Creative destruction? Evidence that buyouts shed jobs to raise returns

Abstract

Building on the work of Cressy, Munari, and Malipiero (2007a) which showed that buyouts have higher operating profitability in the post-buyout period than matched companies, the paper examines contradictory popular claims that private equity (PE)-backed leveraged buyouts (LBOs) generate or destroy jobs as a result of the process of ‘rationalisation’. Using a sample of up to 57 UK whole-company buyouts and a matched sample of up to 83 controls over the period 1995–2000 we run loglinear employment regressions for one to five years after the buyout with buyout year variables as regressors. A PE dummy represents companies that have PE backing while other variables control for initial employment, gearing, investee size and profitability together with industry and macro effects. We find that there is no PE-‘choice’ effect: in the buyout year there are no significant differences between buyout companies and controls in terms of employment. But in the post-buyout regressions the PE dummy is highly significant and negative reaching a peak of 23% per annum after four years. So to achieve efficiency gains, buyouts bring about quick and substantial reductions in employment in target companies during the initial period of ‘rationalisation’. However, initial profitability, three-year average post-buyout profitability and three-year sales growth have positive elasticities with respect to future employment suggesting that buyouts, by generating higher operating profits from job cuts, may ultimately be associated with compensating job creation. This, however, is the subject for future research.

Keywords:

• buyouts
• private equity
• employment
• job creation

Acknowledgements

The authors would like to thank Harpreet Kang for collecting the employment data for this study and the referees and the editor of this journal for their helpful comments and suggestions for improvements to the paper. The usual disclaimer applies.

Notes

 1. These results are summarised in the context of an overview of private equity performance in Wright, Gilligan, and Amess (2009).

 2. The one exception, only for the US, and confined to buyins, is Davis et al. (2008). We discuss this paper in more detail below.

 3. Heckman sample selection regressions deal with the problem of missing employment data.

 4. For example, both initial profitability, three-year average post-buyout profitability and sales growth have positive elasticities with respect to future employment.

 5. The lone study is for Austria.

 6. A divestiture consists in the sale of a divisions or subsidiary of the company bought out.

 7. In this paper we use the term ‘buyout’ to cover management buyouts (MBOs) and leveraged buyouts (LBOs). The primary distinction here is between a buyout that is organised by the management of the company (MBO) and one organised by a third party (first and second parties being the firm and bank) (LBO) and where the management of the company remains in post after the buyout. We distinguish buyouts from buyins (MBIs) in which the management of the company is replaced after the event.

 8. A divisional buyout involves the buyout of a division of a company only.

 9. There is no control sample used in this study, so it is difficult to be sure that this restructuring would not have taken place if there had been no LBO. See the discussion of ideal research criteria above.

10. As shown by Amess and Wright (2007a) in the UK context at least there are major differences between buyouts and buyins in terms of employment effects.

11. Number estimated graphically from their Figure 1.

12. The use of establishment data rather than firm data enables them to examine the effects of MBIs on productivity more accurately than some other buyout analyses since divestments can be tracked through time.

13. The length of the periods for the event studies is justified by the authors on the grounds that most going-private transactions have gone public again within five years.

14. This focus reduces the sample size substantially.

15. In the two years post-buyout the acquisition rate is 7.3% for MBO firms and 4.7% for controls. Comparable divestiture rates are 5.7% and 2.9% respectively.

16. They also calculated that companies which had received PE funding employed 2.8 million people in the UK, roughly one in five workers.

17. Bryant and Taylor (2007).

18. The report uses data from the University of Nottingham's Centre for Management Buyout Research (CMBO) on 1350 buyouts in the UK between 1999 and 2004 discussed above.

19. The impartiality of this report can itself be questioned on the basis that it was funded by a trade union.

20. Our dataset consists of buyouts of whole companies rather than divisions of companies. Hence reduction in employment is a reduction for the firm and economy rather than the transfer to a division that has been bought out.

21. According to the four-digit Venture Expert industry classification.

22. It should be mentioned that in the UK, unlike the US, accounting data are generally available for private companies.

23. A critical task in this phase was that of correctly matching the name of the PE-backed company, as provided by Venture Economics, with the accounting information provided by FAME. For dubious cases we consulted the WebCheck service provided by Companies House ( http://www.companieshouse.gov.uk//index.shtml), offering searchable information on company names, addresses and main business on more than 1.8 million companies in the UK. This service allows checking for current, previous and dissolved company names.

24. The sample selection issues associated with this procedure are discussed later in the paper.

25. Thus, for each buyout company of the final sample, we identified from FAME the primary industry of the buyout using the NACE four-digit industry classification. We then formed a list of all the private companies in the same industry in the FAME database. From this list, we chose the company that was most similar to the PE-backed company in terms of total sales in the year of the buyout. We should also mention incidentally that controlling for size and industry across the two groups (buyouts and non-buyouts), also helps to control for systematic risk.

26. Full-time equivalent employment.

27. Probits using Totass0 and its square had approximately the same fit and level of significance.

28. We do not yet know how much of this is due to sample attrition effects, as the sample size declines significantly over the post-buyout period. See the later regression analysis.

29. These results are confirmed in a multivariate context in Table 4.

30. To avoid endogeneity problems we use the lebit3 variable only in regressions for lemp4 and lemp5.

31. See Table 4 and following for details. The only difference in the number of covariates is the presence or absence of lebit3.

32. An initial set of 129 buyouts was randomly selected from Venture Economics.

33. This is commonplace in the industrial economics literature where the classic model of Gibrat's Law (growth rates follow a random walk) implies that the previous period's growth rate explains all of variation in current growth.

34. Note that, as might be expected from an examination of Table 2, the inverse Mills ratio is completely insignificant except in years 4 and 5, where its positive sign indicates that firms with missing employment data are generally smaller in employment terms than those with data.

35. To test the hypothesis that turnover is positively correlated with jobs despite the diminishing sample size we ran additional (unreported) regressions for years + 4 and + 5 with sgrow3 as an additional explanatory variable. In each case the coefficient was positive and significant while the coefficient of PE retained its former significance levels. This provides additional support to the claim that the effect of turnover increases on employment is to offset the effects of rationalisation. However, the elasticities of the sgrow3 variable turn out to be much smaller than those of lebit3, suggesting that profitability is a better lever to employment creation than growth in turnover.