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Private Equity Takeovers and Employment in the UK: Some Empirical Evidence

Private Equity Takeovers and Employment in the UK: Some Empirical Evidence. Marc Goergen Cardiff University European Corporate Governance Institute Noel O’Sullivan University of Sheffield Geoffrey Wood University of Sheffield. Motivation, Objective and Contributions.

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Private Equity Takeovers and Employment in the UK: Some Empirical Evidence

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  1. Private Equity Takeovers and Employment in the UK:Some Empirical Evidence Marc Goergen Cardiff University European Corporate Governance Institute Noel O’Sullivan University of Sheffield Geoffrey Wood University of Sheffield

  2. Motivation, Objective and Contributions • Private equity transactions have been on the increase since the late 1990s • Private equity houses have traditionally focused on • Relatively small companies • Facilitating management buy-outs • However, more recent transactions have included some of the largest UK companies (Alliance-Boots) • According to Thornton (2007), 20% of all private sector workers are now employed by organisations with some private equity investment

  3. Motivation, Objective and Contributions • There have been public concerns about the employment consequences of these transactions • On 24 February 2007, Brendan Barber, the General Secretary of the TUC, challenged private equity investors • To attend a roundtable • “To tell [the public] what they stand for and whether they accept any responsibilities to their workforce or the wider community” 2

  4. Motivation, Objective and Contributions • The objective of this study is to investigate the effects of private equity acquisitions on employment • The paper’s contributions to the literature are: • There are as yet few studies on the employment effects of private equity transactions • This study focuses on a particular type of private equity acquisition, so called institutional buy-outs (IBOs) • It is important to distinguish between the different types of private equity acquisitions as their effects on employment are likely to be significantly different • We conduct both interviews and a quantitative analysis 3

  5. What are IBOs and why the Focus on IBOs? • Private equity concerns two distinct types of investors • Venture capital provides early stage financing and management support • Private equity per se involves • The acquisition of a public firm by an investor or the facilitation of that purchase • The firm being taken private in a public-to-private transaction (PTP) • A change in management or at least a change in managerial style 4

  6. What are IBOs and why the Focus on IBOs? • There are three types of PTPs (Renneboog et al. 2007) • Management buy-outs (MBOs) • The incumbent management takes the firm private with the support of a private equity firm • Management buy-in (MBIs) • The firm is taken private by outside managers • Institutional buy-outs (IBOs) • Are carried institutional investors and private equity houses • Any equity held by the management arises from their compensation package 5

  7. What are IBOs and why the Focus on IBOs? • IBOs are different from other types of PTPs • They involve the complete replacement of the incumbent management, hence weakening implicit agreements with the employees • They are often financed by significant amounts of debt (leveraged buy-outs (LBOs)), putting pressure on management to seek cost savings • Institutional investors will seek to recover their investment within a short time frame 6

  8. Ownership Changes and the Consequences for Employment • Takeovers have been seen as a major mechanism to ensure the efficient use of assets (Manne 1965; Jensen 1986) • Private equity acquisitions address agency problems by reversing the separation of ownership and control (Jensen 2006; Wright et al. 2006) • This view is supported by the substantial premiums paid for the targets (Andrade et al. 2001) • However, takeovers may also lead to a breach of trust (Shleifer and Summers 1988) • Employees may be a potential source of wealth extraction • The new management may renege on the implicit contracts of employment 7

  9. Ownership Changes and the Consequences for Employment • E.g., employees may work for lower wages early in their career with the expectation of higher wages as they advance their career • The new management has an incentive to breach this implicit contract as older workers are more expensive 8

  10. Ownership Changes and the Consequences for Employment • A small number of studies have investigated the impact of mergers and acquisitions on employees • Denis (1994) finds evidence of declines in employment in hostile takeovers. However, the declines normally occur in factories owned by the acquirer • MGuckin and Nguyen (2001) also report job losses in acquirer owned, larger factories • Beckmann and Forbes (2004) do not find any evidence of job losses for UK takeovers 9

  11. Ownership Changes and the Consequences for Employment • Conyon et al. (2002) find evidence of decreases in the demand for labour in hostile UK takeovers • There is no evidence of wage cuts for UK takeovers (Rosett 1990; Beckmann and Forbes 2004; Conyon et al. 2004) • Gokhale et al. (1995) do not find any evidence of extra-marginal wages being paid to employees prior to the acquisition 10

  12. Ownership Changes and the Consequences for Employment • Studies on the employment effects of private equity acquisitions have adopted two distinct approaches • A quantitative analysis based on secondary data • Questionnaire surveys to assess changes in HR practices post-acquisition • The quantitative studies find somewhat mixed results, but generally very little support that MBOs/private equity acquisitions have a negative impact on employment 11

  13. Ownership Changes and the Consequences for Employment • Amess and Wright (2007) find a difference in employment growth between MBOs and MBIs • Amess et al. (2007) find that MBOs enjoy a greater degree of discretion over work practices than non-MBOs • Davis et al. (2008) report that MBOs experience lower employment during the first three years after the acquisition 12

  14. Ownership Changes and the Consequences for Employment • Questionnaire surveys usually find an improvement in work practices in MBOs • Increased employment, greater employee involvement, training, flexibility and share ownership (Bacon et al. 2004) • Increase in high commitment practices in the UK and Europe (Bruining et al. 2005; Bacon et al. 2008) • No evidence of changes to union recognition, union membership density and managerial attitudes to union membership, but evidence of increased employee consultation (Bacon et al. 2010) 13

  15. Evidence from the Interviews • We interviewed • Two union representatives • A representative from an independent research centre • A representative from the private equity industry • Key findings • It is important to distinguish between MBOs and IBOs • Breaches of implicit contracts are unlikely in MBOs • All agreed that MBOs were likely to have positive effects on employees • There was disagreement as to the effects of IBOs 14

  16. Sample, Variables and Methodology • We obtain the list of UK IBOs during 1997-2006 from Thomson One Banker • We add some transactions which were excluded from the list • Thomson One Banker makes a somewhat arbitrary distinction between IBOs and strategic investors • In what follows, year 0 is defined as the year when the acquisition was completed 15

  17. Sample, Variables and Methodology • We also attempt to match each sample firm with a non-acquired firm • With the same three-digit SIC code • The closest turnover in year 0 (or year -1) • Which survived until year 2 at least • We were able to match 95 of our sample firms following the above criteria • Another two sample firms could be matched with a firm surviving until year 1 16

  18. Sample, Variables and Methodology • Both the descriptive and regression analysis are based on the following labour demand equation where Lit is Log(employment) Qit is Log(real output) (sales) Wit is Log(real wages) 17

  19. Conclusions • Our study focused on IBOs • Finance theory as well our interviewees indicate that it is important to distinguish between IBOS and other private equity acquisitions • Implicit contracts are more likely to be broken in IBOs • The main result from our empirical analysis is a significant reduction in employment for the acquired firms in the year after the acquisition • We fail to identify any parallel or subsequent increases in profitability or productivity

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