The Uneasy Crown

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

This claim has some academic support. In a recent study, “The Performance of Reverse Leveraged Buyouts”, Jerry Cao of Boston College and Josh Lerner of Harvard Business School, examined the post-IPO performance of nearly 500 companies floated by private-equity firms in 1980-2002. They found the shares of the firms sold outperformed both the overall stockmarket and shares issued in other IPOs that were not backed by private equity. Highly leveraged firms performed no worse than those with less debt. Bigger IPOs backed by private equity did even better than smaller ones.

But Messrs Cao and Lerner sounded a note of caution. Those firms that were owned by private equity for less than a year performed relatively poorly, suggesting that “buying and flipping” back to the market — increasingly common nowadays — is a less useful role for private equity than building improvements into the business over a few years.

Old Hands

Experience also counts for more. Private-equity firms used to be run only by financiers, but they are now adding partners (albeit not as fast as some would like) who have run big companies. These include superstars such as Jack Welch, formerly of General Electric (GE), and Lou Gerstner, once head of IBM. A huge service industry has grown up to help, providing lots of work for consultants and headhunters. Bidding consortia allow generalist firms to team up with specialists to gain expertise. Silver Lake, for instance, is much sought-after by clubs bidding for technology companies; Providence Equity Partners plays a similar role in media deals.

Firms in private-equity portfolios are free of the most onerous regulations to which public companies are subjected, such as aspects of America’s Sarbanes-Oxley act, which was rushed into law after the collapse of Enron. They are subject to less scrutiny in the press, especially when it comes to short-term dips in profits. And they can pay executives whatever they wish without facing an uproar. Compared with public companies, private-equity firms tend to be more generous in rewarding good performance, but they punish failure more heavily. Given that many of the most talented executives are risk-takers who want to get rich, it is no surprise that many are switching to private equity.

The “drain of management talent at all levels to private equity is one of the main reasons I am open to taking the firm private,” the boss of a company with a market capitalisation of $16 billion recently told The Economist. That is the most striking difference between private equity today and in the 1980s, says Chicago’s Mr Kaplan. “In the 1980s company bosses were implacably opposed to LBOs. Now they see an opportunity to be able to do a better job and be better paid when they succeed.”

Many bosses have become evangelists for private equity. Cristóbal Conde, the boss of SunGard, is quick to enthuse about how much more helpful his financial software company’s new private-equity owners were than he expected, encouraging him to concentrate on long-term growth.

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