Private Equity and Portfolio Companies: Lessons from the Global Financial Crisis

• Author: Filippo Mezzanotti,Shai Bernstein,Josh Lerner
• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/jacf.12416
• Date: 01 September 2020

IN THIS ISSUE:

Private Equity

and Public

Companies

VOLUME 32

NUMBER 3

SUMMER 2020

APPLIED

CORPORATE FINANCE

Journal of

8Private Equity: Accomplishments and Challenges

Greg Brown, University of North Carolina; Bob Harris, University of Virginia; Tim Jenkinson,

University of Oxford; Steve Kaplan, University of Chicago; and David Robinson, Duke University

21 Private Equity and Portfolio Companies: Lessons from the

Global Financial Crisis

Shai Bernstein and Josh Lerner, Harvard University; and Filippo Mezzanotti, Northwestern University

43 Board 3.0: What the Private-Equity Governance Model Can Oer

Public Companies

Ronald J. Gilson, Columbia University and Stanford University; and Jeffrey N. Gordon,

Columbia University

52 e Growing Blessing of Unicorns: e Changing Nature of the

Market for Privately Funded Companies

Keith C. Brown and Kenneth W. Wiles, University of Texas at Austin

73 EQT: Private Equity with a Purpose

Robert G. Eccles, University of Oxford; and Therése Lennehag and Nina Nornholm, EQT AB

87 Private Equity and the COVID-19 Economic Downturn:

Opportunity for Expansion?

David Haarmeyer

92 University of Texas Roundtable on LP Perspectives on the

State of Private Equity

Panelists: Chris Halaska, Memorial Hermann Health System; Tom Tull, Employees Retirement

System of Texas; Russell Valdez, Wafra; and Shelby Wanstrath, Texas Teachers Retirement System.

Moderator: Ken Wiles, University of Texas at Austin

100 Columbia Law School Roundtable on Public Aspects of Private Equity

Panelists: Emily Mendell, International Limited Partners Association; Chris Cozzone, Bain Capital

Double Impact; and Donna Hitscherich, Columbia Business School. Moderated by Aamir Rehman,

Columbia Business School

108 A CEO’s Playbook for Creating Long-Term Value: Ten Essential

Resource Allocation Practices

Harry M. Kraemer, Jr., Northwestern University; Michael J. Mauboussin, Counterpoint Global;

and Alfred Rappaport, Northwestern University

118 A Tale of Leadership in Value Creation

Greg Milano, Fortuna Advisors

128 What Public Companies Can Learn from Private Equity Pay Plans

Stephen O’Byrne, Shareholder Value Advisors

21

Journal of Applied Corporate Finance • Volume 32 Number 3 Summer 2020

A particular concern around PE ownership, and the high lever-

age that comes with it, is whether it makes companies more

vulnerable during economic downturns. One clear feature

of the private equity market is its intense cyclicality, with the

volume of PE transactions moving in highly correlated fash-

ion with equity valuations and economic cycles. Moreover,

the deals transacted during market peaks dier greatly from

those in other periods. Steve Kaplan and Jeremy Stein, in their

analysis of PE’s rst major boom and bust published in 1993,

reported signs of “overheating” in the U.S. buyout market in

the late 1980s, including higher valuations (as multiples of

operating cash ow), transactions in riskier industries, higher

leverage, and signicant reductions in the net equity contrib-

uted by LBO sponsors.2

In a much more recent (2013) study of PE market cycles

in several countries, Ulf Axelson and colleagues showed that

the extent of leverage in buyouts has had far more to do

with interest rates and general credit conditions than with

the underlying characteristics of the companies themselves.

3

Periods of high leverage have been associated with higher

transaction prices and lower returns, suggesting a clear

tendency of PE investors to overleverage and overpay when

access to credit is readily available. Other work suggests lower

relative rates of productivity growth by PE-backed companies

during such boom periods, suggesting an increased emphasis

on the kind of nancial engineering that can weaken rms.4

ese cycles in the PE market may well have broader

economic effects that extend well beyond the markets

themselves. According to data from the Preqin database,

during the three years (2006-2008) leading up to the nan-

cial crisis, global PE groups raised almost $2 trillion in

equity, with each dollar typically leveraged by more than

$2 of debt. e United Kingdom—the focus of the study

discussed in this article—was the most PE-driven economy

in the world at the time of the crisis: PE-owned assets repre-

sented about 11% of gross domestic product (GDP). In

line with these numbers, the Bank of England estimated

that PE-backed companies had issued more than 10% of

all nonnancial U.K. corporate debt before the crisis, and

3 Axelson et al. (2013).

4 Davis et al. (2019).

5 These numbers were obtained by dividing the total private equity fundraising

between 2004 and 2008, as estimated by the European Venture Capital Association and

PEREP Analytics (in the case of the United Kingdom) and Buyouts magazine (in the case

of the United States) by GDP in 2008 (as reported by the World Bank). In both cases,

we exclude venture capital funds.

oes private equity contribute to nancial fragility during economic crises?

As discussed at length in the article at the top of this issue, there is extensive

literature that explores the effects of private equity ownership on corporate productivity,

product quality, employment, and related dimensions during normal times. In general, the

picture painted by these studies is one in which PE sponsors have a mixed impact on the

companies in which they invest: while the rms do well on productivity and a variety of other

operational metrics, employee headcounts shrink and wages suffer.¹

by Shai Bernstein and Josh Lerner, Harvard University and NBER, and Filippo Mezzanotti, Northwestern University*

Private Equity and Portfolio Companies:

Lessons from the Global Financial Crisis

D

*This article draws on, while summarizing the ndings of, the authors’ earlier pub-

lished article, “Private Equity and Financial Fragility during the Crisis,” The Review of

Financial Studies, Vol. 32 (Fall 2019), pp. 1309-1373. The authors thank the Harvard

Business School’s Division of Research for nancial support. They also thank seminar

participants at Columbia, Duke, LBS, MIT, and Northwestern—especially Efraim Ben-

melech, David Matsa, Sabrina Howell, Steve Kaplan, David Robinson, and Morten So-

rensen—for helpful comments. Lerner has advised institutional investors in private eq-

uity funds, private equity groups, and governments designing policies relevant to private

equity.

1 Davis et al. (2014, 2019). Eaton, and Howell, and Yannelis (2019) highlight these

issues from another perspective.

2 Kaplan and Stein (1993).