Research Suggests Recent LBOs Have Generally Had a Positive Impact on the Financial Performance of Acquired Companies, but LBOs Were Associated with Lower Employment Growth

Academic research on recent LBOs by private equity firms suggests that  the impact of these transactions on the financial performance of acquired  companies generally has been positive, but these buyouts have been  associated with lower employment growth at the acquired companies. We also found some  evidence that recent private equity-sponsored LBOs were associated with  lower employment growth than comparable companies. However,  uncertainty remains about the impact of such buyouts on employment, in  part because, as one study found, target companies had lower employment  growth than their peers before acquisition. Nevertheless, some large club deals have been the object of several recent  shareholder lawsuits and, according to media reports and securities  filings, have led to inquiries by the Department of Justice’s Antitrust  Division. Our Analysis Indicates That Public-to-Private Club Deals, in Aggregate, Generally Are Not Associated with Lower or Higher Prices Paid for Target Companies, and the Private Equity Marketplace Is Predisposed to Perform Competitively

To examine the potential effect club deals may have on competition  among private equity firms, we developed an econometric model to  examine prices paid for target companies in a subset of all private equity  deals—that is, those transactions where the target company is publicly  traded. 4). Because private equity funds and their advisers typically claim an  exemption from registration as an investment company or investment  adviser, respectively, SEC exercises limited oversight of private equity  funds and their advisers. Growth in Private Equity- Sponsored LBOs Has Led to Greater Regulatory Scrutiny

SEC and others generally have not found private equity funds or their  advisers to have posed significant concerns for fund investors. Before the problems related to subprime mortgages spread to the  leveraged loan market in mid-2007, the regulators generally found that the  major commercial and investment banks had adequate risk-management  practices but noted some concerns, such as weakening of underwriting  standards and significant growth in leveraged loan commitments. In light of this situation, regulators have  reviewed the risk-management practices of commercial and investment  banks and identified some weaknesses. However, it is often difficult  to determine whether the impact resulted from the actions taken by the  private equity firms or other factors, due to some limitations in academic  literature. In that regard, further research may shed light on the  causal relationship between private equity and employment growth, if any. Our econometric analysis of a sample of public-to-private LBOs generally  found no indication that club deals, in aggregate, are associated with  higher or lower prices paid for the target companies, after controlling for  differences in targets. But, our analysis does not rule out the possibility of  parties engaging in illegal behavior in any particular LBO. SEC generally has not found private equity funds to have posed significant  concerns for fund investors. While  financial institutions have taken steps to decrease their leveraged lending  exposures, the unexpected increase in such exposures due to the spread  of problems with subprime mortgages to other credit markets illustrates  the importance of understanding and monitoring the conditions in the  broader markets, including potential connections between markets. Failure of regulators to understand and fully consider such  interconnections within the broader markets and their potential systemic  risk implications can limit their regulatory effectiveness and ability to  address issues when they occur. Appendix I: Objectives, Scope, and Methodology

As agreed with your staff, the report’s objectives are to    determine, based largely on academic research, what effect the recent  wave of private equity-sponsored leveraged buyouts (LBO) has had on  acquired companies and employment;   analyze how the collaboration of two or more private equity firms in  undertaking an LBO (called a club deal) could promote or reduce  competition, and what legal issues have club deals raised;  review how the Securities and Exchange Commission (SEC) has overseen  private equity firms engaged in LBOs under the federal securities laws; and review how the federal financial regulators have overseen U.S. commercial  and investment banks that have helped finance the recent LBOs. As a result, total debt decreased by $555 million from 2005 to 2007.
Why GAO Did This Study

The increase in leveraged buyouts (LBO) of U.S. companies by private equity funds prior to the slowdown in mid-2007 has raised questions about the potential impact of these deals. Some praise LBOs for creating new governance structures for companies and providing longer term investment opportunities for investors. Others criticize LBOs for causing job losses and burdening companies with too much debt. This report addresses the (1) effect of recent private equity LBOs on acquired companies and employment, (2) impact of LBOs jointly undertaken by two or more private equity funds on competition, (3) Securities and Exchange Commission's (SEC) oversight of private equity funds and their advisers, and (4) regulatory oversight of commercial and investment banks that have financed recent LBOs. GAO reviewed academic research, analyzed recent LBO data, conducted case studies, reviewed regulators' policy documents and examinations, and interviewed regulatory and industry officials, and academics.

What GAO Found

Academic research that GAO reviewed generally suggests that recent private equity LBOs have had a positive impact on the financial performance of the acquired companies, but determining whether the impact resulted from the actions taken by the private equity firms versus other factors is difficult. The research also indicates that private equity LBOs are associated with lower employment growth than comparable companies. However, uncertainty remains about the employment effect--in part because, as one study found, target companies had lower employment growth before being acquired. Further research may shed light on the causal relationship between private equity and employment growth, if any. Private equity firms have increasingly joined together to acquire target companies (called "club deals"). In 2007, there were 28 club deals, totaling about $217 billion in value. Club deals could reduce or increase the number of firms bidding on a target company and, thus, affect competition. In analyzing 325 public-to-private LBOs done from 1998 through 2007, GAO generally found no statistical indication that club deals, in aggregate, were associated with lower or higher prices paid for the target companies, after controlling for differences in the targets. However, our results do not rule out the possibility of parties engaging in illegal behavior in any particular LBO. Indeed, according to securities filings and media reports, some large club deals have led to lawsuits and an inquiry into the practice by the Department of Justice. Because private equity funds and their advisers typically claim an exemption from registration as an investment company or investment adviser, respectively, SEC exercises limited oversight of these entities. However, in examining some registered advisers to private equity funds, SEC has found some control weaknesses but generally has not found such funds to pose significant concerns for fund investors. The growth in LBOs has led to greater regulatory scrutiny. SEC, along with other regulators, has identified conflicts of interest arising in LBOs as a potential concern and is analyzing the issue. Before 2007, federal financial regulators generally found that the major institutions that financed LBOs were managing the associated risks. However, after problems with subprime mortgages spilled over to other markets in mid-2007, the institutions were being exposed to greater-than-expected risk. As a result, the regulators reassessed the institutions' risk-management practices and identified some weaknesses. The regulators are monitoring efforts being taken to address weaknesses and considering the need to issue related guidance. While the institutions have taken steps to decrease their risk exposures, the spillover effects from the subprime mortgage problems to leveraged loans illustrate the importance of understanding and monitoring conditions in the broader markets, including connections between them. Failure to do so could limit the effectiveness and ability of regulators to address issues when they occur.