The Uneasy Crown

The buy-out business is booming, but capitalism's new kings are attracting growing criticism.

Regulators, too, are growing agitated. Last year Britain’s Financial Services Authority concluded after an inquiry that at least some of the industry’s activities will end in tears. America’s Department of Justice is investigating whether the increasingly common bidding consortia, in which several private-equity firms club together, are in breach of antitrust laws. Last month the Federal Trade Commission ordered Carlyle and Riverstone to cease day-to-day involvement in one of the two energy firms they own, so as to ensure competition. In Congress Barney Frank, the new Democratic chairman of the powerful House finance committee, is due to hold hearings on private equity.

Shareholders of targeted companies are also starting to smell a rat. They suspect that top managers, who usually remain in charge when their business passes into private hands, are selling too cheaply in order to get a bigger slice of the profits for themselves when the private-equity buyer eventually sells the firm on. Recent attempts to take ClearChannel and Cablevision private met fierce opposition from shareholders feeling short-changed.

Making Their Case

The kings of capitalism have started to respond. In December several top American private-equity firms formed the Private Equity Council to fight their corner in Washington, DC. Similar groups already play that role across the Atlantic.

In Davos Carlyle’s Mr Rubenstein conceded that the industry “does an awful job” in presenting itself to the public. Rather than talk about the jobs created for blue-collar workers, too often people in private equity “brag about how much money we make”. As a first step, the private-equity bosses agreed to sponsor a two-year research project. Mr Rubenstein expects it to show that “most of the money we make goes to public pension funds. We create a lot of jobs and pay a lot of taxes.”

The main defence offered by private-equity firms is that they are good for the companies they own and for the economy as a whole. Henry Kravis of KKR claimed last year that private-equity investing “leads not only to value creation, but also to economic and social benefits, for example, increases in employment, innovation, and research and development”.

The past three years have been extremely good for private equity with returns for all but the smallest funds comfortably beating the S&P 500 index (see chart 2). Long-term performance also looks strong, at least at first glance. From 1980 to 2001, the average fund generated higher gross returns than investing in the S&P 500, according to a study by Steve Kaplan of the University of Chicago and Antoinette Schoar of the Massachusetts Institute of Technology.

CBOE Volatility Index

Given the obsession of investors with yield, no wonder so much money has poured into private equity. There are now some 2,700 private-equity firms, managing assets of $500 billion. They are led by a number of giants (see chart 3). Only two years ago the largest fund was worth $6 billion, but some reports say Blackstone’s fund is now worth some $20 billion.


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