Hedge funds and Private Equity - PES

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The impact of capital funds on the way that companies operate extends far beyond the – until
now relatively limited – number of companies that have been bought out by private equity funds
or suffered speculative attacks by hedge funds. Indeed it seems likely from theoretical considerations
and some anecdotal evidence – even if difficult to prove with hard data – that the
activities of such funds have affected the behaviour of a very large number of companies, both
publicly-listed large and medium sized and family-owned SMEs. Indeed, in principle all but the
smallest companies are affected, and thus the impact on the functioning of the economy as a
whole can be expected to be substantial.
This indirect effect results essentially in the preventive measures taken by managers and owners
to ward off unwanted approaches by private equity and hedge funds. In many cases the negative
impacts are similar, if less pronounced, than those identified in those firms actually taken over.
In particular, incumbent managers of listed companies are expected to be increasingly
concerned, if not obsessed, by the short run share price: a high share price is the best deterrent
to a hostile takeover. A depressed share price – for whatever reason – will quickly attract the
interest of capital funds looking for quick profits. This is likely to have a series of negative consequences.
Large-scale investment projects, particularly those with a long payback period may be
cancelled or postponed, as managerial planning horizons collapse to the demands of quarterly
reporting deadlines and their priorities focus on the latest fad that, for a short period, is at the top
of the likes or dislikes list of ‘the market’. In particular, jobs may be axed to offer investors some
‘good news’. Dividends are likely to be pushed up at the expense of real investment and the
company’s human capital. Some firms engage in macroeconomically irrational share buyback
schemes. Others rush into mergers and takeovers that lack a genuine economic rationale merely
to avoid an unwelcome takeover bid or speculative interest. Ultimately managers are forced into
Enron-style false accounting. More generally the pressure on other stakeholders, and especially
workers, as described in section 2, is likely to be ratcheted up.
1.2 Growth and financing
A 2005 study by PricewaterhouseCoopers (PwC), commissioned by the German organisation
BVK, attempts to document the allegedly positive effects of the growth of private equity investments
with figures from the companies they interviewed: over a five-year period from 2000 to
2004, the average turnover of German target enterprises grew by approximately 10 per cent
with PE funds. The average growth of the German gross domestic product was only 1.6 per
cent in this period. Moreover, the average growth in turnover of all German companies in the
same period amounted to a mere 0.1 per cent. But on closer examination this illustration appears
problematic. Numerous factors influence the gross domestic product and these do not make for
a sensible comparison with LBO target enterprises. There simply limits to what you can compare!
In the case study of DT Group it is described how the number of employees has increased
with 10% since the take over. However this is due to acquisitions of formerly privately owed
building markets. Direct investment in property and equipment is lower than before the
take over.
Even a comparison with all German companies is problematic. LBO funds deliberately select
target enterprises that already promise success without their help and which are therefore
already way above average. The turnover of these companies would have grown substantially