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The Private Equity Enigma: Should Antitrust Enforcement Differ for Private Equity?

Shane Alexander Bryan and Alyxandra Klotz

The Private Equity Enigma: Should Antitrust Enforcement Differ for Private Equity?
Alan Schein via Getty Images

In recent years, the Department of Justice and Federal Trade Commission (collectively, the “Agencies”) have taken special aim at transactions and practices involving private equity companies. The Agencies argue that private equity’s focus on short-term profits and cost-cutting measures distinguish these forms of ownership from other market participants. Over the past year, however, the animus toward private equity has evolved beyond public outcries by the Agencies and academics and manifested in novel challenges to private equity transactions. AAG Jonathan Kanter and Chair Lina Khan have vocally expressed concerns regarding the perceived risks associated with private equity and alleged competitive harms that private equity buyers cause across industries. On just March 5, the Agencies, together with the Department of Health and Human Services, hosted a virtual public workshop scrutinizing private equity’s impact in health care (the “Virtual Workshop on Private Equity in Healthcare”).

The outsized distrust of private equity begs the question of whether antitrust enforcement should differ depending on ownership—private equity or otherwise— and if so, how.

Unpacking Agency Animus Toward Private Equity

This distrust of private equity has led to heightened scrutiny targeting various practices purportedly employed by private equity firms. In particular, the Agencies have taken issue with “roll-up” strategies, characterized by the consolidation of companies through a series of small transactions which, when nonreportable, may avoid Agency review. Additionally, proposed changes to Hart-Scott-Rodino (“HSR”) reporting requirements signal a concerted effort to identify and address “interlocking directorates” among private equity investments, where one firm has representatives on the boards of competing companies. There has also been skepticism around the suitability of private equity companies as divestiture buyers.

Any inclination to disfavor private equity ownership contradicts the longstanding principle that U.S. antitrust law treats all organizational forms equally. Moreover, the intensified scrutiny of private equity seems to extend beyond the typical concern of heightened market concentration or anticompetitive effects, the traditional focus of antitrust merger enforcement. Instead, the apparent focus is on isolated instances of undesirable outcomes in specific industries – outcomes that may not necessarily result from a reduction in competition or anticompetitive behavior within those industries – and which have no causal connection to private equity ownership (instead of traditional public or private company ownership).

Antitrust Enforcement Should Not Differ Based on Private Equity Ownership

Disproportionate suspicion of private equity transactions risks conflating ownership structure with antitrust concerns that would exist regardless of organizational form. Moreover, it overlooks the reality that there is no “singular” private equity business model and discounts empirically demonstrated benefits of private equity investment and ownership.

Do private equity firms fundamentally differ from other profit-maximizing entities and warrant disparate antitrust treatment?

Statements made by current antitrust enforcers suggest that private equity firms’ purportedly short-term investment model leads to price increases and job cuts as part of an effort to generate large profits as fast as possible, harming consumers and workers. The irony, of course, is that public companies were long thought to be too focused on short-run returns to appease Wall Street investors who themselves are more focused on short-run returns. Because private owners both own and control their portfolio companies, they can pursue whatever strategy is likely to optimize the long-term profitability of the business, or its saleability if and when it is sold to another owner. Indeed, the value creation thesis for a private equity firm taking a public company private is not infrequently so that it can make investments on a longer horizon than the public company itself would be willing to do given concerns about the short term accretiveness of investments and their effect on public stock price.

Nevertheless, the suspect belief that private equity has only short-run focus continues to be a core theme of critical rhetoric. For example, at the FTC’s recent Virtual Workshop on Private Equity in Healthcare, Chair Khan pointed to cautionary anecdotes concerning private equity ownership as justification for increased enforcement of private equity acquisitions. In particular, Chair Khan suggested that exploitative strategies used to maximize profits to private owners have impacted union nursing jobs, the doctor-patient relationship, and nursing home mortality rates. However, the reality is that non-private equity firms engage in the same profit-maximizing tactics as private equity firms.

Critics also view private equity, and particularly roll-up acquisition strategies by private equity firms, as leading to higher prices and lower quality of products and services. Yet this is nothing more than a theory of harm applicable to any series of acquisitions that give rise to market power, whether by private equity owners, public or private companies, or non-profits.

The FTC’s challenge against Welsh Carson’s acquisition of U.S. Anesthesia Partners (“USAP”) embodies a law enforcement challenge alleging roll-up strategies by a company with private equity investors. The FTC’s primary allegation is that USAP acquired more than a dozen large anesthesiology practices over a decade and raised subsequently acquired groups’ rates to existing USAP practice’s higher rates, resulting in a substantial markup for doctors. Even though the FTC premised the suit on a somewhat unique combination of conduct and market concentration, the agency has sought to send a deterrence message to other companies employing roll-up strategies.

Despite the frequent association of roll-up strategies with private equity ownership, roll-up tactics are used by numerous types of acquirers in product markets involving smaller local or regional markets – an unsurprising business tactic given distributional, operational and other economies of scale that often present themselves in such businesses. For example, the FTC, in its opposition to Kroger’s acquisition of Albertsons – in an industry widely acknowledged for operating on thin margins – alleged that both grocers achieved their size through a series of mergers over the past three decades as part of a broader trend of significant consolidation in the U.S. grocery industry. Notably, consolidation in the grocery industry has occurred with both privately and publicly owned companies.

Consequently, policymaking and enforcement in response to certain industry consolidation concerns or profit-maximization tactics should remain owner-agnostic. This viewpoint, momentarily acknowledged by one panelist at the FTC’s Virtual Workshop on Private Equity in Healthcare, was otherwise absent from the discussion.

Critics often overlook the fact that private equity-sponsored companies are no different than public firms in the diversity of investment approaches and operation strategies. Where some private equity firms focus on short-term passive investments, many others prioritize serving as long-term business partners to their portfolio companies and providing expert resources to improve and expand access to companies’ products and services. Many private equity firms, large and small, provide support to portfolio companies to help set and implement strategic priorities and make operational improvements. Furthermore, many portfolio companies are focused less on roll-up strategies, and are instead focused on growing companies organically by making capability-expanding vertical and adjacent acquisitions.

The variation of private equity approaches, many of which are procompetitive, raises questions about the logic of a broad formal or informal enforcement policy based on behavioral assumptions of private equity firms (or worse, cartoonish characterizations of them) instead of evaluating transactions or practices or firms on a case-by-case basis. In fact, Goldman Sachs recently highlighted both the variety of PE approaches to portfolio company management, and the possibility that interest-rate-driven headwinds will require many PE sponsors to take different approaches to ownership and growth, including focusing on organic growth in lieu of merger and acquisition strategies.

Applying Behavioral Assumptions Based Solely on Nature of Firm Ownership is Misguided and Harmful

Unsupported assumptions and aggressive enforcement towards private equity is misguided and risks inadvertently harming industries and consumers. Criticisms of private equity’s short investment horizon overlook the potential benefits of private equity investment and ownership. Shorter-term investments are not unique to private equity ­or private ownership more broadly and do not necessarily indicate adverse competitive effects under any antitrust theory.

Private equity firms’ investment strategies and desire for profitability do not imply that private equity portfolio companies will be less competitive. Even if private equity’s investment implied a shorter-term focus, economic models show that a focus on short-term profits can actually result in more aggressive competition. One study examining the effects of private equity ownership on consumers using price and sales data shows an increase in product variety and availability (geographic expansion) following investment by private equity. Further, private equity companies may be particularly well-suited as buyers in divestitures and carve-outs, due to their ability to provide both capital and managerial expertise to companies that would be considered unattractive by other investors’ standards. Scholarship suggests that, particularly in times of financial downturn, private equity backed companies have access to more capital and will invest more than non-private equity backed peers.

It is important to recognize that private equity firms and public companies share comparable competitive motivations and strategies. Narrowing the focus on private equity based on broadly painted behavioral assumptions poses significant risks. Such an approach could deter investment in developing and distressed businesses, potentially limiting access to vital resources that play an important role in fostering competition and consumer benefits across industries.