There are strange-goings in the world of management. Just a single issue of Business Week (October 30th) contains three stories that would have seemed unbelievable a few years back. The cover story is especially amazing. It’s called Gluttons at the Gate and is summarised thus: ‘private equity firms are using slick new tricks to gorge on corporate assets, helping themselves to fat fees, while leaving the companies they sell dazed and depleted’.
You would expect such daylight robbery to result in a flood of lawsuits and criminal investigations. Sure enough, another report says that ‘charges of outright stealing taint some private-equity outfits’. But most of the daylight robbers appear to be getting away with the loot without any difficult, and in several different ways.
First, they take vast dividends and enormous fees from the companies they temporarily own. They don’t mind dipping into their companies’ piggybanks several times a year for huge charges. They finance their depredations by raising gigantic quantities of debt, so large that it sometimes bankrupts the companies. And they bring private companies to the public market faster and faster - sometimes even before the original public-to-private buy-out is completed.
This high-speed cash-in goes dead against the previous philosophy of the private equity firms, which was to nurse their investments along for up to ten years before taking their enormous profits via the stock market. They could thus pose as capitalist benefactors, improving corporate performance and creating new wealth. Well, they are indeed creating new wealth - for themselves. Money is pouring into the funds - a record $159 billion so far in 2006, four times the whole year’s inflow of 2003. A firm with, say, $30 billion in assets, starts coining money by charging 1-2% management fees on the $30 billion.
With dividends and fees piling up on top, it’s no surprise that a ‘managing general partner’ averaged pay of $6.1 million in 2005, double the 2004 figure. They can, of course, claim that their workload is larger. They’ve become investment bankers, and how. Writes BW: ‘Nowadays, when a private-equity firm buys a company, it typically collects a toll for giving itself advice on the deal, sometimes more than investment bankers receive’. We could be talking of $45 million here - nice work, but nothing like as nice as the $1 billion dividend that the investors in Hertz paid themselves in dividends six months after the purchase.
There’s no end to the greed. When companies go public, their private-equity backers have the gall to demand -and get compensation - for terminating the advisory activities which they have been supplying - again, for fat fees. Where do managers stand in all this? Actually, they don’t, because the legs on which they might stand have been removed - the private-equity buyers have total control over the companies which they have purchased.
If all goes well, anyway, the top management of the buyout will cash in handsomely themselves. Another story in BW shows how greedy senior executives can become. It turns out that, led by Apple, companies in Silicon Valley have been gilding their lilies by illegally backdating option grants to dates which guarantee fat gains on said options; 18 executives have already lost their jobs as the investigators discover more and more of this heinous behaviour.
Another BW item shows that, even without criminal investigation, the topmost managers - CEOs - are becoming notably more insecure. Last year 1,322 of them lost their jobs, a number which may well be exceeded in 2006. But the number of would-be CEOs is not rising to match. According to consultants Heidrick and Struggles, ‘It’s getting harder to fill high-level openings as more candidates opt to work at private-equity firms or run private companies’.
Thus the wheel turns full circle. The vast earnings of CEOs (at least 300 times average worker pay), plus their huge pay-offs on departure (including dismissal) act as springboards to the private-equity honey-pots. And none of this has anything to do with better management or improving American economic performance. Quite the reverse. The short-term is dominating the long-term more and more, creating a bubble which, like all bubbles, is certain to burst.
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