An Equitable Take on Private Equity

As the presidential race builds toward the major party conventions, one source of attacks and counterattacks has involved Republican Mitt Romney and his work with Bain Capital, the private equity firm he founded in 1984 and where he worked for at least the next 15 years. Romney has been accused of being a “corporate raider” and “sending jobs overseas,” while Romney has pointed out that President Obama has almost no private-sector work experience.

We thought we’d step back from the minutiae of this particular fight and instead examine what Peter Drucker had to say more broadly about private equity firms and leveraged buyouts. (For those interested in the presidential mudslinging, here is a link to Factcheck.org, which offers a more neutral take on the claims and counterclaims. It should also be noted that Romney is reported not to have engaged in hostile takeovers, only in non-adversarial investments.)

In Drucker’s view, the very rise of what he called “the frantic financial manipulations of the 1970s and 1980s” were a product of larger forces: inflation; pension funds with lots of money to invest; and a bunch of old-line American companies that had grown fat and happy during the halcyon days of the ’50s and ’60s and weren’t in any shape to face a sudden surge of global competition.

Private equity forced many of these businesses to streamline and restructure. “The raiders and buyout firms thus perform a needed function,” Drucker wrote in Management: Tasks, Responsibilities, Practices.

But there was also a cost. “What made all this traumatic,” Drucker wrote in Managing for the Future, “was the that the ‘restructuring’ was done largely though financial manipulation: mergers, acquisitions and divestitures, leveraged buyouts, asset-stripping, and hostile takeovers.” The result was many displaced employees who felt they were being “sacrificed to enrich a few speculators.”

Another problem was that the money for all these transactions usually came from large institutions that invested as speculators and not as long-term stockholders. This was damaging, Drucker declared, because modern enterprise can do its work “only if it is being managed for the long run.”

On the positive side, though, many of the displaced victims of these financial transactions found that their own form of capital—their knowledge—was portable. “It was a tremendous shock at first for most of them” to lose their jobs, Drucker noted in his 1989 book The New Realities. “Then almost without exception, even people in their mid-50s found new jobs within a few months. In a good many cases the new job was better than the one they had lost. They found that knowledge gives them mobility— a lesson unlikely to be forgotten.”

Do you think that private equity firms have played a generally positive or negative role in the economy? Why?