Private equity is a form of alternative investment that involves buying and selling companies or parts of companies that are not publicly traded.
Private equity firms have invested in various sectors, such as technology, healthcare, consumer goods, energy, and infrastructure, and have influenced the strategies, operations, and governance of thousands of companies around the world.
But what is the impact of private equity on the economy, society, and environment? Is private equity a force for good or evil?
In this article, we will explore these questions and provide some insights into the pros and cons of private equity alternative investment strategy.
Private Equity and Job Creation or Destruction
One of the most debated aspects of private equity is its effect on employment.
Private equity firms often claim they create jobs by investing in growth opportunities, improving efficiency, and fostering innovation.
However, critics argue that private equity firms destroy jobs by cutting costs, outsourcing functions, closing plants, and loading companies with debt.
The empirical evidence on this issue is mixed and depends on various factors, such as the type of deal, the industry, the geography, and the time horizon.
A recent study by Bain & Company found that private equity-backed companies in the US had similar net job growth rates as their peers in the public market between 2006 and 2017.
However, the study also found that private equity-backed companies had higher gross job creation and destruction rates than their peers, reflecting a higher degree of creative destruction.
Another study by Harvard Business School found that private equity buyouts led to modest net job losses but large increases in productivity at target firms between 1980 and 2005.
The study also found that job losses were concentrated among public-to-private deals and transactions involving the service and retail sectors.
These findings suggest that private equity has a complex and nuanced impact on employment.
Private equity can create jobs by supporting growth-oriented businesses and sectors but can also destroy jobs by restructuring underperforming ones.
The net effect may depend on the balance between these two forces and the ability of workers to transition to new opportunities.
Private Equity and Innovation or Disruption
Another important aspect of private equity is its effect on innovation.
Private equity firms often claim that they foster innovation by providing capital, expertise, incentives, and networks to portfolio companies.
However, critics argue that private equity firms stifle innovation by focusing on short-term returns, imposing financial constraints, extracting value, and discouraging risk-taking.
The empirical evidence on this issue is also mixed and depends on various factors, such as the type of deal, the industry, the geography, and the time horizon.
A recent study by Stanford University found that private equity buyouts increased patenting activity and quality at target firms between 1986 and 2013.
The study also found that private equity buyouts enhanced the alignment between patenting activity and market opportunities at target firms.
Another study by London Business School found that private equity investments increased innovation output at target firms in Europe between 1991 and 2007.
The study also found that private equity investments improved the efficiency of innovation spending at target firms.
These findings suggest that private equity can foster innovation by supporting research and development activities and improving their effectiveness at portfolio companies.
Private equity can also enable innovation by facilitating industry consolidation, market-entry, technology transfer, and business model transformation.
However, private equity may also hinder innovation by imposing excessive leverage, dividend payments, or exit pressure on portfolio companies.
Private Equity and Corporate Governance or Activism
A third aspect of private equity is its effect on corporate governance.
Private equity firms often claim that they improve corporate governance by aligning the interests of managers and shareholders, monitoring performance, and implementing best practices at portfolio companies.
However, critics argue that private equity firms undermine corporate governance by reducing transparency, accountability, and stakeholder engagement at portfolio companies.
The empirical evidence on this issue is generally positive and consistent across different factors, such as the type of deal, the industry, the geography, and the time horizon.
A recent study by Oxford University found that private equity buyouts improved corporate governance at target firms in Europe between 1997 and 2009.
The study also found that private equity buyouts increased the value of target firms and reduced the agency costs of free cash flow.
Another study by Harvard Business School found that private equity investments enhanced corporate governance at target firms in emerging markets between 2002 and 2013.
The study also found that private equity investments increased target firms' profitability, growth, and survival.
These findings suggest that private equity can improve corporate governance by introducing more effective ownership structures, incentive schemes, and oversight mechanisms at portfolio companies.
Private equity can also influence corporate governance by engaging in shareholder activism, proxy contests, and takeovers at public companies.
Private Equity and Environmental, Social, and Governance (ESG) Criteria
A fourth aspect of private equity is its effect on environmental, social, and governance (ESG) criteria.
Private equity firms often claim that they incorporate ESG factors into their investment decisions and portfolio management, as they believe that ESG performance is linked to financial performance and stakeholder expectations.
However, critics argue that private equity firms neglect ESG issues or use them as a marketing tool, as they face less scrutiny and regulation than public companies.
The empirical evidence on this issue is limited and inconclusive, as ESG reporting and measurement are still evolving and vary across different factors, such as the type of deal, the industry, the geography, and the time horizon.
A recent survey by PwC found that 91% of private equity firms reported on their responsible investment activities in 2019.
The survey also found that 35% of private equity firms used ESG criteria as part of their investment screening process.
Another survey by Bain & Company found that 80% of limited partners viewed mature digital investments at portfolio companies as a value driver at exit in 2019.
The survey also found that 75% of private equity firms planned to invest in digitization over the next year.
These findings suggest that private equity is increasingly aware of and responsive to ESG issues, as they see them as sources of value creation and risk mitigation.
Private equity can address ESG issues by adopting ESG policies and frameworks, conducting ESG due diligence and monitoring, implementing ESG initiatives and improvements, and reporting on ESG outcomes and impacts.
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