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FINANCE Banking
Bank investments
in private equity: an
unfair advantage?
Private sector, government and logistics industry
collaboration vital to realize potential economic success
by Stuart Pallister
A
recent study has called into question
private equity investments by
bank-affiliated PE firms. The study
by INSEAD Professor Lily Fang with coauthors
Victoria Ivashina and Josh Lerner
of Harvard, called ‘An Unfair Advantage’?
Combining Banking with Private Equity
Investing, found that between 1983 and
2009, bank-affiliated groups accounted for
more than a quarter of all PE investments.
It also found that the involvement of
banks increases during peaks of PE cycles,
with deals by bank-affiliated groups getting
financing on ‘significantly better terms’ than
other deals when the parent bank is part of
the lending syndicate.
Yet, the bank-affiliated PE investments
have slightly worse outcomes and deals
during market peaks have ‘significantly
higher rates of bankruptcy’.
So while there are clearly risks in
combing bank and PE investing, are the
bank-affiliated PE groups getting an unfair
advantage?
“We argue in the paper that the concerns
that regulators have, in terms of allowing
banks into different risky opportunities
and the concerns of risks associated with
combining various activities (of banks and
PE groups), do seem to be well justified”,
Fang said in an interview with INSEAD
Knowledge.
The study was completed as US
lawmakers considered the so-called ‘Volcker
14
bank-affiliated PE groups
accounted for more than a
quarter of all PE deals between
1983 and 2009
26 Link January 2011
rule’, named after Paul Volcker, the former
chairman of the Federal Reserve who had
championed it. The rule, part of the Dodd-
Frank Act, seeks to curb the proprietary
trading operations of US banks, in terms of
speculating on the markets.
Fang says she and her co-authors were
‘quite lucky’ with the timing of the paper.
“We started this paper in early 2009. At
the time, the ‘Volcker rule’ hadn’t been talked
about and in fact the phrase -- ‘Volcker rule’
-- hadn’t been coined.”
She adds that the phrase became
common currency a year later, just as the
research team had prepared its initial draft.
“The study compares the financing and
performance of private equity deals done by
bank-affiliated private equity groups (such as
Goldman Sachs Capital Partners) with those
done by standalone private equity groups
(such as KKR).”
“I, myself, was actually a bit surprised
by how extensively banks were involved
in private equity investments” as the
researchers found that just 14 bank-affiliated
PE groups accounted for more than a
quarter of all PE deals between 1983 and
2009.
“That’s a significant amount. If we used
our (data to assess) larger deals, they
actually account for nearly 30 per cent of
them.”
There was also a high concentration
of activity, with Goldman Sachs alone
accounting for more than a third of all the
deals done by bank-affiliated PE groups.
Moreover, many of the bank-linked deals
were done at the peaks of PE markets. One
possible hypothesis is that this may have
been due to the banks being more prepared
to lend money based on the information they
have about potential deals.
However, the authors believe another
hypothesis may be more relevant: that
the banks can take advantage of creditexpansion
cycles and then pass this capital
on to their subsidiaries.
“We do find that the banks seem to be
able to take advantage of the cheap credit at
the peak of the market and essentially that
benefits the financing of the private equity
deals done by their PE subsidiary.”
Asked whether the Volcker rule, which