Abstract
Private Equity at Work by Eileen Appelbaum and Rosemary Batt is a sober and illuminating analysis of the changes wrought by the growth in private equity firms in the United States. It is a companion volume to the authors’ 1995 book, The New American Workplace (Appelbaum & Batt, 1994). Twenty years ago it appeared that the “high performance workplace model” had the potential to enhance both the quality of work and enterprise performance if advanced by public policy. Now Appelbaum and Batt find that the financial leverage strategies of private equity firms have shaken the foundation for desirable workplace systems. Their two volumes together represent a formidable contribution to the institutionalist tradition in labor economics and social policy. Most importantly for this journal, the authors have uncovered trends that must inform management education. Appelbaum and Batt describe a world in which managers and workers have much less freedom to devise positive sum bargains than in the previous era of labor-inflected managerial capitalism.
Private Equity at Work is a few books in one. The authors evaluate the mainstream scholarship on private equity owned firms. They find much reason to doubt claims of enhanced economic performance under private equity, and their review of the literature is extensive and scrupulous. They proffer a powerful hypothesis as to the impact of private equity on the “debasement of work,” as Robert Kuttner (2014) calls it. This is empirically informed institutional analysis at its best. Their assessment of the altered organizational terrain of American business is fit to join classics like The Modern Corporation and Private Property by Berle and Means (1967) and Braverman’s (1998) Labor and Monopoly Capital.
This book is a tightly organized synthesis of exposition, diagnosis, critique, and problem-solving. Chapter 1 previews the path of argument. Chapter 2 explains the relationship between the rise of private equity, the deregulation of finance and labor markets, and the academic debates that reflected and accelerated this process. The advocates of agency theory (e.g. Jensen and Meckling, 1976) helped galvanize a movement to link management compensation to stock options and reinforced the trend toward more aggressive profit-maximizing. Despite considerable jurisprudence supporting multiple goals for corporate enterprise, maximizing shareholder value has received rising acceptance. (Appelbaum and Batt do not explore the roots of agency theory in the law and economics scholarship funded by the Olin Foundation and other conservative donors.)
Chapter 3 explores the structure and behavior of private equity firms, describing private equity firms, funds, and portfolio companies and distinguishing the roles of general partners and limited partners. The authors have adduced considerable evidence that the limited partners, including pension fund managers, often fail to receive the out-sized returns promised them.
Chapter 4 adds an historical dimension. The 2008 financial crisis significantly altered the practices of private equity firms. The enactment of Dodd-Frank in 2010 has required private equity firms to register as “investment advisors,” a minimal form of regulation that many private equity firms would like removed. In post-crisis years, there has been increased emphasis on mid-market deals.
Chapter 5 “disaggregates” the private equity sector, distinguishing firms by size and other factors and describing differential impacts. This rich and fine-grained analysis identifies the disparate operational and financial engineering strategies of small, mid-sized, and large firms.
Chapter 6 considers private equity performance. The authors question much finance scholarship affirming private equity as a constructive intervention in corporate governance with wide rewards. They challenge leading finance scholars on this and speculate about the impact of substantial contributions from private equity firms to business schools. Appelbaum and Batt consider a large set of case studies and empirical analyses without prejudice and in doing so have received compliments from Michael Jensen (2015) himself.
Chapter 7 reviews the employment effects of private equity interventions on jobs and labor. Appelbaum and Batt find that private equity firms have created some jobs through improvements in enterprise performance and but have also reduced employment levels (and job quality) through enterprise-destructive financial engineering, as defined below. Given the frequently negative effects on jobs and conditions of work, employee pension fund managers’ choice to invest in private equity over other vehicles is worthy of some scrutiny.
The authors helpfully define financial engineering. The private equity firms impose high levels of debt on the portfolio companies to magnify returns and reduce tax liabilities. They further improve their position through the negotiation of debt exchanges with creditors, while failing to prioritize the survival of the enterprises themselves. The general partners capture most of the value in the unfolding transactions.
Chapter 8 focuses on the results for limited equity partners who are promised much by the general partners but receive a small fraction of the returns (and no fees, of course), much less favorable treatment by far. Chapter 9 proposes public policy changes to improve results for the limited equity partners as well as reduce the job destructive effects. The authors suggest regulatory measures to limit the compensation of general partners, reduce the tax preferences for debt imposed upon the portfolio companies, and enhance transparency. Needless to say, these reforms are modest and will still meet aggressive opposition from well-funded opponents. (The only weakness I find in this excellent volume is the authors’ inability to devise remedies that match the dimensions of the problems they describe.)
Private Equity at Work is full of detailed case studies which can be easily translated into class exercises. Consider the story of Mervyn’s Department Store Chain in the US Southwest in chapter 3. Private equity owners took over the faltering chain, stripped it of property, burdened the stores with debt and the payment of rent when they had previously owned their sites, paid general partners sizable dividends, and made bankruptcy nearly inevitable. The case studies provide important institutional detail that quantitative analysis alone tends to obscure. Appelbaum and Batt explain that the laying off workers, the intensification of work, and the breach of commitments to vendors were the direct results of private equity strategy.
I am convinced that management scholars must consider the analyses presented in this book and alter their curricula accordingly. What we teach must be informed by an understanding of institutions rather than rigid assumptions. If a labor-inflected managerial capitalism has been replaced by financial capitalism and private equity interventions have transformed enterprises into fleeting ventures increasingly stripped of community and purpose, will we continue to teach human resource management as before? Will we affirm the “strategic” element of human resources while denying the “human side of enterprise” (McGregor, 2006)? Will we introduce models of business ethics founded on management agency without acknowledging the other powerful actors in the economy? It is time to rediscover the value of rich institutional inquiry, and Appelbaum and Batt have provided an excellent example.