Creative Destruction? UK Evidence that Buyouts Cut Jobs to Raise Returns

Abstract

Building on previous work (Cressy et al, 2007) showing that buyouts have higher operating profitability in the post-buyout period the paper examines contradictory popular claims that Private Equity (PE)-backed LBOs generate or destroy jobs as a result of the process of 'rationalization'. Using a sample of 48 UK buyouts and a matched sample of 84 non-PE-backed UK companies over the period 1995-2000 we run log linear employment regressions for 1-5 years after the buyout. A PE dummy represents companies that have PE backing whilst other variables control for initial employment, gearing, investee size and profitability together with industry and macro effects. Heckman sample selection regressions deal with the problem of missing employment data. We find that there is no 'choice' effect: in the buyout year there are no significant differences between buyout companies and controls. Furthermore, in the post-buyout regressions the PE dummy is highly significant and quantitatively important so that buyout organizations involve job losses. Over the first post-buyout year for example PE companies' employment falls relative to controls by 7% rising to 23% over the first 4 years. In the last year of the study (year 5) employment increases. Leveraged buyouts thus bring about quick and substantial reductions in employment in target companies during the period of 'rationalization'. However, both initial profitability, 3-year average post-buyout profitability and 3 year sales growth have positive elasticities with respect to future employment. Therefore, buyouts generating higher operating profits from job cuts are associated with compensating job creation as profitability increases and sales expand, thereby helping to offset job losses arising from initial rationalization of the business.