In GOP Campaign, Private Equity Firms Draw Flak | WAMU 88.5 - American University Radio

In GOP Campaign, Private Equity Firms Draw Flak

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Was Mitt Romney a job-creating turnaround artist? Or was he, as some on the campaign trail have said, a "vulture capitalist"? That question has become a top issue in the Republican presidential primaries.

In the 1980s, Romney ran a private equity firm called Bain Capital. It's an industry where it's hard to avoid getting your hands dirty.

Here's what private equity firms like Bain Capital do: First, they go out and find a few large investors — usually pension funds, university endowments and possibly wealthy individuals. Then, says Ohio State professor Steven Davidoff, they take that money, borrow a lot more and buy companies — usually companies that are in trouble or undervalued.

"They buy them in hopes that they can increase the value of the companies and sell them at a fantastic profit," Davidoff says.

Romney made a fortune doing just that. He also provided big returns for his investors. The problem is, in an effort to make companies more valuable, he also shut down factories and cost people jobs. That led one of his opponents, Texas Gov. Rick Perry, to suggest Romney was a "vulture capitalist."

"There's a real difference between venture capitalism and vulture capitalism," he said. "Venture capitalism, we like. Vulture capitalism, no."

Another candidate, former House Speaker Newt Gingrich, characterized what Romney did at Bain Capital similarly.

"Those of us who believe that in fact the whole goal of investment is entrepreneurship and job creation, would find it pretty hard to justify rich people figuring out clever legal ways to loot a company, leaving behind 1,700 families without a job," Gingrich said.

Steven N. Kaplan, an expert on the private equity industry, says that's "ridiculous."

"Looting a company and destroying a company does not create value," says Kaplan, also a professor at the University of Chicago Booth School of Business. "At the end of the day, in order to make money, you have to sell the company to somebody, and if the company ... has been looted and is unproductive, nobody is going to buy it."

The public relations problem for private equity capitalists at firms like Bain, KKR and Blackstone is that they're the agents of the creative destruction part of capitalism. They aim to take over underperforming firms and operate them more efficiently. Davidoff, who worked on merger and acquisition deals as a lawyer before becoming a professor at Ohio State, says there's no doubt that in that process people can get hurt.

"Sometimes operating them efficiently means that employees lose their jobs, plants are closed down and companies are restructured," he says.

Still, there's no doubt that private equity firms create value. Kaplan says research shows that from 1993 through 2008, money invested in private equity firms produced much higher returns than money invested in the stock market. That also benefited many typical Americans through the public and private pension funds that are big investors in the industry.

As for job gains or losses, Kaplan says the direct effect in companies taken over by private equity firms is pretty much a wash.

"Employment ... grows. It maybe grows a tad less than in other companies, and what you concluded from that is that the companies have become more productive," he says.

More productive firms need fewer workers for the same output. Of course, if the underperforming firms had not been taken over, might they have lost lots of jobs because they went out of business?

Davidoff says a more valid criticism of private equity firms is that their managers make use of a lucrative loophole to cut their tax bill.

"The barons of private equity are probably paying a lower tax rate than their secretaries, in terms of percentages," he says.

That's because they structure their compensation in a legal — but controversial — way, so they pay the capital gains rate of 15 percent, instead of the top rate on ordinary income of 35 percent. That has saved private equity managers billions in tax payments.

Copyright 2012 National Public Radio. To see more, visit http://www.npr.org/.

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