Private Equity and Human Capital Risk
The social costs associated with private equity restructuring have been the subject of emotional debates. The head of the German Social Democratic Party, Franz Müntefering, once compared buyout firms to “swarms of locusts” who “descend on companies, graze, and then move on,” suggesting that private equity firms make short-term profits by imposing large costs on employees. Public discussions in other European countries and the US reflect similar concerns.
In our paper, we ask three interrelated questions in the context of this debate about whether LBOs create wealth or transfer wealth. First, we ask whether private-equity buyouts create or mitigate human capital risk for the employees of target firms. Second, we wish to shed some light on the question whether the influence of private equity is more consistent with the transfer-of-wealth view or the modernization view, where we differentiate between organizational and technological modernization. Third, and finally, we are interested in the channels through which LBOs affect employees' human capital and investigate how LBOs affect employees' career paths.
We analyze data on 479 LBOs between 2002 and 2008 in Germany, which involve 147,116 employees, and match each employee of an LBO target to another employee with similar characteristics. We find a short-term positive effect of LBOs on employment, wages, and income, which reverses about two years after the LBO. In the long term, LBOs cause a decline relative to the control group of 11% in annual earnings, of more than 5% in employment, and a marginal decline in daily wages of about 1%. The long-term decline in wages is concentrated in those LBO employees who become unemployed or have to accept jobs in other industries. However, the wages of employees who stay with the LBO target increase at a rate of about 3% per year after the transaction in absolute terms, in line with the wages of the control group. Hence, there is no evidence of a transfer of wealth through wage cuts from employees who stay with the target to shareholders.
The long-term decline in income and employment falls largely on older LBO target employees, who seem to lose their jobs often and receive lower wages. Hence, employees who are presumably less able to adapt to a new organizational and technological environment (or, perceived to adapt less well), suffer larger losses. Furthermore, most of the losses of employment and wages fall on middle management and white-collar employees, in line with the notion that LBOs reduce layers of management, trim the administration of the firm, and potentially also cut wage premiums that resulted from entrenched management. Overall, we see LBOs in our sample period as facilitators of organizational change, a streamlining of firms' administration and management, and a reorganization of supply chains.