Hedge funds and Private Equity - PES

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6. Coherence, co-responsibility and ethics
Our welfare societies in Europe and our social market economy have for a century been built
on a certain feeling of coherence, justice and shared responsibility. Our tax systems, public
sector services, social policies, universal education etc. are based on that shared responsibility.
Throughout the years the different actors have accepted this balanced interest including the
social partners and their collective bargaining on the labour market.
6.1 Manager remuneration – coherence and justice
The relationship between LBO funds and incumbent management is a contradictory one, the
nature of which can vary greatly depending on the attitudes of both sides, the attachment of
management to the existing structures of the firms (including established systems of collective
bargaining, worker participation, etc.) and the dependence of the fund on their specialised knowledge
etc. In the worst cases the buyout firm enters into an unholy alliance with management:
managers are enticed with a share of the spoils (stock options etc.) to participate in the looting
of the firm by the fund. In others they are compensated for acquiescing to the takeover with
generous – in some cases scandalous – golden handshakes. If their specialised technical or
firm-specific know-how gives incumbent management a strong hand, the fund has to offer
generous inducements for management to change its mode of operation. If not they may simply
be replaced overnight (and can thus be expected to be interested in cooperating with employee
representatives and other stakeholders in blocking takeovers). Of course, in genuine rescue and
restructuring cases, the fund may be the mechanism by which the firm is able to shed incompetent
management or disinterested and untalented owners.
The shareholder value approach, originating in the USA, has been spreading vigorously in the
European economy. It follows the unilateral alignment of companies with the interests of shareholders
who have their sights on the greatest possible increase in value of their company shares
and the highest possible dividends. The private-equity industry consistently follows the shareholder
value model. Such funds frequently replace the management if the latter does not actively
support their goals. PE funds use a differentiated incentive scheme in order to induce management
to adopt their short-term goals of increasing the value of the enterprise and freeing up
liquidity including premiums, share options, participation in the enterprise, performance-based
pay and bonuses for meeting PE-fund targets. For managers this can mean a significant increase
in their income. For the company and its employees, this often has a detrimental effect.
Managers take greater risks that can produce excesses, such as falsifying balance sheets or
backdating share options. Managers even change their attitude towards staff. According to statements
made by the works councils, managerial obligations towards financial investors, incentive
systems and shorter office hours, as an alternative to firing employees, create a purely numbersbased
approach that takes less account of the practical operational business, as well as inducing
a cold social climate and indifference towards the company and its staff.
Enterprises being run exclusively according to economic success indicators are becoming the
norm, while management increasingly loses touch with actual production and the people involved
in the target enterprise. What is remarkable is the increasing frequency with which takeovers are
becoming more aggressive. Enterprises are increasingly being regarded as mere financial products
and shareholders are becoming share traders. Sustainability and viability are losing their
importance in the development of enterprises. Short-termism in business strategies is constantly
on the rise.