The Past and Future of Private Equity
AEI Newsletter

Even though the private equity (PE) sector represents only a small fraction of the financial assets in the American economy, its importance to capital formation and economic growth and the level of controversy it generates is large. At a major conference organized by NRI fellow John L. Chapman on November 27-28, leading economists and PE executives discussed the sector's history, impact, and future. "Buyouts and private equity have been a growing part of the landscape of the American financial system and, increasingly, the global financial system over the past quarter century," R. Glenn Hubbard of AEI and Columbia Business School said in opening remarks. Harvard Business School's Josh Lerner followed with a discussion of PE's future, asserting that the ups and downs of venture capital over the past few decades are "part and parcel" of the industry.

During a panel on PE's impact on corporate governance, Steven N. Kaplan of the University of Chicago favorably compared the sector's corporate governance, productivity, and firm operations to those in the 1980s. Kenneth M. Lehn of the University of Pittsburgh commented, as did Chapman, who suggested that PE is "a story of specific knowledge . . . whether it's [of] industry or specific market conditions."

Douglas Cumming of York University and Kent Smetters of AEI and the Wharton School responded to a paper by AEI and Chicago's Steven J. Davis on how PE-backed firms compare to others in terms of labor force and productivity effects.

In his keynote address, Harvard Business School's Michael Jensen called PE "a new and powerful model of general management." He said that issues raised by the sector have not changed much since the 1980s, "and to the extent [PE has] changed, it's probably changing for the not-so-good." Jensen expressed concern about PE's overvaluations and subsequent mal-investment, but he affirmed PE's positive effects on corporate productivity and profit growth and the changes it drives in public companies.

Karen H. Wruck of Ohio State University highlighted two noteworthy achievements of PE: "reinvention of the market for corporate control" and the "routinization of an approach to reorganizing for value creation." Peter J. Klein of the University of Missouri-Columbia commented that such reorganizations transform equity holders into active investors. The University of Georgia's Annette B. Poulsen added that Wruck's examination of private placements offered a helpful balance to the tendency to focus on buyouts.

Mike Wright of Nottingham University Business School addressed the growth of the PE sector in Europe, especially in Britain and other major economies. David Ravenscraft of the University of North Carolina at Chapel Hill urged the inclusion of data from emerging-market PE sectors, such as those in Latin America and Asia. Adam Lerrick of AEI and Carnegie Mellon University said that researchers should survey "the impact of private equity and its business model on different cultures."

Leading PE practitioners Brian P. Simmons of Code Hennessy & Simmons, Tully M. Friedman of Friedman Fleischer & Lowe, Thomas Puetter of Allianz Capital Partners, and Rick Rickertsen of Pine Creek Partners discussed issues facing PE investors today.

The final keynoter, David M. Rubenstein of the Carlyle Group, articulated several challenges--including the debate over "carried interest"--and ways that PE can adapt and thrive. Many Americans are wary of PE because of the employment controversy surrounding buyouts, taxation of carried interest, and the alleged enrichment of deal-makers at the expense of employees or taxpayers. Rubenstein defended private equity as a valuable change agent while acknowledging the public image problems and difficult investment environment facing the sector. "The golden days are gone," Rubenstein said, but "the private equity model works very well if it is allowed to operate without undue constraints."

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