Stakeholder Impact of Private Equity Investments

Abstract

We survey the academic literature about the impact of private equity investments in the broader economy. Private equity fund managers respond to high-powered incentives and seek to maximize shareholder values via a variety of channels. The literature identifies two broad approaches to value creation taken by private equity funds with sharply divergent outcomes for stakeholders and the aggregate economy. The first approach, associated with public-to-private deals, exploits leverage and interest tax shields, cost reduction, and operating margin improvement. The second approach, associated with private-to-private deals, targets growth-oriented and capital-constrained companies and adds value by relaxing financing constraints, imparting operational and managerial expertise, increasing investment, and inducing top-line revenue growth. Innovation tends to increase with the latter approach (private-to-private deals) while it either declines relatively or becomes more narrowly focused with the former approach (public-to-private deals). For employees, post-buyout high-skilled workers tend to benefit from increased IT investments and upskilling in the jobs, whereas low-skilled workers tend to be hurt from automation and job cuts. For consumers, private-to-private deals imply greater variety and broader geographic availability of products, whereas public-to-private deals imply higher prices and reduced availability. In regulated or subsidized industries, distortion in incentives given by the regulatory framework tends to get magnified when combined with high-powered incentives of private equity. The literature provides evidence of this in healthcare, for-profit education, insurance, and the fracking industry. Collectively, the emerging evidence suggests that welfare outcomes for the broader environment and society depend on the regulatory and competitive structures within which the private equity portfolio companies operate. Thus, regulators need to consider the impact of the high-powered incentives of private equity when assessing the market impact of a given regulatory policy or decision. Finally, impact funds are posited as a mechanism for explicitly aligning the shareholder preferences with the broader public interest. Impact fund investors derive utility from holding impact funds that generate positive impact, and thus are rationally willing to invest in them even though their expected financial return alone may be lower than that from investing in non-impact private equity funds. The result is consistent with the theory of sustainable investing in equilibrium with explicitly pro-social investors. Suggestions for future research are discussed.

Keywords: Private equity; leveraged buyout; stakeholders; ESG; sustainable investing; impact investing; corporate governance; LBO; government policy and regulation; public-to-private transactions; going-private deals; private-to-private deals; value creation

JEL Classification: G23, G24, G28, H41, M14