The effect of private equity and buy-outs on HRM Essay


            This paper presents an analysis of the article by Nicolas Bacon, Mike Wright, Natalia Demia, Hans Bruining and Paul Boeslie. The topic of the article is “The effects of private equity and buy-outs on HRM in the UK and the Netherlands”. In this article the authors have taken a very sensitive and pertinent issue related to human resources management – effects of private-equity, takeovers and buy-outs. The mindset of employees during any form of takeover is usually fixed on the number of people who will be laid off because they are considered to be redundant. In many cases this happens even when the companies are making a profit and are being taken over solely to improve their market reach and capital. Hence, such mergers and takeovers are increasingly being viewed with suspicion by politicians, regulatory authorities and, needless to say, the trade unions. People belonging to these segments consider that the business owners are mercenarily seeking profits at the expense of a more humane capitalism. In the wake of the current economic instability and the rising unemployment levels across the globe, these claims are extremely serious, and pertinent.

The authors have analyzed these claims in their article, taking UK and Netherlands as their analysis zone, by looking into the corresponding management practices and changes in the companies based in these two countries, at the time of mergers and takeovers. The method of analysis used by them includes both archived data as well as data from a recent questionnaire. The results obtained by researchers’ points out that the proposed reasons i.e. mergers and takeovers do not represent the complete layoff-scenario. They also find that introduction in the newer management practices would be to a lesser degree in Netherlands than in UK, and are also lesser in case of private equity backed buyouts as compared to non-private equity buyouts. This paper analyzes the aforementioned article in detail comparing the suppositions used by the researchers with other similar researchers. The research results are always affected by the methodology used, and hence this part of the article has also been analyzed thoroughly in this paper.

Buyouts and HRM

The article primarily concentrates on buyouts which in recent times have become controversial in the wake of the large number of employee layoffs and change in management policies they bring. This aspect has been analyzed in the article because of the increasing number of such events in the business world. Mergers and acquisitions have in fact come up as an extremely popular strategy for achieving market growth and also diversification. The number of mergers and acquisitions in Europe has increased tenfold in the period between 1991 and 2000, according the M&A Almanac (Harzing, van Ruysseveldt, 2004: 89). The main reason for this is attributed to the global economy, which views the whole world as a single marketplace. Whenever any company merges or is acquired by another company, the strategic vision of the company changes. This means that naturally some of the departments become less important or even redundant. In addition, the company culture of the new company also means that there are certain organizational structure changes, which means certain job-roles and pay structures are no longer viable.

Theoretically these are the reasons why companies look towards cutting the employee force and bring in new management practices. However, it is increasingly been seen that the layoffs are gaining a lot of negative attention by the media as well as political and regulators, not to mention the trade unions, which are always opposed to such practices. The stand taken by these parties, many a times even offensive in nature, is always for the employees being laid off. While this might be a socially good practice, yet the companies are almost always blamed for laying-off employees and no caring about them. The data usually shown is the number of the employees being laid off and the reduction in salaries and perks that are available. However, there is usually no systematic study done to evaluate whether such a move was necessary or fair, and the accurate analysis of the motives behind such practices are usually not done on a case-by-case basis, even though the data is available. The article is important because it attempts to analyze these issues. Mike Wright, Michael Jenson, Douglas Cumming, and Donald Siegel conducted what is the largest study of buyouts till date with a sample of 979 firms, which included firms based in UK and Netherlands. They found that compared to other buyouts the firms in UK and Netherlands has comparatively higher levels of employment, employee empowerment, and wages. Among the two countries, the effect was more pronounced for UK based companies than the Dutch companies. Also the employees in UK enjoyed more discretion over their work practices in private-equity buy outs than non-private-equity buyouts (Wright et al. 2008: 2).

Private equity buyouts and HRM

As can be seen, the HRM issue has two opposing sides – the opinion of the parties considering that the private equities tend to sabotage the employee-employer relations with only short-term profits in mind, and the opinion of the company shareholders who maintain that only non-performing employees are sacked and that the corresponding downsizing and tightening the belt is a necessary option. The research article mentions agency theory which supports the views of regulatory authorities and trade unions. This theory predicts that there will be a tendency to reduce the agency costs posts a buyout. One of the most important features of a buy out is the shedding of employee force. In fact buy outs are usually synonymous with inevitable employee lay offs and in many cases reduction of perks. This is because buy outs need to show some immediate positive results.

As there is a lot of shuffling involved at the time of a management buy out, it is unrealistic to expect results. Hence, many firms look into short term profits, the easiest way of which is to reduce the operational cost by taking off employees. Needless to say, a focus only towards the short term profits is unhealthy for any firm. Usually a complete evaluation is done before a company decides to reduce its labor force. However, in recent times, the profit margins have increased and so have the expectations of the short term profit. This might be one of the reasons for the increased reduction in labor force whenever there is a management buy out or a merger. The concern of the trade unions about redundancies, though valid, is not the only reason why so many parties are suspicious of the private equity. The country’s economy depends on the overall creation of jobs, and many feel that private equity tends to do just the opposite. The private equity firms maintain that their reasons are valid and fair. The one factor that cannot be argued upon is the disturbing number of incidence where large number of redundancies follow a private equity buyout.

An interesting observation which the research article has made is the difference between the mode of cost reduction during buyout between Dutch and UK companies. In the former case, first the employee wages are reduced to industry norms and then the no. of employees are adjusted to meet the remaining changes in the demand. In contrast for the UK companies, the first focus is to reduce the number of employees. The first step probably would be to reduce the number of full-time workers, and shift them to part-time mode. Usually there is no mention of a wage reduction for the existing employees. This fact is corroborated by McFall, who in his book has mentioned a study of private equity buyouts between the two countries. It was found that in both the countries the number of countries recognizing the trade union itself reduced from 34% to 29%. This naturally points towards a presence of hostility between the trade unions and the managers in the buyout firms. The study showed that only one in 10 managers has a positive attitude towards trade unions, and as much as 40% admitted that they were hostile In addition to this, the research also pointed out the workers’ terms and conditions too were weakened by private equity buyouts (2007: 177).

Another study carried out the Center for Management Buy Out Research and Nottingham University Business School found that after buyouts, it was usually seen that the firms has a significantly lower annual wage growth than non-buyout firms. The pressure to do this was extremely high in case of management buy-ins. The study also showed that the size of the firm was directly proportional to the downward pressure on the wages. This meant that a larger firm would face more pressure to reduce the rate of increase in the workers’ wages. A pertinent question that comes then, which was also asked at the end of this particular study, is that the private equity finds usually earn very high returns from the firms they buy and in the light of the fact the employees are the key to long term growth it is certainly surprising that they do not have a corresponding share in these financial benefits (2007: 178). Looking at the above results, one might theorize that the private equity buyouts are less interested in the long term interests of the firm than non-private equity buy outs. Because of this, or a key reason for this is why that private equity buyouts would be less interested in high commitment management practices. This is the first hypothesis that is being verified in the research article.

            Needless to say this forms one side of the argument mentioned above. Private equity firms naturally scoff with this idea, and justify their actions. According to them, it is extremely necessary that management changes are done in the firms because they bring efficient practices with their wide experience, and then the changes they suggest, while not savory in the short terms are definitely in the interest of the firms in the long term. Corroborating this fact is the survey conducted for 1350 UK buyouts over the period 1993-2004 by Wright et al., which pointed out that the employment in the private equity buyouts no doubt decreases initially after the buyout, but after this the figure increases above what it was in the pre-buyout levels. The corresponding figure fund was 21.4% higher than the average by the fourth year after the buyout compared to the year before the buyouts. Management buy-ins on the other hand saw a greater drop in the employment levels immediately after the deal, and the level of employment remains below the figure at the pre-buyout level. The corresponding figure was 3.3%below the pre-buyout level by the fourth year onwards. It is a fair assumption however that the pre-buyout levels may not always be sustainable keeping in view the new strategic vision for the firm (Wright et al. 2008: 2-3). This forms the second hypothesis to be examined in the research article, which is the opposite of the first hypothesis, though the negation one the first one does not automatically indicate that the second is true, which is the reason for this being mentioned as a separate hypothesis.

Role of Financiers

            Role of financiers in private equity is so indispensable that many theorists consider that the actual private equity buy outs started to happen only after financiers such as JP Morgan, Charlie Allen and John D Rockfeller entered the field and used the money they borrowed against the assets of a target company to acquire multiple smaller companies and ultimately build a large business. That is to say the money for the buy out does not directly come from the buyout managers but from third party investors. The investors have their returns while the financiers charge a percentage as management fee. The financiers are professional firms overseeing the buyout and hence have their personal interest in seeing to it that the firm is profitable long after the buyout takes place. However, the role of the financiers is not always the same and ranges from being merely a financial advisor or finance provider to a role where they act as a reviewing and motioning authority for the various processes in the firm (Rickertsen and Gunther 2001: 138-139). As can be seen, the last case is where the financiers have hands on approach towards the take over companies and they have a chance to support the HRM practices taking in view the long term strategic vision of the company. The role of financiers and the corresponding state of management practices form the third and fourth hypothesis to be analyzed in the research article. The hypothesis examines the case where the role of financiers is limited to financial involvement, while the fourth hypothesis is where the role of financiers extends to HRM based advices.

Results analysis

The research article, based on its analysis, found that the buyouts in general have a positive effect on the human resources in terms of the high commitment practices reported (Bacon et al. 2008: 1426). This result is in contrast to the popular beliefs held that the effect of buyouts on human resources is negative. Again the report also mentions that in case of private equity based buyouts too, while there is likelihood that high commitment management practices would be reported, it does not mean that the practices themselves are ignored. The report also mentioned that this result is not universal i.e. not true in case of all companies involved. The results of positive effect on buyouts is usually in case of buyouts based on financiers, who as discussed earlier, have more experience in the management of business. Such buyouts as a rule show an increased tendency to follow good management practices, though again it does not mean that private equity backed buyouts have a negative effect. Hence, the researchers came to the conclusion that the general opinions held by politicians, regulatory authorities and trade unions are not actually correct for the complete buyout market. One factor that does stand out is that while the arguing parties do not agree on the negative and positive effects of the type of buyouts on HRM, both the sides agree that there is most definitely a significant effect. An earlier research based on survey and analysis conducted by Bacon, Wright and Demina, also proves the idea that buyouts have a positive effect on the HRM and eventually leads to increased employment generation. They also take care to point out however that the effect actually depends on the type of buyout – a result that is closely an echo of the present research article being analyzed (2004:340-341).

A previous research paper by Barbara Davison is also pertinent in this case. The research paper pointed out that even in the case of an economic down turn, it does not always pay to cut staff randomly, and that the staffing plans must be linked to the business strategy. This research paper specifically addresses the issue of resizing the organization in case of economic downturn, and staff reduction is a key par of the strategy. The research paper mentioned the rightsizing of Ernst and Young and Schwab, were the resizing was done either by redeploying people to other areas of the company or offering extremely high compensation packages (2002: 34). The sentiment is generally echoed by all the management theorists. It is fair enough to expect that the financiers based buyouts would take care of sizing their organization according to their new  strategic vision. The employee cuts will then follow the number and types of job roles that are considered to be redundant. That is to say, no financier expects immediate payback after they have purchased the company and look for long term profits, and hence they cannot afford to do random decisions to boost up immediate profits.

            The present world is facing an extremely depressing market situation. In this environment many companies feel getting public or private equity to bail them out is the only option as against bankruptcy. In such cases if the company is picked dup by a private equity backed buyout, there is a big chance that there would be too many changes. However, private equity as Wright correctly mentions in his paper, is not a purely private transaction. The details of the deal in general and the condition of the company before and after the deal are generally made available publicly, especially for larger companies. Hence these details have also been analyzed independently as well as with unbiased scientific logic. The results show clearly that while in come cases private equity based buyouts, the practices might be detrimental to the interests of all the stakeholders. However, it cannot be denied that because its own money is involved, the private equity based buyout will perform useful restructuring tailored to the current situation and with the present strategic vision in mind (Wright, 2007: 16-18).

Methodology analysis

Quantitative techniques attempt to eliminate the subjectiveness of the qualitative methods. Quantitative analysis allow for statistical analysis that can help verify or provide confidences in the data. They include methods such as market tests, trend analysis and exponential smoothing. The first step in the quantitative analysis process is to count and rank the responses on the basis of frequencies. The second step is to calculate percentages. The processes and concepts include raw data, frequency, measures of central tendency, normal distribution, asymmetric distribution, spread of distribution, variances, the standard deviation, inferential statistics, bivariate statistics, testing techniques, regression analysis, multivariate analysis, multiple regression, factor analysis, cluster analysis, and discriminant analysis (Nykiel, 2007: 102).

This survey uses questionnaire to collect the information from the managers of the buy out firms. In addition to this archival sources and other financial performance data were also used at the time of analysis. The variables for the analysis were divided into: dependent, independent and control variable. That is to say the independent variable on the action of some control variable would produce dependent variables. The analysis strategy is the multivariate regression analysis. Count data regression approach was chosen as the most appropriate and negative binomial approach was chosen over Poisson approach because of the presence of over dispersion in the data i.e. the mean of the variable is smaller than the variance of the variable. This is because Poisson’s regression model is meant for equal dispersion property. It does handle over dispersion, by moving away from complete distribution specification to the specification of the first two moments. As can be seen the modeling would be inflexible with such an approach in case the degree of over dispersion is large. A more flexible in fact the standard parametric model to account for over dispersion is the negative binomial approach. Negative binomial approach is actually a generalization of the Poisson’s model and includes a disturbance term to account for the over dispersion. Count data regression approach is appropriate in this case because the first dependent variable i.e. high commitment management practices is a count variable that is directly constructed from the responses indicating the presence or absence of a range of HRM practices. All other dependence variables were mean of the variables measuring respective changes taken on a five-point Likert scale. Further analysis was also done to check for the robustness of the result in the model specification using OLS and ordered logic regressions. OLS regression has a single analytical solution. OLS regression tells the degree of variance from a set of change variables. That is to say this analysis will give the extent of variation of the model, in other words its robustness. Ordered logic regression is a more complex modeling process which predicts the ordinal outcome that can be ranked higher than others.

            A fairly local approach used was that each country data was analyzed separately. This gives a clear picture of the information. Also there might be some factors that might exist as a quirk for a certain country, and so it is much better to first view the data separate rather than comparing their corresponding information directly. However, the tests confirmed that there was not much different between the regression coefficients for the two countries, meaning that they could be analyzed together comparatively. Or testing for a country specific structural break, L count models, Wald OLS equivalents of Chow test were used.


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