Final Data Collection Report as of 24 June 20091
EUROPEAN ECONOMIC AND SOCIAL COMMITTEE (EESC)
CONSULTATIVE COMMISSION ON INDUSTRIAL CHANGE (CCMI)
Data collection study on the impact of private equity, hedge and sovereign funds on industrial change in Europe
Final Report (*)
This study was prepared by WILKE MAACK UND PARTNER (Hamburg, June 2009) as input for the EESC opinion CCMI/049 on "The impact of private equity, hedge and sovereign wealth funds on industrial change in Europe",
available at
(*)The contents of this study do not necessarily reflect the views of the EESC.
Contents
Executive Summary
1Introduction and overview of this report
1.1Background and key questions addressed
1.2Character, methodological approach and structure of this report
1.2.1Objectives and tasks of the study
1.2.2Compiling, evaluation and presentation of existing data and sources
1.2.3Analysis of functioning of private equity, hedge and sovereign funds
and impacts on industrial change
1.2.4Structure of this report
2Private Equity, Hedge Funds and Sovereign Wealth Funds – their role in European financial markets 2003 - 2008
2.1Overview and assessment of data sources
2.2Overview of relevant financial databases
2.3Role of different forms of private investment in European financial markets 2003 - 2008
2.3.1Overview
2.3.2Private Equity
2.3.3Hedge Funds
2.3.4Sovereign Wealth Funds
3Functioning and Business Models of Private Equity, Hedge Funds and Sovereign Wealth Funds
3.1Introduction and overview
3.2Private Equity
3.2.1Evolution of transaction volumes
3.2.2Main industry sectors of activity
3.2.3Duration of involvement
3.2.4Financial instruments to complete the transactions
3.2.5Ways of terminating transactions
3.3Hedge Funds
3.3.1Evolution of transaction volumes
3.3.2Main industry sectors of activity
3.3.3Duration of involvement
3.3.4Financial instruments to complete the transactions
3.3.5Ways of terminating transactions
3.3.6Other forms of Hedge Fund investments
3.4Sovereign Wealth Funds
3.4.1Evolution of transaction volumes and main sectors of activity
3.4.2Duration of involvement and financial instruments to complete the transactions
3.4.3Ways of terminating transactions
3.5Fund-specific SWOT assessments and initial conclusions regarding the impact on industrial change
3.5.1Private Equity Funds
3.5.2Hedge Funds
3.5.3Sovereign Wealth Funds
4The impact of Private Equity, Hedge Funds and Sovereign Wealth Funds on industrial change
4.1Dimensions of industrial change and the impact of alternative investments
4.2Overview of existing research and analyses
4.3Methodological problems and other limitations of analyzing the impact of funds on industrial change
4.4Empirical evidence on the impact on industrial change at company level
4.4.1Firm performance, profits and value creation
4.4.2Impact on employment development
4.4.3Wages and working conditions
4.4.4Social dialogue and information and consultation at firm level
4.4.5Management practice, corporate cultures and governance
4.5Evidence from case study research
4.5.1Evidence on the impact on industrial change at enterprise level
4.5.2Impact on employment, working conditions and labour relations
4.6Conclusions: What we know and what we don’t know
5The financial crisis and Private Equity: Implications for industrial change
5.1Introduction
5.2 The Current Situation in Private Equity
5.2The crisis in Private Equity and its implications for financial stability
5.3Implications for the Micro Level
5.4Upcoming Problems in PE Target Companies
6Conclusions
7References
Executive Summary
- This report summarizes findings of a data collection study carried out between January and June 2009 in order to support the ongoing work of the EESC’s Consultative Commission on Industrial Change (CCMI) on the impact of private equity, hedge and sovereign wealth funds on industrial change in Europe.
- Purpose: The main purpose of the research was to collect, evaluate and present a comprehensive overview on existing data and relevant sources of knowledge and empirical evidence on the impact of the three types of funds on industrial change in Europe. With regard to the latter, the focus was mainly on industrial change at the company level.
- Tasks: Our research in particular focused on three distinctive tasks: First, to compile, evaluate and summarize existing data and sources on the three types of funds; secondly to analyse the functioning and respective business models of private equity, hedge and sovereign funds and thirdly, to summarise existing knowledge on the impact of the three types of alternative investment funds on industrial change in Europe.
- Transparency and availability of data: it can be stated that there is a lack of transparency in PEF, HF and SWF reporting, which creates a serious problem for evaluating the impact of these funds. On the fund level decision makers are generally not required to publish data accessible to the public at large, and the quality and accuracy of information that can be gained through data bases is uneven. On the company level the reporting requirements for private (non-listed) companies vary considerably from country to country, as does the mode in which this information is made available to the public. Furthermore, companies often change name when ownership is transferred due to an investment transaction. As a result, it is virtually impossible to present a large and comprehensive dataset of private companies with more information than sector, address, date of investment, etc. from the typical online data services.
- Growing importance of PE,SWF and HF as investors: While the relative size of HF, PE and SWF may seem modest at a global level, the relative importance of the first two types of investors is increased by 1) the use of leverage of 2-3 times own capital and by 2) the concentration of many activities within certain markets. The report gives indications and figures for the relative importance of the different funds in Europe and a list of the 10 most important actors for each of the fund types.
- Different business models and impacts on industrial change: Private Equity, Hedge Funds and Sovereign Wealth Funds in general follow different business models which also influence their behaviour and specific expectations as investors and/or owners. Differences for example exist in the type of investment made and in the time horizon, which is in some cases very short-term and focused on liquid financial assets. In contrast Sovereign Wealth Funds generally following a long-term agenda which is following not only financial but also national economic policy goals.
- Differences within the three types of investment funds: Beside these general differences between the funds it is also important to stress differences within certain types of funds and differences with regard to the role of these funds in different stages and situations of business development, e.g. a start-up situation, growth phases, merger and acquisitions, turnaround and crisis situations. Since all of these forms of business development either follow or result in industrial change at the enterprise level it is important to assess the role of the three types of funds also with regard to these different stages/situations of company development.
- SWOT analyses of the three types of funds: A SWOT analyses of the different business models characterizing PE, HF and SWF reveals some significant strengths, weaknesses as well as opportunities and threats both with regard to the micro-dimension of restructuring and change at the enterprise level as well as with view on macro-economic impacts on industrial change.
- Impact on industrial change: Regarding the impact on industrial change we are offering first a set of hypothesis how such an impact can take place. Additionally we have screened the existing research on the impact on items such as firm performance, profits and value creation; employment development; wages and working conditions; social dialogue and information and consultation at firm level; and management practice, corporate cultures and governance.
- Summarising main findings: As a summary of the findings one can say that there is not a black or white picture on the impact assessment. One can find proof and arguments for a short term negative impact on employment at company level. But also proofs for a weak positive long term impact on the overall employment level in general.
- Impact on labour relations and working conditions: Similar to the issue of job creation, the impact of alternative investment strategies on wages and other aspects of working conditions are highly controversial and there is a large variation between messages of business orientated surveys and studies on the one hand and more critical studies on the issue, which often are based on case study evidence.Additionally we find there is hardly any significant research on the impact of PE, HF and/or SWF investments on social dialogue and information and consultation practice at the company level.
- Impact of the current crisis: Our analyses of the current global financial crisis on PE and its implications for industrial restructuring shows that that PE activity has in fact generated a major risk for the financial system. Given the complexity of the PE financing process this risk is distributed along different parts of the system, including originating banks, institutional investors that have purchased LBO debt from originators, and also institutional investors who have invested directly in PE. Large banks and institutional investors are affected.
- Micro level: On the micro level, the default probability of many portfolio companies is increasing, and credit ratings were downgraded. This will destabilize PE firms and the companies in which they are invested. We have tried to identify the magnitude of the refinancing problem over the next ten years as well as which companies will be running into refinancing problems in the next few years.
- Macro level: On the macro level the risks for banks which have guaranteed these investments is considerable. The amount to write off loans is probably somewhere between EUR 50-80 billion, i.e. still a substantial risk to bank balance sheets and thus to financial system stability.
- Overall conclusions and recommendations: The conclusion of our report summarizes some political recommendations arising from the research findings carried out. These recommendations in particular include suggestions to increase the transparency for PE, HF and SWF industry through binding reporting requirements regarding strategies of funds, level of risk, and detailed information on the financial and employment status in each portfolio company and further improvements of the regulatory frameworks. With regard to existing gaps in the European framework regulation of information and consultation in takeover situations, we are suggesting that information, consultation and participation rights are re-examined in order to ensure that workers are informed about the economic status of their company and have real bargaining rights before PE deals are consummated, during the restructuring process, and before exit.Finally, it is suggested that the establishment of a European rating agency should be discussed which provides objective ratings on the financial soundness and default probabilities of issuer companies. Ratings should be mandatory for all issues above a certain size.
1Introduction and overview of this report
1.1Background and key questions addressed
Hedge funds (HFs), private equity funds (PEFs) and sovereign wealth funds (SWFs) have existed for quite some time.[1] Their enormous growth in recent years is closely connected with the fundamental changes in financial markets occurring in the context of globalisation. As the current financial crisis illustrates, these funds and their impact on financial markets and business have important implications for the global economy, the structure and behaviour of financial markets as well as corporate practice within them. From the European point of view there are crucial questions resulting from the growing influence of private equity, hedge funds and, to a growing extent, sovereign wealth funds as well:
What impact do these funds have on industrial change and the functioning of the “real economy” throughout Europe, e.g. in terms of employment development, working conditions and industrial relations?
Which implications and effects do these capital funds and their increasing role have in particular on the specific European strategy of combing economic and social goals, i.e. the Lisbon objectives of making Europe “The most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth, more and better jobs and better social cohesion”?
Does the current organization of financial markets in Europe provide optimal conditions for achieving the Lisbon goals?
Even before the current financial crisis emerged different European institutions and key actors such as the European Commission[2], the European Parliament as well as social partner organisations and business organisations have raised and addressed these questions, leading to an ongoing debate on the nature, functioning and effects of capital funds.
At the same time, there is quite a controversial debate on both macro- and micro-level effects of private and state-owned capital funds on industrial change and restructuring in Europe today. While surveys and studies carried out by or on behalf of capital fund organisations themselves stress the overall positive effects of these funds on employment creation, innovation and other aspects of business development in Europe[3], other surveys highlight the negative effects both at the level of micro-economic restructuring (i.e. reducing wages, R&D investments and the long term innovation capacity in favour of short term profits) as well as on the sustainability of financial markets in Europe.[4]
1.2Character, methodological approach and structure of this report
1.2.1Objectives and tasks of the study
This report has been carried out as an independent expert report in order to support the work of a study group of the EESC’s Consultative Commission on Industrial Change (CCMI) on the impact of private equity, hedge and sovereign wealth funds on industrial change in Europe.
In light of uncertainties about the impact of private equity funds, hedge funds and sovereign wealth funds on industrial change in Europe it would seem to be important that the deliberative process within the European Economic and Social Committee and the drafting of an EESC opinion be built upon a solid base of data and other empirical evidence.
The main purpose of the research documented in this report was to collect, evaluate and present a comprehensive overview on existing data and relevant sources of knowledge and empirical evidence on the impact of the three types of funds on industrial change in Europe. With regard to the latter, the focus was mainly on industrial change at the company level.
Arising from this our research focused on the following three sets of tasks:
(1)Compiling, evaluation and presentation of existing data and sources
(2)Analysis of functioning of private equity, hedge and sovereign funds and their impact on industrial change
(3)Summarizing existing knowledge on the impact of the three types of alternative investment funds on industrial change in Europe
1.2.2Compiling, evaluation and presentation of existing data and sources
Due to the uneven degree of transparency regarding the three types of funds, the comprehensiveness of any data collection will vary by type of fund:
There are several comprehensive commercial databases on Private Equity Funds offering information on individual PE investments, including identity of investing PEF, timing of investment, characteristics of the target company (and, in most cases for larger investments, value and mode of financing of the deal).
Due to the secrecy of most Hedge Funds regarding investment strategy and portfolio, the database must by necessity be restricted to significant shareholdings in listed companies. Since the 1990s investors in listed companies in the European Union have been required to disclose shareholdings of over five percent. Many countries have set this disclosure threshold much lower. Significant shareholdings by HF thus in principle must be registered with the target company and disclosed to the public. Due to this requirement, it is possible to put together a comprehensive database of significant HF investments in industrial companies, either through drawing on the databases of individual regulatory authorities at national level or, more conveniently, through the Thomson ONE Banker Ownership Module (provided by Reuters Thomson). This data allows for determining when HF have initiated and exited significant investments in listed companies.
Sovereign Wealth Funds vary widely regarding transparency, with the Norwegian government fund generally regarded to have the highest level of transparency. SWFs are (as are all investors – see discussion in PEFs above) required to disclose significant shareholdings in European listed companies. Above and beyond this, the database includes investments made by SWFs with high levels of transparency (e.g. through lists of investments in their annual reports or on their websites).
Based on existing data and literature we have elaborated a grid in order to classify and gather the different sources which are presented and assessed with regard to accessibility and reliability in this report. Furthermore and on the basis of this grid data sources and secondary data have been stored in an electronic format: For each database source a profile sheet has been prepared while secondary data and other information relevant to our survey have been stored in electronic form (excel worksheet).
1.2.3Analysis of functioning of private equity, hedge and sovereign funds and impacts on industrial change
The quantity of literature on the three types of funds to be studied varies widely. The literature on PEFs is most extensive, with the oldest studies already some decades old. Although the earlier literature focused on the US, more and more studies have been done in Europe. These studies have focused on a variety of outcomes, including returns for investors in PEFs, and the employment, sales and profitability outcomes of PEF investments in portfolio companies. The relevant literature on HF is less extensive, and due to the lack of transparency regarding most HF investments, focuses mainly on returns to investors. Some recent econometric work, however, has looked at significant shareholdings by HF in listed companies. Scientific interest in SWFs, however, has been quite recent. The literature here is quite thin, particularly on econometric studies on the impact of SWF investments.
In general, the econometric studies have focused on trying to asses the overall or average affect of specific types of investors on companies and various outcomes (e.g. employment levels). An issue that has been largely unexplored here has been heterogeneity between different funds within each fund group, i.e. some types of PEF may have very different investment strategies than other PEFs, with correspondingly different types of outcomes. Furthermore, the impact of different national regulatory regimes (e.g. worker information and participation rights) on the way these funds restructure companies has been largely unexplored.