The Business Book

(Joyce) #1


are in the same position. Only the
private-equity shareholders are
protected—by limited liability.
When publicly traded soccer
team Manchester United was
purchased by US businessman
Malcolm Glazer and his family in
2005, the transaction was
effectively a private-equity deal.
The Glazers followed standard
practice, buying the publicly-listed
company for $ 1.3 billion, then put
the debts onto the balance sheet of
the new Manchester United Ltd.
Private-equity owners suggest that
debt is an effective means of forcing
employees to work efficiently to
make a profit and meet interest
payments. More plausibly, though,
it is a way of transferring risk from
the private-equity owner to a limited
liability subsidiary. If Manchester
United Ltd. were to enter financial
trouble, the liability of the Glazers
would be minimal due to the
protection of “limited liability,”
which limits the owners’ liability to
the value of their investment, not
the total debts of the business.
Research published in 2013
compared the performance of 105
companies purchased through
private equity and 105 “control”
companies in the same industries.

They were investigated over a ten-
year period—the six years leading
up to the buy out, and the four
years after it. The researchers found
that in the year following the buy
out, 59 percent of the private-equity
owned businesses cut their staffing
levels, compared with 32 percent in
the control group. In the following
years, private-equity ownership
was associated with falling average
wage levels among staff. In the
short term employees appear to
lose out—and in the medium to
long term their chances of losing
their jobs are higher due to the
greater level of debt of the
companies they work for.

Private-equity iniquity
Not everyone loses out under
private equity. In 2003 the British
retailer Debenhams was purchased
by three private-equity companies.
The businesses paid themselves
a dividend of $1.9 (£1.2) billion
before floating the publicly traded
Debenhams onto the stock market
in 2006—laden with debt. Years
later, in its 2012 annual accounts,
the financial strain still showed.
The degree of “gearing” (debt as a
percentage of capital employed in
the business) at Debenhams was a
high 51.5 percent, and its liquidity
(as measured by the “acid test
ratio,” which determines whether a
company has enough short-term
assets to cover its immediate
liabilities) was a very weak 0.175.
Yet for the private-equity owners,
the deal was highly profitable—
they made $1.9 (£1.2) billion very
quickly and still retained shares in
Debenhams (a stake that was sold
in the years that followed). Their
overall profits exceeded 200 percent.
For the bosses of private-equity
companies, the rewards can also be
impressive. Bernard Schwarzman of
US private-equity investment


company Blackstone Group earns
$130 million a year. He is closely
followed by the bosses of Carlyle
Group, Apollo Global, and KKR—
who each earn in excess of $100
million a year. Remarkably, all these
bosses enjoy favorable tax treatment
in both the US and the UK. This
became an important issue in the
2012 US presidential election, when
Republican candidate Mitt Romney
(a former private-equity boss) had
to admit that his income tax rate, at
14 percent, was lower than that of
average, working Americans.

Executives on the hot seat
In the world of public limited
companies and corporations, the
CEO might be in the riskiest
position of all. They may have the
most to gain from their business’s
success, but also the most to lose
from its failure. These risks may be
partly financial, but even more they
are reputational. Richard Fuld, chief
executive of Lehman Brothers at
the time of its 2008 bankruptcy,
went from being an award-winning
CEO to a nominee for a range of
“worst ever...” awards. From being a
director of the Federal Reserve Bank
of New York, he became a pariah. ❯❯

We have corporate
CEOs who raise their pay
20 percent or more in years
when they lay off thousands
of people. It’s obscene.
Charles Handy
UK management expert (1932–)

There is a simple way of
avoiding excess risk taking
by the managers of our
financial institutions. It is
to make it a crime.
Paul Collier
UK economist (1949 –)
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