Private equity firms increase the economy’s productivity by catalyzing “creative destruction,” while also reducing earnings per worker, says the newest version of a long-running analysis of buyout companies.
The widely cited research by University of Chicago Booth School of Business economist Steven Davis and others has previously established that buyouts trigger a wave of both hirings and firings, with the gist being a net decline in jobs of about 1 percent over two years. (That excludes the effect of acquisitions and divestitures.) The new finding, based on further analysis of the same set of data, is that buyouts make companies about 2 percent more efficient over two years, enabling them to produce more goods and services for any given input of labor and equipment.
One puzzle for the researchers was to figure out why productivity increases. They concluded it’s not because inefficient companies are replaced by more efficient ones. Rather, it’s because existing companies become more efficient. You might assume that private equity managers whip their operations into shape, but that’s not how it happens, Davis says: “Somewhat to my surprise, we discern no effect on the efficiency of ongoing units.” What happens is that companies close down inefficient “establishments”—factories, warehouses, stores, and the like—and open more productive ones. It is, Davis writes in an e-mail explaining the research, “a directed reallocation of jobs within target firms.”
As for pay and benefits, the researchers concluded that two years after a buyout, total annual compensation per worker was 4 percentage points lower than at comparable firms that weren’t bought.
The research covers data from 1980 to 2005, before the financial crisis and deep recession of 2007-09. A paper incorporating the latest findings has been accepted for publication in the prestigious American Economic Review. In addition to Davis, its authors are John Haltiwanger of the University of Maryland, Kyle Handley of the University of Michigan’s Ross School of Business, Ron Jarmin and Javier Miranda of the U.S. Census Bureau, and Josh Lerner of Harvard Business School.