A Change in Agency Views on Private Equity
Since the U.S. administration change in 2021, antitrust agency rhetoric on private equity has ramped up significantly, both in frequency and aggressiveness. Indeed, recent FTC and DOJ commentary has suggested private equity transactions/behavior warrant close scrutiny and should perhaps even be evaluated differently. Specifically, agency leadership has expressed concerns that a perceived private equity focus on short-term profits and aggressive cost-cutting at the expense of long-term strategic growth ultimately harms consumers. For example, FTC Chair Lina Khan, in her 2021 “Priorities” Memo, argued explicitly that “[private equity firms’] business models may distort ordinary incentives in ways that strip productive capacity and may facilitate unfair methods of competition.”
The agencies’ increased attention to, and scrutiny of, private equity has specifically manifested in a greater focus on so-called industry “roll-ups,” increased skepticism of private equity firms as merger-related divestiture buyers and more aggressive enforcement of perceived potential anticompetitive board interlocks. “Roll-ups”—the practice of serially buying and integrating multiple small or mid-sized businesses in the same industry—are, according to DOJ Assistant Attorney General Jonathan Kanter, “designed to hollow out [an industry] . . . and essentially cash out,” a practice “very much at odds with the law, and very much at odds with the competition [the DOJ is] trying to protect.” Ryan Danks, currently the Director of Civil Enforcement at the Antitrust Division, has gone so far as to suggest that private equity firms “are existential threats to [the DOJ’s] merger enforcement program” due to their alleged consistent failure to observe HSR filing protocol, particularly in the context of bolt-on transactions.
With respect to merger-related divestitures, both Chair Khan and AAG Kanter have questioned whether private equity buyers are incentivized to aggressively compete using the divested assets, and, in turn, whether they are suitable buyers for those assets. According to Chair Khan, regulators should be “skeptical” when private equity firms take on the divested assets so as to not “miss the bigger picture” that an industry may have “a huge private equity firm controlling [it].” The DOJ was equally critical of private equity’s incentives—and the parties’ proposed private equity divestiture buyer—in its challenge to the UnitedHealth/Change Healthcare merger in 2022, arguing that private equity firms are allegedly poor divestiture buyers because “[t]heir incentives or commitments to innovation are not always aligned with those of the strategic buyer.” This view was ultimately rejected by the court in its ruling in favor of the merging parties.
Further, the agencies have signaled a renewed focus on Section 8 of the Clayton Act, which prohibits anticompetitive board interlocks (i.e., where an individual concurrently serves on the boards of independently-owned competitors). For example, AAG Kanter has publicly advocated for Section 8 as “[o]ne tool that I think we can use more” and stated that the DOJ “will not hesitate to bring Section 8 cases to break up interlocking directorates.” These investigations recently culminated in numerous directors resigning from multiple U.S. public company boards. Director Danks echoed this sentiment, noting recently that “private equity companies should not consider nominally independent directors to be automatically safe [from Section 8 issues].”
The largely anti-private equity views expressed by Chair Khan and AAG Kanter are, however, not necessarily consistent with previous agency policy, opinions of past agency leadership or even, in the case of Chair Khan, other current FTC commissioners (at least until Commissioner Christine Wilson’s recent resignation). In fact, the antitrust agencies historically held the view that private equity—especially in the divestiture context—can be a positive competitive force. For example, the recently revoked DOJ Merger Remedies Manual included a statement that “in some cases a private equity purchaser may be [a] preferred” divesture buyer. In 2018, FTC Chair Joseph Simons defended private equity firms’ participation in merger-related divestitures as providing needed liquidity and management expertise without a significant risk of anticompetitive effects. More recently, former DOJ AAG Makan Delrahim warned that viewing private equity ownership as inherently suspect “actually will harm consumers and competition,” and pointed to multiple academic studies suggesting that private equity is both good for competition and helps companies survive—and sometimes thrive—in adverse economic conditions. Similarly, former Obama administration Treasury Secretary Larry Summers recently stated that he is concerned about the “generalized feeling of hostility and outrage towards business” at the FTC and DOJ and does not understand why “whether a firm is owned by public shareholders or private equity shareholders” should affect the outcome of a merger review.
Former FTC Commissioner Christine Wilson, the lone Republican commissioner among the 3-1 Democratic majority until her recent resignation, maintained a skepticism of Chair Khan’s arguments regarding the negative impact of private equity on competition. In a November 2022 dissenting statement, Commissioner Wilson suggested that the Commission’s proposed expansion of its authority under Section 5 of the FTC Act, which portends greater private equity-related enforcement, “resemble[d] the work of an academic or think tank fellow who dreams of banning unpopular conduct and remaking the economy.” In an article announcing her resignation, Commissioner Wilson called recent FTC actions “a tax on all mergers” set up to “substitute for unfulfilled [Progressive] legislative desires.” Commissioner Wilson was also highly critical of the FTC’s reimplementation of prior approval requirements in connection with divestitures, a policy which disproportionately affects private equity firms given their generally acquisitive business model. Specifically, Commissioner Wilson stated in public remarks at the 19th Annual International Mergers and Acquisitions Conference in June 2022 that “[l]abeling an acquirer a recidivist and penalizing it with a broad and burdensome prior approval requirement . . . is a substantial change in the accepted process for merger review.”
In sum, the anti-private equity approach endorsed by Chair Khan and AAG Kanter represents a substantial change in FTC and DOJ policy. It is certainly far from a well-established fact (as current agency leadership contends) that private equity involvement necessarily leads to reduced incentives to compete—in fact, as noted above, private equity ownership may have significant procompetitive benefits. As we explain further below, the antitrust agencies’ current approach to private equity is not only a substantial—and suspect—enforcement shift, but also lacks unambiguous empirical support.
Empirical Evidence For Pro-Competitive Effects of Private Equity Ownership
As noted above, while recent DOJ and FTC statements on private equity are not grounded in long-standing agency precedent, they also lack consistent empirical support. One common criticism of the private equity business model in the competition context is that private equity firms are typically focused on a near-term investment horizon that does not prioritize long-term, sustainable growth (though it is important to note that private equity ownership does not necessarily equate to a short investment horizon by default). Another is that private equity access to a wide variety of financing options leads to highly leveraged—and unstable—investments that are vulnerable to economic swings. A third is that private equity management lacks specific hands-on industry experience required to effectively run the acquired business.
From the perspective of economic principles, there is no reason to expect these characteristics—even if they were true, for argument’s sake—to necessarily result in anticompetitive effects. For example, in standard economic oligopoly models, a focus on short-term profits can result in more aggressive competition because firms have increased incentives to under-cut competitors and gain market share. Furthermore, a company that reduces marginal costs and increases productivity would be expected to pass through at least some of those savings to consumers in the form of lower prices. Greater alignment between the incentives of firm management and private equity ownership may also lead to more efficient management, cost savings, and focused R&D, which are also likely to increase a firm’s ability to compete.
In fact, private equity plays an important role in disciplining incumbent firms and corporate leadership to maximize profit in the interest of their shareholders—if management of a public company underperforms, the company becomes an attractive target for private equity investors and management risks being replaced. This threat by itself serves to keep management on their toes. Private equity investors may also be willing and able to invest in companies that few other investors would—for example, merger-related divestitures, mis-managed or neglected carve-outs, start-ups, or smaller businesses from which the owners are seeking to exit. Increasing the hurdles for private equity acquisitions would likely lead to overall less efficient allocation of capital and managerial skills. While the articles referenced in this section are focused on effects at individual companies that were acquired by private equity and not at the macroeconomic level, these articles also illustrate the impact of a well-functioning market for corporate control.
The effects of private equity ownership on the performance and competitive behavior of portfolio companies is ultimately a question that can be addressed empirically and is the one we examine below. It is important to note, however, that empirical studies face a number of challenges. First, a particular study’s findings may be difficult to generalize to other settings or industries. Second, it may not be clear that a firm’s ownership is really causing the identified effects—i.e., typical private equity targets may differ from other companies in important ways, not all of which may be observable. Finally, in many settings and industries, pricing data and other measures of consumer welfare are not readily available, making it impossible to study effects on these metrics directly. Notwithstanding these caveats, however, economic literature on the effects of private equity ownership is robust and, seemingly contrary to recent FTC and DOJ opinion, often finds a positive correlation between private equity ownership and improved company performance that is indicative of procompetitive effects.
Positive Effects on Labor Productivity and Employment. The most comprehensive study of the economic effects of private equity ownership is likely a study by Davis et al. that uses firm- and establishment-level data from the U.S. Census to study approximately 6,000 private equity acquisitions between 1980 and 2013. The authors specifically examine employment and productivity changes at companies acquired by private equity firms relative to observationally similar companies, and relative to the company’s own growth history. The study finds that labor productivity, measured as revenue per worker, generally increases substantially after a company is acquired by a private equity firm. In the case of previously privately-held targets, the target company, on average, added jobs. In the case of previously publicly-held targets, the target company, on average, saw job reductions. These different effects between privately-held and publicly-held targets are consistent with the economic literature finding that publicly-traded companies are more likely to be bloated, while privately-held companies are more likely hampered in their expansion due to difficulties in accessing capital. Private equity investors are able to address both of these problems by providing access to capital for privately-held firms and greater managerial oversight for publicly-held firms. In sum, this study suggests that private equity management typically leads to more efficient production, which in turn has obvious positive competitive effects.
Positive Effects on Quality. Further evidence of private equity ownership leading to better operational efficiency is documented in a study of the restaurant industry conducted by Bernstein and Sheen. Using data on close to 50,000 Florida restaurants from 2002 to 2012, the authors compare changes in health inspection outcomes at restaurants within the same zip code that were acquired by private equity vs. those not acquired by private equity. The study finds that after the private equity acquisition, the number of critical violations found by surprise health inspections decreased significantly relative to the control group restaurants that were not acquired by private equity. Digging further into how private equity firms achieved these improvements, the study finds that they are likely attributable to the operational expertise provided by the private equity firm: private equity restaurant acquisitions where at least one responsible partner had previous experience in the restaurant industry saw particularly large improvements in quality.
The above study paints a data-based picture that is at odds with qualitative statements by agency leadership that suggest private equity ownership leads to lower quality. On the contrary, the study shows that private equity ownership tends to enhance quality, which is a significant procompetitive benefit. It also casts doubt on the very premise of these agency statements—that a supposed short-term investment horizon necessarily means lower quality and an otherwise lessened ability or incentive to effectively compete. The quality gains reflected above are neither indicative of a nearsighted strategy nor suggestive of reduced competitiveness.
Positive Effects on Responding to Financial Crises. A study by Bernstein, Lerner and Mezzanotti investigates the ability of private equity-owned firms to respond to substantial macroeconomic changes and economic crises by looking at the financial decisions and performance of private equity-owned companies during the 2008-2009 financial crisis. The study sample consists of almost 500 private equity-owned companies and over 1,000 observationally similar control companies headquartered in the U.K. The study finds that companies generally decreased their capital investments substantially during the financial crisis; however, private equity-owned companies reduced these investments significantly less than companies not owned by private equity, and saw a resulting boost in their sales relative to the industry. In connection with the study, the authors conducted a survey of private equity firms, which confirmed that many of these firms actively assisted their portfolio companies during the financial crisis by, e.g., arranging financing that was otherwise difficult to obtain. The survey respondents also cited freedom from the demands placed on public companies to deliver short-term results and answer to shareholders as beneficial in facilitating a rapid response to a changing economic environment (interestingly, the survey respondents indicate that it was public companies that are required to focus more on short-term gains, which is opposite of the agencies’ concern regarding private equity). These results provide strong evidence that private equity ownership increases—or at the very least, sustains—the competitive viability of portfolio companies during financial crises.
Positive Effects on Product Variety and Availability. A recent study by Fracassi, Previtero, and Sheen investigates the effects of private equity ownership on product market outcomes. The study uses supermarket scanner data on nearly 2 million consumer products sold between 2006 and 2016 in the U.S. 236 manufacturers in the sample were acquired by private equity firms during the relevant time period.
The study finds that sales revenues increased dramatically for private equity-acquired companies in the years following the acquisition. Critically, this growth was not driven by higher prices (which increased minimally), but rather by expansion in the number of products sold and the geographic sales area. In particular, private equity-acquired manufacturers launched new products in existing—as well as new—product categories and expanded the availability of products across retail chains and geographies. Consistent with certain of the studies discussed above, this study presents further evidence suggesting that private equity investors are often well-positioned to grow consumer goods companies by alleviating financing constraints and providing managerial experience, which in turn make these companies more competitive.
Positive Effects on Innovation. A study by Lerner, Sørensen, and Strömberg investigates the effects of private equity ownership on innovation by looking at changes in patent activity by private equity-acquired companies, comparing the period before and after the acquisition. The study’s sample consists of close to 500 companies that were acquired by private equity firms between 1986 and 2005, and over 6,000 patents applied for by these companies over an eight year period, spanning from three years prior to the acquisition until five years post-acquisition. The study finds evidence that the patents applied for after the private equity acquisition are both more important, as measured by patent citations, and more focused on the company’s core technologies. At the same time, the study finds no evidence for substantial decreases in the total number of patents or in the patents’ originality or generality. These results suggest that private equity firms generally do not sacrifice long-term investment for short-term gain, but rather tend to implement a greater focus on R&D efforts that are essential to the company’s growth.
Positive Effects on Divestitures. The studies discussed above generally look at acquisitions of entire firms by private equity. A specific concern about private equity in the merger context, however, is whether private equity buyers are “good” buyers of assets that merging firms need to divest in order to mitigate antitrust concerns. Although not focused on merger-related divestitures, a study by Hege et al. investigates the performance of operating assets sold to private equity using a sample of approximately 500 sales of operating assets by public companies (“divisional buyouts”) that occurred between 1994 and 2006, of which 161 were purchased by private equity. The study finds that the enterprise value of the divested assets in the hands of private equity investors on average grows faster than public companies in the same industry and of similar size. The authors conclude that these empirical findings are consistent with private equity investors having restructuring capabilities that allow them to pay more for the acquired assets—and grow their value more—than corporate acquirers.
Empirical Studies of Antitrust Issues Associated with Private Equity Acquisitions But Not Unique to Private Equity
As noted above, current agency leadership has suggested that “roll-up” transactions and Section 8 issues are particularly relevant to the private equity space. However, a number of studies suggest that these issues are not unique to private equity firms and do not merit special treatment when they do implicate the private equity space.
Roll-Ups. “Roll-up” acquisitions are currently under particular scrutiny, in part, because they may not trigger reporting requirements and thus can “fly under the radar” of the antitrust agencies. As an initial matter, “roll-ups” are far from the norm—according to Bain, only about one fifth of private equity transactions globally have been acquisitions that “add” to existing portfolio companies (which presumably includes “roll-up” acquisitions, but may also include acquisitions that add new capabilities or have a vertical component). The concern is also not exclusive to private equity. As several economic studies have found, firms in numerous industries and settings structure deals in ways intended to minimize antitrust risks. For example, Kepler et al. looked at all U.S. mergers and acquisitions announced from January 2001 through February 2020 (with the exception of very small deals and certain regulated industries), including both public and private targets and acquirers, and found a large concentration of deals right below the HSR filing thresholds. From an economic perspective, this behavior is hardly surprising—one would expect firms to respond to incentives created by the regulatory environment. Importantly, however, Kepler et al. also found that a relatively large proportion of transactions bunched right below the HSR filings thresholds was comprised of acquisitions of privately-held targets by publicly-held firms, while a relatively small proportion was comprised of acquisitions of privately-held firms by other privately-held firms, suggesting that private equity acquisitions are unlikely to be a major component of this number.
Additionally, it is not accurate to assume that “roll-up” acquisitions are inherently anticompetitive—indeed, small, incremental acquisitions often generate the largest efficiencies (these acquisitions may also generate economies of scale that could not otherwise be achieved). A 2019 McKinsey study found that companies engaged in many small deals that accrue to a meaningful amount of market capitalization over multiple years achieved higher excess total shareholder returns compared to companies that engaged in other M&A strategies. Such acquirers typically have well-established organizational infrastructure and integration/management best practices, which may explain the success of this strategy. While this study was limited to large public companies, it supports the idea that efficiencies may be particularly large for small acquisitions that are part of a “roll-up” approach.
Interlocking Directorates. This issue of interlocking directorates is similarly not unique to private equity. Looking at companies in the S&P 1500, Nili found that, in 2016, over 80% of these companies had at least one director on their board who concurrently served on the board of another company in the same industry. Additionally, over one quarter of companies had at least one director on their board who concurrently served on the board of another company in the same four-digit SIC code. Firms operating in the same four-digit SIC code may not necessarily be competitors, but directionally these findings suggest that interlocking directorates are also a significant issue for publicly traded companies as well as private equity firms. A study by Manjunathet et al. also supports this point—there, the authors found a substantial number of director interlocks in publicly traded life science companies.
It is critical to remember that, despite recent statements from FTC and DOJ leadership to the contrary, the notion that private equity investment is “bad” for competition is a relatively recent—and novel—theory. As we have demonstrated in this article, the mere fact that private equity firms may have a different investment strategy or operating philosophy than public companies or other privately-held businesses does not mean private equity-owned portfolio companies will be less competitive or sacrifice long-term competitive viability in the interest of making a “quick buck.” In fact, some of the present concerns with private equity, such as a focus on short-term profits, can also produce procompetitive benefits. Previous FTC and DOJ leadership—and longstanding FTC and DOJ policy—recognized as much and acknowledged the many benefits private equity offers from a competition standpoint, including the fact that private equity ownership can actually enhance long-term competitive success by providing relief from adverse macroeconomic conditions. Empirical evidence also supports the notion that private equity ownership allows for faster growth and greater investment in critical R&D, and improves a company’s ability to respond to shifting market conditions. The goal of many private equity firms—to generate returns for investors—is not at odds with competitive growth; lest we forget, public companies have a similar duty to maximize value for their shareholders, and yet current agency leadership has not subjected public company boards to the same criticism. It is important to remember that the recent flurry of agency skepticism regarding private equity does not represent long-standing policy—or even consensus opinion—and, at the very least, is inconsistent with empirical and academic studies that recognize the competitive benefits of private equity ownership.