Right Now | Take Two on Takeovers
Gordon gekko, the antihero of the 1987 movie Wall Street, epitomizes the excesses of the U.S. financial sector in the 1980s. Gekko embraces insider trading and the strip-and-flip model of the hostile takeover—buy a company, ruthlessly lay off workers, cut corners wherever possible, and sell soon after for a huge profit. “I am not a destroyer of companies,” he proclaims during one memorable speech. “I am a liberator of them!”
Helped along by media coverage focused on deals that were the exception, not the norm, the corporate-raider stereotype of buyouts took hold in the public consciousness. But in a recent study of 5,000 buyouts that occurred between 1980 and 2005, Josh Lerner, Schiff professor of investment banking at Harvard Business School, and colleagues call into question just about every component of this unflattering stereotype.
The research updates an academic literature that had not seen much work since the 1980s, when buyouts were a new phenomenon and when, says Lerner, “there were almost as many papers about buyouts as there were buyouts.” The absence of systematic analysis in the interval has led to a reliance on anecdotal evidence—a newspaper story on the $26-billion Clear Channel buyout here, a CNN clip on the $17-billion Albertson’s supermarkets buyout there. Labor unions have long described buyouts in terms of American jobs shipped overseas. Lobbyists and trade groups for the private-equity industry, meanwhile, depict a sector that provides an invaluable contribution to the U.S. economy by making companies more efficient, jarring them out of inertia, and improving corporate governance. Lerner and his coauthors suspected the truth lay somewhere in between.
Their analysis, originally presented at the World Economic Forum’s 2008 annual meeting in Davos, Switzerland, examined 300,000 factories and offices associated with companies that were bought out, and compared those with a control group of six million more facilities. The results suggest that buyouts tend to happen to companies that are already struggling, but do not increase the likelihood that a company will fail. The authors found evidence that the private equity firms home in on management controls and invest in R&D during the holding period—evidence, says Lerner, that the goal is to make companies not just leaner, but better organized.
Sometimes this entails cutting jobs, he notes, but the notion of buyout firms taking an ax to employment rolls doesn’t hold water. In fact, the study found that companies were more likely to cut back in the two years before a buyout; takeover targets had 4 percent lower job growth than similar firms that were not bought out. In the two years following a buyout, the targeted corporations did cut jobs—7 percent more than comparable firms—but they added employment in other U.S. locations. In fact, new facilities opened by the bought-out companies grew 6 percent faster than comparable firms in terms of jobs created. (The study did not look at jobs created outside the United States, and did not count them as offsetting domestic shrinkage.) “Buyouts,” says Lerner, “increase the pace of ‘creative destruction’—the pace of job creation and destruction both accelerate.”
News accounts mostly cover public-to-private deals, partly because investors care about companies in which they hold stock, and partly because public companies are easier to cover due to the financial statements they must file. But the average buyout involves a private, rather than public, company; Lerner and his colleagues found that the vast majority of the deals in their database—more than 93 percent—affected companies that were not publicly held. Even accounting for the fact that the public-to-private transactions typically involve bigger companies, such transactions were less than 30 percent of the total by value.
The study also found that quick flips (companies that went public again less than a year after a buyout) make headlines—but the average holding time was far longer. Lerner’s study found that only 12 percent of the private-equity firms exited within two years; 58 percent took more than five years to exit. Another headline-grabbing situation, the company that collapses in the wake of a buyout, is also not the norm. Among firms that were bought out, the five-year failure rate—6 percent—was actually lower than the rate for all U.S. companies that issue public debt.
Although Lerner teaches a course on venture capital and private equity, and has spent much of his career studying those sectors, he says even he was surprised by the findings. “If you read something in a business magazine a hundred times,” he says, “you sort of begin believing it.”