Buzz

PE Buzz: A PE-rfect union

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP


Originally published in The Deal.com on July 20, 2007.

The extraordinary success of the managers of private equity funds has provoked controversy in the United States.

A major issue has to do with the entitlement of labor unions to sit at the table when a buyout is negotiated. The unions argue egregious returns are being achieved on the backs of the target's rank and file, who have no voice in the process.

In an interview with Andy Stern of the Service Employees International Union in The Wall Street Journal on May 30, Stern said that the SEIU wants to "engage . the buyout kings," with whom he "much prefers working" versus "their public company counterparts."

The verb "engage" needs definition. What exactly does the union have in mind? The answer is contained in a formal SEIU study, "Behind the Buyouts: Inside the World of Private Equity," from which I quote . first, the union's case for "engagement."

"The buyout deals and money-generating strategies that are generating immense wealth for the private equity buyout industry and many of its investors can have harsh consequences for workers and the companies they buy and sell.

"In every case [cited by the union], the workers themselves had almost no voice in the process, little information about their new employers and no role in developing the plans that were going to change their lives for the worse."

On the other side of this coin is an interesting piece in The New Yorker by James Surowiecki, which turns the SEIU argument on its head by suggesting it is the public company managers who opt, when under attack by activist shareholders and/or quarter-to-quarter investors, for a seemingly easy fix . reduce costs by firing a bunch of employees even though the layoff makes no sense in the long run.

As Suroweicki put it: "A CEO is likely to look to layoffs [in the public company context] as a solution because that's what almost everyone else does."

He wrote that, "downsizing has become less a responsible disaster than a default business strategy . the increasingly short-term nature of CEO's jobs, along with the pressure on them to deliver results quickly, doesn't help matters. The average CEO's tenure today is just six years, long enough to see the benefits of downsizing (like a lower payroll) but not long enough to suffer costs that may appear in the long term. And the lack of job security means executives have to worry more about what shareholders and analysts are saying."

If Suroweicki is right, private managers have a better appreciation of the value of the work force; and, since they are not driven by the necessity of quarter-to-quarter performance, they can take a long-range view toward enhancing value based on increased contributions, not knee jerk cuts.

All that said, if clueless layoffs are designed only to serve symbolic purposes, why not give the unions a voice . "you [the new managers] don't have to send factitious signals to investors in the public markets; let us help you exploit the value of your work force and mine it for more profits."

Pretty seductive. But one problem may be the full scope of Stern's objectives, of which avoiding layoffs is only one piece, see the formal proposals in the SEIU, viz:

a Workers should have a seat at the table when deals are being made.

a Workers should have paychecks that can support a family.

a Workers should have quality, affordable healthcare coverage.

a Workers should have secure retirement benefits.

a Community stakeholders should have a voice in the deals.

a Buyout firms should play a proactive and constructive role in the communities affected by their deals.

a Community stakeholders should be involved as deals are being made.

a The private equity buyout industry and community stakeholders should use wealth generated by deals to improve the quality of life, the environment, the health, the safety and the long-term stability of communities.

On the surface, the words are appealing. Who could be against "qualify of life, the environment, healthcare, long-term community stability, secure retirement benefits"? That said, it does not take the proverbial rocket scientist to call up historical analogies; a statist regime like those mandated, at least until quite recently, in Germany: labor unions, plus local and national politicians, all staking claims, alongside those of the shareholders, on company profits and management strategies.

As such, the program Stern suggests runs afoul of the findings of an influential academic, Michael Jensen, who remarked that the "arbitrage favoring the private over the public market [lies] . in the control the actual owners are able to exercise over the manager; absent that iron-fisted control . the pressure on [public] management to waste cash flow through organizational slack or investment in unsound projects is often irresistible."

Think about it. Fund X wants to buy Acme Products and pay the shareholders $10 to $15 a share for stock that has never been traded above $10. The theory: Ownership control over management will improve the investment strategy . no cash flow into "unsound" projects. Acme shareholders like the deal . but "whoa!" The SEIU demands guarantees from Acme's new owners: defined benefit retirement for all, plus "quality" healthcare. And, the mayor of Acmetown demands: no plant closures ("long-term stability") and underwritten responsibility for "quality of life," including low-cost housing; a new football stadium; and no plant deliveries during school hours.

The argument against the SEIU, in short, is that diversion of management attention from the single-minded pursuit of revenues and profits is "unsound," i.e., uneconomic, even though the collateral objectives are appealing. To cite one example, where is that uber manager able to figure out how to satisfy the SEIU menu of objectives and balance the same against profits to the owners, when the plenipotentiaries in Washington have fallen down on just about every (e.g. quality healthcare, secure retirement environment) item on the list.

In short, SEIU and other activists would be well advised to heed the advice of Samuel Gompers, one of the greatest labor leaders in U.S. history: "The worst crime against working people is a company which fails to operate at a profit."


Joseph W. Bartlett, Special Counsel, JBartlett@McCarter.com

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