To understand private equity, you need to go back to what finance historians call the "Go-go `80s." It wasn't called private equity back then; it was called "leveraged buyouts" or LBOs. It was the heyday for corporate finance, to be sure. It made heroes and villains, depending on which side of the transaction you were on, of geeky investment bankers like Henry Kravis, George Roberts and Michael Milken.
These were such dramatic times that they made movies about corporate takeovers. Everyone remembers "Wall Street," a pretty bad movie from a finance perspective. More accurate were films like "Other People's Money" and "Barbarians at the Gate," about the real-world takeover of RJR-Nabisco, then one of the largest corporations in the United States.
It's not about "greed is good," as Gordon Gecko said in "Wall Street." If you look at the deals and you try to understand how someone could offer to take over a company by paying twice what the shares were selling for in the market prior to the takeover, you'll see it was about corporate waste and excess. The former CEO of RJR-Nabisco, F. Ross Johnson, spent corporate money lavishly on golf tournaments, jets and glitzy parties.
In a perfect world, the stockholders' representative, the board of directors, would simply fire someone who is wasting corporate money. But that can take a long time. Executives, hired by boards that are composed of friends, often believe that there's a grand strategy to these extravagances. And in the world of high finance, there really isn't a way to prove that spending is wasteful until years of underperformance drags your stock price down.
Enter the corporate raider. The LBO, now known as private equity, was a way of speeding up the process and making corporate America more accountable and thus more productive. Henry Kravis, George Roberts (both educated in Claremont at Claremont Men's College, now Claremont McKenna College) and others were able to raise billions of dollars, buy huge corporations like RJR-Nabisco and eliminate lots of wasteful spending to make these firms more competitive.
So do these takeover firms fire people? Of course they do - starting with the bad executives like F. Ross Johnson. That's the point.
And of course people further down the food chain also get fired, but these corporations are being run very poorly. The jobs that are lost in takeover were not going to last. Wasteful spending and bad corporate decisions risk the entire corporation and one could argue that fewer jobs are lost in a takeover than the jobs that could be lost by leaving the firm in the hands of bad executive.
"Greed is good" is actually a badly re-written, cynical way of saying competition is good. And it is. It forces producers to be efficient. It brings for consumers the best products at the lowest price. Competition is a powerful force of nature - but it is Darwinian.
If you are the best bakery in town, you will succeed in all likelihood. If you are not, you will fail and your job as a baker will be lost. Similarly, if you are a well-run corporation that produces things efficiently and re-invests in projects intelligently, you will succeed. If not, your firm will fail and all of your employees will lose their jobs.
Corporate raiders try to find wasteful corporations and take them over before they are broke. They try to fix badly run companies so that some jobs survive. They do not ruin firms. Efficient, well-run firms are not the targets of corporate raiders. And the jobs that are lost in corporate takeovers were going to be lost anyway.
But remember, that includes the over-paid, wasteful executive. Firing him or her is the point of the takeover.