Can Education and Training Save Low-Wage Workers in the U.S.?
Financial Capitalism, Breach of Trust, and Collateral Damage: Four Cases Eileen Appelbaum, CEPR Rosemary Batt, Cornell University Ian Clark, University of Birmingham BJIR Conference: Across Boundaries London School of Economics December 12-13, 2011 This sessions agenda New Financial Intermediaries Breach of Trust Actively manage claims on wealth creation, distribution Private equity business model
Agency theory and profits Default on implicit contracts and stakeholder claims Four cases will focus on two Challenges to Employment Relations Research 2 New Financial Intermediaries Private equity sponsors (investment firms) Raise PE funds that invest in operating (portfolio) companies Actively insert themselves into management and operations Private equity business model Investment firm (general partner) raises capital from pension funds, endowments, individuals (limited partners) Uses PE fund to acquire portfolio of operating companies
Expectation is fund will make profitable exit in a few years Two and twenty model management fees, carried interest 3 Agency Theory (Jensen & Meckling 1976, Jensen 1986) Provides rationale for LBOs, PE intervention in management Separation of ownership, control = managerial opportunism LBO takes company private, ownership is concentrated Debt good ?
Retained earnings used to service debt Have to borrow to invest subjects these decisions to market test Leads to more efficient allocation of capital LBO boom in 1980s ended in bankruptcies, scandal Buyout firms came back at end of 1990s, as private equity 4 Breach of Trust Distinguish value creating/value redistributing effects of LBOs Agency theory view of commitments to employees, suppliers Defaulting on implicit obligations can benefit shareholders
Can be a virtue shift resources to more productive uses Can be a vice improve financial performance in short-run, undermine competitiveness, viability of firm in long-run PE can seek rents rather than create wealth and profits Change structure and financing to reduce taxes Co-opt management via out-sized financial incentives 5 Four Cases of Collateral Damage Collateral damage
Outcomes that are unintended or incidental to intended outcomes May result from privileging interests of shareholders over those of other stakeholders Often due to breach of implicit contracts with other stakeholders Four cases of LBOs where costs to other stakeholders outweigh gains to shareholders US: Mervyns, Stuyvesant Town/Peter Cooper Village UK: EMI, Cadbury Focus in presentation on two: Mervyns and EMI 6 Mervyns Mid-tier retailer, profitable but needed sprucing up Bought by PE included Sun Capital in 2004
30,000 employees; 257 stores, 155 company owned $1.2 B - $400 M equity, $800 M debt against real estate Op Co/Prop Co model PE prospered via sale of Prop Co, dividend recaps 05, 06 Stores saddled with high rents Promised Investment for turnaround not forthcoming Op Co went through 4 CEOs in 4 years 7 Mervyns Breach of implicit contracts w/vendors led to downfall Trust is critical in dept. store operations Orders to manufacturers paid after delivery of goods Factors finance production, need to believe retailer will pay
Sun Capital refused to give assurances of payment Factors cut off financing for back-to-school Declared bankruptcy July 29, 2008 High rents made it impossible to sell chain liquidated Vendors owed > $102 M, Levi-Strauss owed $12 M PE did fine profits from Prop Co > losses on Op Co 8 EMI
Divisions music publishing, new recording releases Bought by Terra Firma in August 2007 4.2 B, 2.5B loan from CitiBank high debt burden Unlike Odeon cinema deal, no RE assets Difficult to issue bonds against rights to publish songs Publishing profitable, new music division losing money Failure to turn EMI around due in part to global crisis, falling music sales More fundamental: breach of trust w/established artists 9 EMI Breach of trust with established artists
Music industry requires a form of patient capital PE tried to increase shareholder returns Pruned roster of established artists, reduced new artist pipeline Broke implicit contract between artists/repertoire & line managers Alienated EMIs managers: PE as plantation management Established artists w/back catalogue subsidize new artist pipeline Loss leader approach rests on trust between artists/ managers Artists/managers saw management discretion as source of success PE saw it as opportunism and waste
Led to voluntary departure of valuable talent Managers/artists (Rolling Stones, Radiohead, Paul McCartney) 10 Challenges to Employment Relations Research Organizational context for labor has changed Workers, unions, researchers still think in terms of managerial capitalism PE ownership changes goals and governance of firms Trust relations devalued - implicit contracts breached PE use of debt to drive cost efficiencies is at odds with competitiveness based on knowledge and innovation
Long-run competitiveness of firm takes back seat to maximizing financial returns over 3 to 7 year time horizon 11 Challenges to Employment Relations Research Mechanisms for value extraction have changed Finance capital dominates economic and financial activity beyond financial markets e.g., PE portfolio companies Financial actors actively assert and manage claims on production and wealth creation Do this as owners, not as managers accounting value, not economic value via production, dominates decisions Rent seeking not wealth creation
Default on implicit commitments Increased debt not sustainable Bankruptcy as strategy to reduce pension liabilities 12 Challenges to Employment Relations Research May challenge Varieties of Capitalism approach PE operates across borders => to what extent is acquired firms behavior constrained by interlocking national institutions ? PE ownership alters governance of firms moves firms away from embeddedness in national business system What does country of origin tell us about operation of firms Can we still speak of the Britishness of EMI, Cadbury? 13
Conclusion: Challenges for Researchers Realization of value, not creation of wealth, dominates decision making by PE-owned firms May need to examine assumptions e.g., importance of productivity agenda, influence of country of origin Firms governed by PE less able to keep bargains Breach of trust may realize value for owners, but at expense of workers, vendors, other stakeholders Divergence of interests of owners, managers and workers intensified by PE ownership Who should unions bargain with in PE-owned firms, who should researchers interview and study? 14
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