Impact Of Private Equity On The Global Economy

By M. Isi Eromosele

The past year has seen unprecedented turmoil in the markets, resulting in a fundamental restructuring of the global financial landscape. As the magnitude of the turmoil and its consequences has become clear, there has been a natural desire on the part of political leaders to closely examine the role of financial intermediaries.

These have not only included traditional financial institutions such as banks and investment companies, but also alternative investment asset classes such as private equity, which in many nations have remained largely outside the purview of regulators.

As such, in an era when global financial regulation is rapidly evolving, understanding the role and consequences of private equity has never been more important. Yet the systematic knowledge that can be drawn upon about these institutions is surprisingly limited.

In the last few decades, private equity has emerged as an important class of investment within the financial system and has evolved beyond the US and UK. Today, private equity transactions span different geographies and influence employment, productivity, corporate governance, management practices and broader economies. But global understanding of the impact of the modern private equity industry remains at a relatively low level.

A detailed analysis of the Global Private Equity Industry by Oseme Finance addressed the evolution of the sector during the past decade by including sample studies that covered the following broad topics:

• The demography of private equity investments,
• The willingness of private equity-backed firms to make long-term investments
• The impact of private equity activity on employment  
• The post-acquisition governance practices utilized by private equity firms

The research team complemented these studies with a variety of case studies, which examined these issues and others across a variety of geographies, with a particular emphasis on Germany, the UK and emerging private equity markets such as China and India.

The main goal of the study was to determine whether private equity ownership is a way to achieve improved management practices within firms through the introduction of new managers and better management practices.

Among the key findings are the following:

• Private equity-owned firms are on average the best managed ownership group. Private equity-owned firms are significantly better managed across a wide range of management practices than government-, family- and privately owned firms.  
• Often private equity owned firms are particularly strong at operational management practices, such as the adoption of modern ‘lean manufacturing’ practices, using continuous improvements and a comprehensive performance documentation process.
• Private equity-owned firms have strong operational management practices. Private equity-owned firms have strong people management practices in that they adopt merit-based hiring, firing, pay and promotions practices. Relative to other firms, they are even better at target management practices, in that private equity-owned firms tend to have tough evaluation metrics, which are well understood by the employees and linked to firm performance.
• Firms acquired by private equity groups experience productivity growth in the two-year period after the transaction; that is on average two percentage points more than at controls. About 72% of this out-performance differential reflects more effective management of existing facilities, including gains from accelerated reallocation of activities among the continuing establishments of target firms.
• The probability of establishment shut-down is less likely for more productive facilities for both private equity targets and comparable firms, but the relationship is much stronger for private equity-backed firms. In other words, private equity investors are much more likely to close underperforming establishments at the firms they back, as measured by labor productivity.

 Key findings: Emerging markets study

The Oseme Finance Report examines the rapid increase of private equity investment in emerging markets. During the past decade, the dollars raised by funds investing in the emerging economies of Asia, Russia and the former Soviet Union, Latin America, the Middle East and Africa has increased exponentially.

This report aims to understand the private and social returns of private equity investments in emerging economies by looking at the nature and outcomes of  these private equity deals across nations that differ in the development of their financial sectors, governance, regulatory systems and operational infrastructures.

Key findings are as follows:

• Emerging markets account for an overall modest share of private equity activity over the past decade. This share has grown in recent years, particularly in the growth equity category. Private equity represents a greater share of the gross domestic product (GDP) in nations that are wealthier and whose per capita GDP is growing more quickly.
• Only equity market development matters for the development of private equity, not the provision of debt and the effects are particularly strong for venture capitalists. One interpretation is that exiting through public offerings is particularly important for these firms.
• The measures of operational engineering appear to be particularly important for buyout activity. In particular, the presence of barriers to free trade, greater complexity in establishing new entities and greater corruption are associated with fewer LBOs.
• Minority transactions are associated with faster-growing countries. The presence of syndicated investments is associated with larger deals and with less favorable fundraising environments, which may be attributable to liquidity constraints.

M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance

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