As political tensions rise amongst GOP candidates, many opponents of Presidential candidate Mitt Romney have criticized his time in private equity at Bain Capital, likening him to a corporate raider.  While much is being made of the former governor’s time at Bain, few are truly informed on what function Romney, and similar people within private equity, serve.  Economists Steven Davis and Kevin Hassett, in an editorial for The Atlantic, define and examine some academic work on the role private equity has in a capitalist society.

The piece addresses the principal role of private equity firms, including describing their role in both LBOs and venture capital.  Contrary to critics assertion that such firms are simply interested in buying and looting a company, Davis and Hassett note that “the goal in each case is to create a thriving business so the private equity firm can sell its investment stake at a profit.”  They note that while private equity acquisitions are often associated negatively with employment at the targeted firm, much of the elimination of jobs is a necessary part of restructuring a struggling firm.  Given the high proportion of costs that labor represents, eliminating excessive labor costs can go a far way in making a struggling company successful.

To build a successful and profitable company in the long-term, Davis and Hassett argue that a private equity firm must in fact encourage innovation in their employment efforts.  Evidence suggests that “for manufacturing firms, productivity grows more rapidly at buyout targets compared to otherwise similar firms. In large part, the extra productivity growth reflects a greater tendency by private equity to shift jobs from less productive facilities to more productive ones. Much of this accelerated reallocation activity occurs within the target firms.”

The evidence Davis and Hassett present supports the assertion that private equity is in fact a source of positive, creative destruction.  Private equity has been proven to not only provide positive returns for its investors, but also have only a minimal impact on purchased firms, especially when factoring in the venture capital side of private equity.  By serving as a source of capital for both new and established, but struggling firms, as well as acting as a restructuring force focused on reducing inefficiencies and encouraging innovation, private equity firms, as Davis and Hassett conclude, are a positive force in a capitalist economy.

About these ads