Andrew Dittmer: Eileen Appelbaum and Rosemary Batt on How Private Equity Really Works

Yves here. Naked Capitalism contributor Andrew Dittmer, perhaps best known for his series on libertarianism (see Part 1, Part 2, Part 3, Part 4, Part 5, Part 6, and his responses to reader comments) has returned from his overlong hiatus to interview the authors of the highly respected new book, Private Equity at Work.

Eileen Appelbaum and Rosemary Batt have produced a comprehensive, meticulously researched, scrupulously fairminded, and therefore even more devastating assessment of how the private equity industry operates, including its deal and tax structuring methods, its impact on employment, and whether its returns are all they are purported to be. Their work was reviewed in the New York Review of Books; we also discussed it in this post.

Earlier this year, Andrew spoke with Appelbaum and Batt, and the first part of their discussion covers the problematic relationship between private equity funds (general partners) and their investors (limited partners) and how private equity affects other businesses.

In some cases, Appelbaum and Batt bending over backwards to be evenhanded. For instance, they attribute the explosion in CEO pay not to the leveraged buyouts industry (private equity before it was rebranded in the 1990s) but to an article by Michael Jensen in the Harvard Business Review that argued for paying CEOs like entrepreneurs. While narrowly true that the Jensen article was the proximate cause of the shift in big corporate pay models, having lived through the 1980s and the way that LBOs captured the attention of the business press, it is hard to imagine Jensens thesis being taken seriously in the absence of the LBO boom. The maximize shareholder value theory of corporate governance was first presented in a Milton Friedman New York Times op-ed in 1970 and had not gotten traction with the mainstream. It was the wave of takeovers of overly-diversified conglomerates in the 1980s and the easy profits garnered by breaking them up and selling off the pieces that seemed to prove the idea that too many CEOs didnt have the right incentives to run their businesses well (and in fact, its also true that the business press of the 1970s decried American management as hidebound and much less good at working with labor than the Japanese or Germans). But as weve seen since then, equity-linked pay has produced rampant short-termism and facilitated looting by executives. Even if the old pay model was problematic, its replacement has performed even worse, save for the CEOs themselves.

By Andrew Dittmer, who recently finished his PhD in mathematics at Harvard and is currently continuing work on his thesis topic as well as teaching undergraduates. He also taught mathematics at a local elementary school. Andrew enjoys explaining the recent history of the financial sector to a popular audience

Interactions of General Partners (GPs) with Limited Partners (LPs)

Eileen Appelbaum: Rose and I did a briefing at the AFL for the investment group. We had investment people from both union confederations who are concerned about the fact pension funds are putting so much money into private equity. They told us that they had never been able to see a limited partner agreement until Yves Smith published them. The pension fund people are so afraid of losing the opportunity to invest in PE. Some general partner could cut them off for having shared the limited partner agreement. Unbelievable.

Andrew Dittmer: In general, LPs seem to have a pretty submissive attitude toward GPs. Where do you think this attitude comes from?

Rosemary Batt: One cause is the difference in information and power. Many pension funds dont have the resources to hire managers who are sophisticated in their knowledge of private equity firms. They dont have the resources to do due diligence to the extent they would like to, so they need to rely on the PE fund, essentially deferring to them in what they say.

Eileen Appelbaum: I think that there is a reluctance to question this information or to share it with other knowledgeable people they are afraid that if they do, they will not be allowed to invest in the fund because the general partners will turn them away.

The rest is here:
Andrew Dittmer: Eileen Appelbaum and Rosemary Batt on How Private Equity Really Works