But What About the Workers?
Private equity has historically focused its attention on bringing in and incentivizing the best management teams, as a recent academic study details. Yet another piece of research suggests that firms may be less concerned about the wider workforce in the companies they back. Can they afford to do this at a time of labor shortages?
Originally published in Coller Research Institute’s PE Findings Issue 19, July 2023.
By Vicki Meek
For decades, the private equity industry has pursued the Holy Grail of finding the best management teams for its portfolio companies, on the basis that these individuals drive significant value. And it’s this philosophy – and the fact that an earlier study on public companies showed that they tended to recruit internally – that led three academics to study where PE firms were looking for their CEOs. In The Market for CEOs: Evidence From Private Equity, Paul A Gompers, Steven Kaplan and Vladimir Mukharlyamov studied CEO appointments in larger US buyouts between 2010 and 2016.
They found that PE firms go to great lengths to find the CEOs that they think will best fit their portfolio companies, in contrast to what happens at public companies, as Gompers explains. “This paper follows on from a previous study that found 72% of the S&P 500 CEO appointments were internal promotions, and that of those that weren’t, 90% were already known to board members,” he says. “We thought it was hard to reconcile with the idea that they were finding the best talent. That’s why we looked at PE – it is known for being good at improving company operations and generating strong returns for limited partners.
“We wanted to see if the labour market for PE CEOs was the same as for public companies. And it was dramatically different: in the sample, 70% of CEOs were replaced at the time of the deal. This suggests that finding the right talent for the top is an important value creation lever in PE.”
The research also suggests that this situation benefits the CEOs themselves, with their average compensation higher than for those in similarly sized public companies.
Overall, the study suggests that management is one of PE’s top priorities in deals. “The results were directionally what we expected,” says Gompers. “But we were surprised to find that the percentage of CEO replacement and the percentage of outside appointments was so high. The study really does confirm PE’s mantra of management, management, management.”
The Broader Picture
So far, so good. Yet for an industry with such a laser-sharp focus on value creation, some are questioning whether PE is missing a trick.
Dr. Matt Brubaker
“PE has traditionally been far too focused on the C-suite,” says Matt Brubaker, CEO of human capital advisory firm FMG Leading. “Yet there are often groups of people who create a disproportionate amount of value – perhaps 10 to 20 times more than others, and yet this isn’t always recognised.”
He offers the example of a multisite ambulatory healthcare provider. “You might have a site manager who has the ability to personally affect the most crucial performance metrics, such as clinical outcomes, employee engagement, and provider satisfaction,” he says. “These are the fulcrum roles that drive disproportionate value.”
Indeed, a recent piece of research suggests that PE firms could be doing a better job with the broader employee base in the businesses they back. And this is a particular concern at a time when the labour market is tight and finding workers is both expensive and time-consuming. In their paper, Do Employees Cheer for Private Equity? The Heterogenous Effects of Buyouts on Job Quality, Will Gornall, Oleg Gredil, Sabrina Howell, Xing Liu, and Jason Sockin examine employees’ satisfaction levels with compensation, culture, senior management and work-life balance following a buyout.
“The broad trend of PE becoming more important in the economy – and in some ways supplanting public equity – makes this an important area of study, given how many employees are now in portfolio companies,” explains Gornall. “Many people want to know whether PE is just better at managing companies, or are firms extracting value from others, such as employees?”