Here’s today’s Op-Ed by Pat Toomey, praising private equity. I am tracking down sources on this topic and will pass along what I learn.
I do now trust at least one result: public firms will buy up targets without much discretion, but private equity has been making acquisition decisions in a more rational fashion:
We find that the announcement gain to target shareholders from acquisitions is significantly lower if a private firm instead of a public firm makes the acquisition. Non-operating firms like private equity funds make the majority of private bidder acquisitions. On average, target shareholders receive 55% more if a public firm instead of a private equity fund makes the acquisition. There is no evidence that the difference in premiums is driven by observable differences in targets. We find that target shareholder gains depend critically on the managerial ownership of the bidder. In particular, there is no difference in target shareholder gains between acquisitions made by public bidders with high managerial ownership and by private bidders. Such evidence suggests that the differences in managerial incentives between private and public firms have an important impact on target shareholder gains from acquisitions and managers of firms with diffuse ownership may pay too much for acquisitions.
Here is the paper.
I’m a little suspicious of his op-ed simply because of his focus on opposing p.e. income taxes. Is the gain from taking companies private simply due to tax arbitrage? I’m against corporate taxes and capital gains taxes anyway, but treating p.e. income as capital gains is a step towards a high-tax, high rent-seeking world, not a step towards efficient low taxes.
The difference is between a strategic and financial buyer. A public firm is usually a strategic buyer, by that I mean they extract value (ideally) from synergies, operational efficiencies and financing efficiencies. A financial buyer typically only extracts value through better operational and financial management. As such, a strategic buyer, when available, should always be able to outbid a financial buyer since it can extract those synergies. Investment Banking 101.
About a week and a half ago I was in London. One of the hot topics in the press–and apparently in Parliament–was increased regulation of private equity firms. (Part of this arose in the context of Ford’s shopping Land Rover and Jaguar, for which p.e. firms were identified as the mmost likely buyers.) A large part of the discussion focused on alleged asset-stripping/wage-and-benefit depressing activities of p.e. firms, which would then allegedly flip the remaining parts of the firm back through IPOs. (Similar things have been known to happen in the US.) In the UK, labor unions and executives of publicly-held companies tended to support tighter regulation.
The Congress is losing this argument through their own incompetence and by allowing the PE apologists (I count myself as one) to redefine the debate. This shouldn’t be, as Toomey argues, a discussion about taxation of PE firms, but rather about the preferential tax treatment of the earnings that accrue to the employees of those firms.
The taxation of partnerships is fine as-is and the role of PE firms is, as so many have pointed out, a healthy one. The issue is that the employees of these firms receive capital gains tax treatment without putting their personal capital as risk (traditionally a prerequisite for capital gains treatment). If we are comfortable with this, for instance because “of the value they create,† why are we not also comfortable with applying lower tax rates to other high value occupations (e.g. teachers, fire fighters, police officers, etc.)?
(1) I don’t question the ability for managers or their bankers to manufacture fake synergies, but if a financial buyer wins a bidding war against a strategic buyer, almost by definition they will be overpaying.
(2) The dichotomy isn’t between public and private ownership teams, but rather, one between management ownership and the lack thereof. One of the lessons the public companies have learned from private equity is that you need to align interests of management and shareholder very tightly, thus the renewed focus on equity, options, and long-term comp as a percentage of CEO pay packages. Fact of the matter is, if management has enough stake in the game, they’ll spend much less time empire building and much more time value creating.
(3) Employees and managers of private equity firms oftentimes have almost all of their personal capital tied up in the fund itself, and as such, decidedly at risk. They invest in the fund alongside all the limited partners, even at a very junior level, and why not. Wouldn’t you if you worked there?
(4)This is nothing more than extortion for campaign contributions, and the end result is that if it passes, the lay investor will remain out of private equity while HNW individuals continue to thrive. An excellent plan for solving income inequality. Moreover, it’ll just send more capital and private equity funds elsewhere.
Aschkan, per your point (3) … how should we treat gains on “personal capital” when the capital is provided through non-recourse loans or management fee offsets?
I just read Toomey’s article. It says private equity does some useful things and therefore shouldn’t be taxed. That’s it – about the level of analysis you’d expect from the “Club for Growth.” I don’t understand why Tyler even linked to it.
There is this gem, though:
The former head of Morgan Stanley, Phil Purcell, has highlighted another role private equity investors play. “They try to reduce excess capital — capital tied up in inventory, payables, receivables, and other forms of working capital. When a portfolio company is sold, the capital is reallocated to opportunities with higher returns. The result is rapid reduction of capital in mature industries and increased investment in growing industries.”
Someone tell Purcell that payables don’t tie up capital, they provide it. Someone tell him too that when a company is sold the assets don’t mysteriously turn into cash. They change hands, and some cash goes in the opposite direction.
I agree with Robert Beard that the carried interest should be taxed as ordinary income. A useful way to think about it is to imagine it being paid in cash, rather than an ownership interest, with the manager then investing the cash in the fund. No one would argue that the cash payment is anything other than OI.
Does that mean that the manager has to take some of the cash and pay taxes? Yes. But if I want to invest part of my income I have to do it with after-tax funds also. What’s the difference?
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仓储笼
This is certainly something to write home about.
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