Do critics of private equity misunderstand how the industry affects workers? A new paper confirms the higher unemployment and lower wages of workers let go by the new PE owners following a leveraged buyout, but rejects explanations based on greed or monopsony power. They find that labor decisions post buyout are driven by an intention to raise productivity at the acquired firm. In explaining how PE-owned companies undertake to accomplish this, however, the article confirms what critics have long pointed out about how private equity hurts workers and communities. 

In the paper published on July 11 by the EU-based think tank CEPR, Josh Lerner and his coauthors set out to help us understand the impact of private equity buyouts on employees. In an elaborate research design, the authors compare 2.5 million workers who were employed by 3,600 firms that underwent leveraged buyouts between January 1993 and December 2013 to similar workers at firms that were not acquired.

Their first finding is that “unemployment for these workers rises and wages fall after buyouts.” This, as they note, is not surprising as the great weight of evidence shows that businesses acquired by private equity in a leveraged buyout cut jobs. Wage declines following a buyout are “substantial,” but they are concentrated only among workers who were let go after PE took over the business.

The authors consider three explanations for these phenomena and conclude that it is the desire to increase productivity that drives labor decisions after a buyout. In the words of Lerner and his coauthors: “Private equity managers downsize less-productive plants relative to more-productive ones. Moreover, they move workers from less- to more-productive plants. This effect, however, is confined to the higher-wage workers ….”

Yes, exactly. Private equity advertises that it comes in, makes investments, and improves the performance of underperforming businesses. But by their own admission, that is not what they do. Their secret sauce is that they close plants/stores/hospitals — even those still generating a profit— when they are less profitable than other units of the company.

This is not an increase in productivity in the economists’ sense of more production per hour of work. No effort has been made to raise production per hour of work in the underperforming parts of the business. Neither is it the result of the inexorable advance of science and technology that makes some businesses and industries obsolete. Travel agencies are a contemporary example: Professional trip advisors and booking clerks have been displaced by AI-enhanced Internet search capabilities. Productivity increases broadly as these businesses shut down, their employees lose their jobs, and capital and workers are reallocated to more productive activities.  

But the increase in productivity noted in this paper is different. Productivity has increased because the PE owners have dismantled the acquired companies and disposed of their less productive units. This is an increase in productivity in the same sense that the average height of patrons in a bar increases when the shorter patrons are asked to leave. It’s a mathematically correct statement, but it does not denote a meaningful increase in productivity.

What has actually happened is that the new private equity owners have redistributed the company’s resources post-buyout to increase the company’s resale value a few years hence and maximize their own wealth. It is this behavior by private equity that has played a key role in the decimating of  small towns and suburban malls all over America. The businesses the new PE owners closed were not logo pieces; they were establishments that anchored the economies of local communities and supported jobs with livable wages.

Not to hurt anyone’s feelings, but this is what people mean when they describe PE owners as vulture capitalists.

This jaundiced view of private equity derives from another finding of the report, already documented extensively in books and articles, that the laid off workers do not regain their former level of wages — nor, we might add, their benefits and living standards. We are talking about people’s lives here. The consequences for these workers can be devastating – workers may lose their homes because they can no longer pay the mortgage or the rent. Their marriages may break up under the stress.

It is this experience that underlies community resistance to private equity buyouts, and calls by policymakers for regulation of the private equity industry at federal and state levels.