people and corporations can avoid paying their fair share of taxes when they could be developing cures for cancer or inventing the next big thing. Economists call that a deadweight loss to the economy – and it’s obvious why.
Including growth equity along with buyouts of companies is another sleight of hand that makes private equity look much bigger than it actually is in terms of the number of employees and contributions to the economy. If your 401(k) includes 100 shares of General Motors stock, should you get credit for the jobs of all 170,000 US employees of General Motors? That’s what happens when E&Y includes growth equity in its calculations. A PE firm buys a small slice of a company, and E&Y counted all of the company’s employees in the total for private equity. E&Y also counted the 1.5 million workers employed by the PE firms in its employment numbers. The effect is that it raised total private equity employment in the E&Y report to 8.8 million, up 50 percent compared to the 5.8 million workers employed at PE portfolio companies reported by a consultant a few months ago and quoted by the AIC.
Workers are not fooled by E&Y when their report talks about all the jobs private equity “supports,” or when it claims that the average annual compensation of workers in the private equity sector is $71,000. Let’s hope policymakers and politicians at the state and local levels can see through this report as well.