The failure of capitalism?
Paul Myners β former chairman of Marks & Spencer, current chairman of Land Securities β is on the advisory board of a private equity business, Engelfield Capital. So his and on the Today programme is perhaps all the more serious for the private equity industry.
Heβs also about as close as any businessman to the Treasury, the Government department which for years has been cheerleading for private equity and which alone has the power to do it serious harm through making the tax system less benign for it.
The Treasury will dislike Mynersβs intervention, because it remains of the view that private equity brings net benefits to the British economy. But it will find it hard to ignore his criticisms, which are that private equity is too opaque and secretive, and also that employees at businesses bought by private equity are βthe one party that is not rewardedβ and that generally they βsuffer an erosion of job security and a loss of benefits.β
Myners will hate me saying this, but in a way his attack is predictable. Why? Because he made his fortune creating a conventional City fund management organisation, Gartmore, and he made his name as chairman of M&S fighting off a de facto private-equity takeover attempt from the billionaire Philip Green. So he can be seen as a spokesman and cheerleader for public markets, or businesses quoted on the Stock Exchange.
And the point about private equity is that it represents a serious challenge to public markets and bourses like the Exchange.
Ask almost any manager why private equity has been so successful and what youβll hear is that βit better aligns the interests of owners and managers.β Hereβs Richard Lambert, director general of the CBI β the private sector lobby group β talking about it last week:
βBecause the managers of businesses backed by private equity usually have a significant equity interest in their success, the interests of managers and owners are very closely aligned.β
What does this mean? It means that British managers of public companies increasingly believe that their interests are not βalignedβ with traditional City investment institutions, that they feel frustrated by what they perceive as the shackles put on them when they run a listed company.
These are not shackles put on them by trade unions β even though it is trade unions led by the GMB which are to curb the growth of private equity.
The constraints which chafe on executives are those imposed by the owners of public companies, the shareholders. When managers move over to private equity, what they are trying to escape are:
1) negative stock-market reaction to investments and initiatives needed to grow profits in the long term but which may depress profits in the short term;
2) expensive requirements to publish all manner of financial, social and environmental information; and, of course,
3) limits on what they are paid.
They are making a bolt from mainstream corporate governance and from what they perceive as a lack of understanding and support from the conventional investment institutions that own listed companies.
In a way, the rise of private equity can be seen as a rejection of the shareholder-capitalism that has underpinned the US and UK economies for 150 years. And thatβs quite a big deal.
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surely this is just the usual flight from regulation that all businesses stampede for if offered a more lightly regulated environment?
Yes Mr Peston, a rejection of capitalism in general in fact. Welcome to business Russian style, where everything is opaque and effectively beyond regulation. Good businesses and their leaders will do well on the public markets; poor ones, with leaders who are in it for a quick personal profit, need private equity deals.
Robert,
Quick congratulations on an excellent blog.
I went to an event at Reuters last night looking at the relationship between the Media and the City, your blog was mentioned several times. There was a general view that it is an excellent example of journalism that importantly tries to tackle people's lack of knowledge about these issues (in the UK at least), as well as giving real insight into why the issues matter.
My feeling is that there is a a two-fold problem at work here. You might have heard the co-founder of the Eden Project's, Tim Smit, speech at a recent social enterprise conference where he chellenged the idea that the private sector is the sole source of efficiency and good practice. I think his point was that in some cases profit is made more by mistake or luck than by anything else. [By the way, do you think this is a fair point?] There is a tendancy to just assume that business is doing the best it possibly can and so should be rewarded for that - surely it should be held under scrutiny like everything else?
So there is also not enough of a public consciousness or scepticism about how business is doing, what it is actually doing, how it is making its profits. Not that I'm insinuating that profit is a bad thing, or that pay packets should only ever be the smallest they can be; but I do think we need to debunk the myths that shroud business.
That's why the move towards private equity is a concern. It seems to remove vital information from the public sphere that allow us, as customers as well as shareholders, to take a view of what is happening.
Hope that all makes sense.
Vincenzo
Myners is right.. There are two main problems with Private Equity.
The first is that they contribute absolutely nothing to economic growth.
The second is that they have made it even more difficult to raise risk equity capital for start-ups.
It is therefore quite clear to me that in terms of our economic strategy they are doing nothing but harm.
Is it really a rejection of the shareholder-capitalism of the last 150 years? Isn't it rather that modern fund managers and the modern public markets - by becoming obsessed with liquidity and the ability to trade out of a share quickly rather than sticking by companies for the long-run - have abandoned the shareholder-capitalism tradition in favour of stockmarkets as casinos?
Perhaps the private equity firms are closer to the traditional model of shareholder-capitalism than their public market equivalents are these days. And perhaps that is why they are proving successful.
what exactly is wrong with Paul Myners? Not enough for him to make his fortne out of the City he wants to stop anyone else from doing the same whether it's earning a commission or doing a prtivate equity deal. Don't tell me...he used to be a chain smoker but now has evidence it's injurious to peoples' health...
Private equity has always been an important way to grow business and was the main way that British companies were funded in the 19th century.In those days it was banks and entrepreneurs, now it is the new unregulated banks also known as private equity firms who increasingly dominate the finance of business because they can raise money at a lower cost.
Should we be concerned? I bellieve the answer is yes because the new banks of the 21st century are these funds and they are thriving because of cheap debt from traditional banks, that they can access more cheaply than the companies they buy, butin doing so are often ignoring the risk of that debt becoming much more expensive.In the future possibly threatening the viability of the very companies they have "geared up". Regulation may not be the answer but as these "new" banks find fewer opportunities that can make their returns for their shareholders they will take more risk for less return and that can only lead one way if they don't learn to regulate their own behaviour!
I seem to have heard more on private equity in the last six months than in the previous six years.
My major concern is that they seem to be driving the trend of the rich getting ever richer while everyone else struggles and suffers to make each step up the ladder.
Now I'm not suggesting that people shouldnt be rewarded for taking risks, but it does seem to stick in the throat when the life blood of the business is marginalised to pay these massively increasing C-Level bonus'.
Do you think this is just the nature of modern global capitalism? Or is there a way that this gap can be reined in?
By the way congratulations on the very interesting blog. Great addition to the ³ΙΘΛΏμΚΦ.
It is probably not so much a rejection of shareholder capitalism per se. The process of private equity ownership is about as capitalist as you can get. The rejection is more that of being owned by lots of different fund managers, who do not have the time to really get to know a company properly and understand how it works.
Despite all the reporting that is required of a public limited company, it is very hard to get to the core of what the company is capable of. You can only find out by living and breathing closely with a good management team. Private Equity firms usually only have interest in a few companies at a time. Therefore they can get to know the company well and support the right projects and initiatives.
As long as most public share trading is based on trend analysis, balanced risk portfolio and other high level analysis of companies, Private Equity will always have a competitive advantage for a company.
> In a way, the rise of private equity
> can be seen as a rejection of the
> shareholder-capitalism that has
> underpinned the US and UK economies
> for 150 years. And thatβs quite a
> big deal.
If it turns out that private equity does not serve us as well as shareholder-capitalism has done, then voters would be quite entitled to demand that it should be taxed heavily to make room for better ways to do things.
Robert
As a private equity investor myself I think you are half right on this. To say that we are rejecting the whole model of Anglo Saxon is a gross exaggeration. But it is fair to say that we believe that the way in which publicly listed companies take decisions is not always efficient.
Take the question of debt that you discussed in your previous blogs. You said that private equity was exploiting the fiscal advantages of debt. (This is sometimes the case but not always so by the way.) But is the ability to use debt exclusive to private equity? No. Is there anything that prevents listed companies from gearing up in the same way as private equity does? No.
In fact private equity has no institutional benefits over the listed company at all - except the fact that shareholders can control the company more closely and therefore make better decisions. This means that the CEO must trim costs, cut out those first class airfares, golf days, days hob-nobbing, etc. Private equity does not compensate managers for not achieving results so no big packages unless there are big results. The point is that listed companies are not always controlled in the interests of shareholders but of managers. What private equity seeks to do is to align managers' interests with those of shareholders. Its about corporate governance and the private equity way is much more effective than all the stuff about the Cadbury Code, higgs recommendations, independent directors. The truth is that in a listed company the CEO is almost god despite all the reforms.
If private equity had owned Enron and Worldcom would the CEOs have been able to get away with the misdemeanours they committed? Remember the cost of that to US pensioners of those bankruptcies. US trade union representatives on US public pension funds (and yes I talk to thenm regularly) actually support private equity on the grounds that it disciplines managers.
Who benefits from the work of private equity? Yes the private equity managers but only if they outperform the listed market. The biggest beneficiaries are the invesors in private equity funds - the pension funds, insurance companies and the endowments of charities that provide most of its capital. And yes these are the same people that own the listed companies. What they are doing when they sell to private equity is changing the structure within which they own the company. Why is Myners wingeing about that?
Private equity is only one part of the mix in the market. If managers of listed companies fail to put shareholders first they will find themselves vulnerable. It all adds up to a more efficient market, better allocation of resources and better decisions about where we invest and that returns we should expect.
City Boy
When compared to the extortion funded sector (the state) the enterprise sector is vastly less opaque, generates vastly more useful outputs and uses far fewer inputs as well as being far less corrupt.
As an example try changing your rubbish disposal person compared to changing your supermarket.
but you don't highlight the point that most employees have pensions which are invested in institutional funds which have limited access to private equity. there is a serious danger that too many companies are being taken off the LSE and out of the reach of the investment funds thereby creating increasing volatility
also, institutional ivestors may have short termist views but their investments are supposed to align with long term pensions. private equity may be aligned with mgrs but this is also tied to a short term exit plan
If public companies are suffering because of draconian regulatory requirements and stock market pressure, then why won't the stock market regulators and the government fix it? Why are we always insinuating that private equity is the problem?
Gaps exist in the market because of these issues, not because of the private equity industry. I believe it is only a matter of time before the market and government react to close some of these gaps, but then sometimes some well meaning people misinterpret the issues.
Alignment of management and shareholder interest is of course a major factor in private equity success, but as you mention the losers tend to be the employees.
Perhaps we will start to see a move to employee shareholders, such as John Lewis; allocating 15-20% of a company to all staff would really start to shake up the business
Dear Robert ... the world enjoyed the benefits of private capital for millenia before the creation of the public limited or joint stock company. While private capital excluded -- and still exludes -- the largely interested bystander, the joint stock company allowed any and all to invest in its venture. These small investors morphed into our pension funds, insurance companies and the other big institutions that are the financial backbone of our -- wealthy -- way of life. Some modern managers undoubtedly resent shareholder pressure; others relish the targets it can create. All modern managers resent the wealth of bureacracy and regulation that is more prevalent in the quoted sector, and which is the real enemy of successfully managed business.
Perhaps this march towards 'ultra-capitalism' needs greater exposure and discussion. It appears to be another mechanism that will stretch the division between the haves and have nots in society. Personally, I would love to hear Will Hutton's views on the subject, I'm sure they would make interesting reading.
Regards,
Peter
#11 City Boy says "This means that the CEO must trim costs, cut out those first class airfares, golf days, days hob-nobbing, etc. "
Nothing wrong with that perhaps and as I don't play golf that doesn't worry me personally but.. and it's a big BUT... what he doesn't say is that whilst trimming costs R&D and product development need to be preserved in order to continue growing and adding value.
I also disagree entirely that listed companies are not always controlled in the interests of shareholders but of managers. BP is a classic example of where shareholders have had a major influence over how that company has been run and one can see some of those chickens are now coming home firmly to roost.
Overall, I support what Myners said and I also have to say to City Boy that whilst I agree that PE is only one part of the market mix it is the one that because of the UK's own and peculiar interpretation of so called Anglo Saxon Economics it has led to a substantial fall in the availability of funding for start-ups.
Contrast that with the USA where - for example - in California alone some $2bn was invested last year in just clean technology start-ups. The Americans invented PE but seem to have a much more mature approach than their UK counterparts when it comes to balanced investing.
When does City Boy think that will happen here if ever?
"Is there anything that prevents listed companies from gearing up in the same way as private equity does? No."
Of course the rest of the market has access to the same cheap money. However, listed companies have avoided such huge debts because they are looking to the long term and they know that, historically, interest rates are still very, very low. They do not want to store up trouble for later.
The view is that private equity companies have saddled their targets with debt that, in the event of interest rates pushing up to anything like the long-term average, would be crippling. By then, however,they will have sold the business on and be sitting with the profits on deposit somewhere. Good scheme!
Is it also true, in the US particularly, companies have been effectivly de-listing from the stock exchange by being bought up by Private Equity this removes them from the controls of Sarbannes Oxley?
Not saying that this is a bad thing because a firm who's share price is hit by this regulation (or more likely as they have poor controls), more expencive audit costs and more expencive to borrow money as it hits your credit rating, can be snapped up cheaper than its market value. Then run at a profit without the level of regulation required for a listed company, not saying the PE firm won't insist on any but they are likely to be better targeted for business benefit.
It will be intersting to see how many firms are re-floated if the Sarb-Ox rules are watered down in a few years time.. Or if that does not happen then Sarb-Ox rules introduced at a pace that the firm can cope with and sold off when the whole thing is running a bit sweeter.
> When compared to the extortion
> funded sector (the state) the
> enterprise sector is ...
> far less corrupt ... try
> changing your rubbish disposal
> person compared to
> changing your supermarket.
No problem β if you want it, Iβll
pick up your rubbish and throw it
on Branscombe beach. Just let me know β
I charge Β£50 an hour plus travelling costs.
Aligning employees' interests with that of shareholders is obviously the way to go. Legislate to make all companies co-operatives.
I would like to draw your attention to another growing trend: Private equiety has become the preferred vehicle for charitable giving. It was instrumental for those who really wanted to make sure that the money is used for what it was meant for. Doesn't it say something about competitive advantage?
According to Richard Lambert, private equity investment ensures that 'the interests of owners and management are closely aligned'.
.
The fatal flaw in this argument is that these 'leveraged buyout' boys are only interested in the target company for two or three years at most; just long enough to strip out its fixed assets, load it with debt and repackage it for resale on the market.
Now how can a short-term predatory raid like this be seriously represented as a permanent alignment of interests?
But why do you retail such a plainly specious argument without comment? I notice that Myner wasn't allowed to get off so lightly ('his attack is predictable')
Robert makes an intesting point about "negative stock-market reaction to investments". This brings us back to the short-termism of modern-day stock markets, a key point made in the mid 1990s by Will Hutton. If so, what we see with private equity funds is an attempt to by-pass this short-termism by - in effect - de-listing. But this raises the question of what causes this lack of understanding and support from the conventional investment institutions that own listed companies and how these institutions can be reformed to give a greater emphasis on long-tem investment. Given the growing concern over social and enviromental performance of companies as global-warming is increasingly taken seriously, somehow we need a 'realignment' that factors in both long-term commitment AND social and environmental responsibility. It isn't clear to me that private equity performs on the latter score.
We must remember that the Private Equity houses are not investing their money, they are investing everyones pensions.
As the pension fund managers increase their Private Equity allocations ( CALPER's just announced up to 10% from 5%)the transparency of the public markets is lost in a larger portion of their portfolio. It is also the highest risk part.
This risk is significantly exacerbated by the debt levels that are being combined in the PE house investments. PE is really an all or nothing investment.
Opening up the openness of the PE market is required if only to protect our pensions.
The most immediate concern with Private Equity buy-outs seems to me to be the immense volatility they are creating in stock markets. It only takes the vaguest of rumours to be published in the Sunday papers to produce massive swings in share prices on Monday morning. By their very presence they are increasingly divorcing share valuations away from fundamentals.
And, presumably, if you profit by anonymously leaking a rumour that later turns out to be completely unfounded, you can't actually be done for insider trading.....
That Myner's comments may have been predictable does not mean that they are not valid.
Business managers can be suitably motivated by factors other than cold hard cash and although it is certainly a very effective means of control it can have negative long term impacts on the business and its employees. The 'do-what-ever-it-takes to-jack-the-share-price-up-so we can-flog-it-off-at-a-massive profit' style of management only ever looks to be prudent when you are on the receiving end of the profits. Most of us of course spend most of our lives paying for those profits.
It may be ancient history now but even Marx pointed out the incongruity of a worker investing in equity in a firm that in order to generate better dividends lays him off. Not that Marxism was any better but I'm sure you get the point - Myner I think sees another road to profit, a longer view with less casualties on the way.
The 'invisible hand of the freemarket' is not always good and tends to be less good where organisations are big and detatched from the communities that they operate in.
The massive amounts of global liquitity that are encouraging high levels of gearing makes everyone feel good until it runs dry. In the words of Warren Buffett you only see who is bathing naked when the tide goes out...
When there is high global liquidity, capital is more likely to be misallocated. In the UK who will take responsibility for the all the written off bad debt? The hedge funds? or the BOE and hence eventually the normal uk citizen?