What are the wages and employment consequences of leveraged buyouts, private equity

and acquisitions in the UK?

Kevin Amess, Sourafel Girma and Mike Wright

Centre for Management Buyout ResearchNottingham University Business School

Features of an LBO

� Increased concentration of equity held by managers� Firm is highly leveraged� When involved private equity institutions have

monitoring roles� Offer advice that may contribute to growth� Private equity firms are active investors with a seat

on the Board

The UK LBO market

� Value of deals� 1985 - £2425.4 million� 2004 - £20477.7 million

� As a proportion of the total value of the market for corporate control� 1985 - 14.8%� 2004 - 39.5%

Context

“ Sometimes private equity … give the impression of being little more than amoral asset-strippers after a quick buck. Casino capitalists enjoying huge personal windfalls from deals at the same time as they gamble with other people's futures. ”(Brendan Barber (General Secretary of TUC, 20/2/2007)

Context

"We're in the business of creating strong, long-term competitive businesses.“ (Damon Buffini, Permira. BBC Radio 4 Today Programme).

“The initial attacks on the private equity industry, when stripped down to their essence, amounted to a rejection of profit as the main yardstick for business success.” (Anatole Kaletsky, The Times June 21, 2007)

Context

“Who can tolerate a hedge fund buying a company with debts, firing 25 per cent of staff and then reimbursing them by selling it in pieces? Not me." (President Nicholas Sarkozy, 20/2/2007)

Performance effects

� US and UK evidence of performance gains� Consistent with LBO governance structure

being superior to alternatives� What are the sources of performance gains?

� Efficiency/productivity improvements?� Concern that they create wealth gains to investors

through job destruction and lowering employee wages (ITUC, 2007)

Theoretical background

� Investors reaping rewards from short-term decisions to cut jobs

� But job-cutting might be required if over-employment occurred due to weak corporate governance in the pre-buyout firm

� Also LBO might liberate senior managers to pursue growth which was stifled by bureaucratic control and incentive devices

Mergers and acquisitions (M&As)

� Conflicting evidence concerning the performance gains of M&As.

� M&As have received criticism concerning their impact on employees.

� Ownership change creates an opportunity for new management to breach the implicit contracts with employees involving payments above the marginal product of labour

� This results in wage and/or employment reduction (Shleifer and Summer, 1988).

Distinct features of present paper

� The labour market consequences of LBOs and acquisitions have been analysed separately in the corporate restructuring literature.

� From an empirical perspective this is problematic since the analysis of the labour market effects of ownership change is not carried out within a unified framework.

� From policy perspective this is problematic since calls for specific restrictions on private equity buyouts may be misplaced if their job and wage effects is less detrimental than for M&As.

Distinct features of present paper

� Much of the existing literature has neglected the fact firm that firm experience ownership change via LBO or M&A might not randomly be selected from the population.

� For example, firms might be subject to ownership change because they over-employ and/or make extra-marginal wage payments that are identified as sources of organisational inefficiency.

Distinct features of present paper

� In this paper:1. We treat the analysis of LBOs and M&As within a

unified framework.2. We address the issue of possible selection problem

by using propensity score matching combined with difference-in-differences.

3. We treat MBOs (management buyouts) and MBIs (management buy-ins) as distinct type of LBOs.

4. We distinguish between private equity backed and non-private equity backed LBOs.

A preview of the findings

1. Private equity backed LBOs have no significant causal effects on wages or employment.

2. Non-private equity backed LBOs have detrimental employment effects.

3. Compared to LBOs, employment losses due to acquisitions are more pronounced.

The data

The sample is constructed from three sources:� The Centre for Management Buyout

Research (CMBOR) database to identify LBO governance structure and mode of finance.

� Zephyr to obtain information on acquisitions.

� FAME to obtain relevant firm-level variables (e.g. employment and wages).

The data

� After matching the databases and cleaning the data, we obtain:

1. 232 LBOs, 133 of which are private equity backed, and166 of which are MBOs.

2. 215 acquisitions (neglecting multiple acquisitions per firm).

3. A control group of 23468 firms that experienced no corporate restructuring during the sample period ( 19XX-200X?)

The data

� The ownership changes occurred at different points in time (calendar years).

� For convenience, we transform calendar years into “experimental” time lines

– t-1 refers to one year before the change– t=0 refers to year of ownership change – t+1 refers to one calendar year after the change.

� We don’t have access to worker level data– The best we can hope is to identify average

effects at the level of the firm.

Are LBO and M&A firms different?

According to the table below the answer is “yes”

Difference-in-differences

� DiD relies on three assumptions 1. Treatment (ownership change in our case)

is exogenous or random.2. Time trend (e.g. macro shock) affects

treatment and control group equally.3. The treatment affects the treated only (e.g.

employment in firms without ownership change is not influenced by what is happening in MOB and M&A firms.

Difference-in-differences

� Under those assumptions, the DiD estimate of the employment effect of MBO/M&A can be obtained as simple differences of (unweighted) averages:

• DID = (T1 – T0) - (C1 – C0)

Difference-in-differences

� Intuitively, unweighted averages imply that all firms in the comparison (control) group are equally good “matches” for all treatment group firms.

� But the results shown earlier suggests that, on average, MBO and M&A firms tends to employ more workers and pay higher wages than the control group of firms.

� Use weighted averages, the weights reflecting how good a match a particular control group firm is to a MBO/M&A firm.

� Enter “propensity score matching”.

Propensity score matching

� In “propensity score matching”, the weights are functions of the probability (propensity) to receive the treatment.

� In our case this probability is generated from the multinomial regression estimates (see Table 1).

� Different weighting schemes are available (e.g. nearest neighbour and kernel matching).

� All schemes are equivalent “in large samples”, but substantial variability might be observed in “finite samples”.

– Good idea to try different schemes to ensure robustness of results.

Propensity score matching

� Under certain assumptions (some which are testable), propensity score matching delivers unbiased/consistent estimate of the effect of treatment on the treated.

� Here I present, “three nearest neighbours”matching estimates.

– Other schemes yield equivalent results.– In all cases, the appropriateness of the matching was

ascertained through “tests of balancing”.

Results I:

Results II:

Results III:

Summary and conclusion

� By using difference-in-differences analysis with propensity score matching we are able to obtain estimates of the causal effects of acquisitions and LBOs on wages and employment that are free from selection bias.

� We find private equity backed LBOs have no significant effect on employment. Therefore, we find no evidence to support claims of either unions or LBO practitioners.

Summary and conclusion

� Both non-private equity backed LBOs and acquisitions have negative employment consequences with the latter having the larger negative effect.

� The results provide little motivation for special policy intervention to protect employees when firms are subject to private equity backed LBO.

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