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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 http://www.eesc.europa.eu/sections/ccmi/opinions_reports/total_list/index_fr.asp

(*)The contents of this study do not necessarily reflect the views of the EESC.

http://www.eesc.europa.eu/sections/ccmi/opinions_reports/total_list/index_fr.asp

Final Data Collection Report as of 24 June 2009 2

Contents

Executive Summary 4

1 Introduction and overview of this report 71.1 Background and key questions addressed 71.2 Character, methodological approach and structure of this report 8

1.2.1 Objectives and tasks of the study 81.2.2 Compiling, evaluation and presentation of existing data and sources 81.2.3 Analysis of functioning of private equity, hedge and sovereign funds

and impacts on industrial change 91.2.4 Structure of this report 10

2 Private Equity, Hedge Funds and Sovereign Wealth Funds – their role in Eu-ropean financial markets 2003 - 2008 122.1 Overview and assessment of data sources 122.2 Overview of relevant financial databases 132.3 Role of different forms of private investment in European financial markets 2003 - 2008

152.3.1 Overview 152.3.2 Private Equity 152.3.3 Hedge Funds 202.3.4 Sovereign Wealth Funds 23

3 Functioning and Business Models of Private Equity, Hedge Funds and Sover-eign Wealth Funds 283.1 Introduction and overview 283.2 Private Equity 30

3.2.1 Evolution of transaction volumes 303.2.2 Main industry sectors of activity 303.2.3 Duration of involvement 313.2.4 Financial instruments to complete the transactions 323.2.5 Ways of terminating transactions 34

3.3 Hedge Funds 353.3.1 Evolution of transaction volumes 353.3.2 Main industry sectors of activity 363.3.3 Duration of involvement 383.3.4 Financial instruments to complete the transactions 393.3.5 Ways of terminating transactions 393.3.6 Other forms of Hedge Fund investments 39

3.4 Sovereign Wealth Funds 393.4.1 Evolution of transaction volumes and main sectors of activity 393.4.2 Duration of involvement and financial instruments to complete the transactions 413.4.3 Ways of terminating transactions 42

3.5 Fund-specific SWOT assessments and initial conclusions regarding the impact on indus-trial change 423.5.1 Private Equity Funds 423.5.2 Hedge Funds 443.5.3 Sovereign Wealth Funds 45

4 The impact of Private Equity, Hedge Funds and Sovereign Wealth Funds on industrial change 46


4.1 Dimensions of industrial change and the impact of alternative investments 474.2 Overview of existing research and analyses 484.3 Methodological problems and other limitations of analyzing the impact of funds on in-

dustrial change 494.4 Empirical evidence on the impact on industrial change at company level 51

4.4.1 Firm performance, profits and value creation 514.4.2 Impact on employment development 544.4.3 Wages and working conditions 594.4.4 Social dialogue and information and consultation at firm level 604.4.5 Management practice, corporate cultures and governance 61

4.5 Evidence from case study research 634.5.1 Evidence on the impact on industrial change at enterprise level 634.5.2 Impact on employment, working conditions and labour relations 65

4.6 Conclusions: What we know and what we don’t know 67

5 The financial crisis and Private Equity: Implications for industrial change 685.1 Introduction 685.2 The Current Situation in Private Equity 685.2 The crisis in Private Equity and its implications for financial stability 705.3 Implications for the Micro Level 735.4 Upcoming Problems in PE Target Companies 74

6 Conclusions 77

7 References 82


Executive Summary

1. This report summarizes findings of a data collection study carried out between Janu-ary 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.

2. 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.

3. 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.

4. Transparency and availability of data: it can be stated that there is a lack of trans-parency in PEF, HF and SWF reporting, which creates a serious problem for evaluat-ing 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 accur-acy of information that can be gained through data bases is uneven. On the com-pany level the reporting requirements for private (non-listed) companies vary consid-erably 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 in-formation than sector, address, date of investment, etc. from the typical online data services.

5. 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.

6. 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 hori-zon, 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 fol-lowing not only financial but also national economic policy goals.

7. Differences within the three types of investment funds: Beside these general differ-ences 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 en-terprise 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.

8. SWOT analyses of the three types of funds: A SWOT analyses of the different busi-ness models characterizing PE, HF and SWF reveals some significant strengths, weaknesses as well as opportunities and threats both with regard to the micro-di-mension of restructuring and change at the enterprise level as well as with view on macro-economic impacts on industrial change.

9. Impact on industrial change: Regarding the impact on industrial change we are offer-ing 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.

10. 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 argu-ments 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 gen-eral.

11. Impact on labour relations and working conditions: Similar to the issue of job cre-ation, 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 crit-ical 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 com-pany level.

12. 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 finan-cing process this risk is distributed along different parts of the system, including ori-ginating banks, institutional investors that have purchased LBO debt from originat-ors, and also institutional investors who have invested directly in PE. Large banks and institutional investors are affected.

13. 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.

14. Macro level: On the macro level the risks for banks which have guaranteed these in-vestments 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.

15. 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 transpar-ency for PE, HF and SWF industry through binding reporting requirements regarding strategies of funds, level of risk, and detailed information on the financial and em-ployment status in each portfolio company and further improvements of the regulat-ory frameworks. With regard to existing gaps in the European framework regulation of information and consultation in takeover situations, we are suggesting that in-formation, 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 pro-cess, 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 mandat-ory for all issues above a certain size.


1 Introduction and overview of this report

1.1 Background 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 globalisa-tion. 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 know-ledge-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 condi-tions for achieving the Lisbon goals?

Even before the current financial crisis emerged different European institutions and key actors such as the European Commission2, the European Parliament as well as social part-ner 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 organ-isations themselves stress the overall positive effects of these funds on employment cre-ation, innovation and other aspects of business development in Europe3, other surveys highlight the negative effects both at the level of micro-economic restructuring (i.e. redu-cing 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

1.2 Character, methodological approach and structure of this report

1.2.1 Objectives 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)

1 In oder to simplify terminology these three types of funds will be referred to as "capital funds" in this report. 2 EU Commission (2009): “Open Hearing on Hedge Funds and Private Equity”, February 26th & 27th. http://ec.eu-

ropa.eu/internal_market/investment/docs/conference/summary_en.pdf.3 See for example: Achleitner, Ann-Kristin and Klöckner, Oliver (2005): ”Employment Contribution of Private Eq-

uity and Venture Capital in Europe”, Centre for Entrepreneurial and Financial Studies (CEFS) on behalf of the Euro-pean Private Equity and Venture Capital Association (EVCA).

4 See for example: Socialist Group in the European Parliament/PSE (2007): “Hedge Funds and Private Equity – A Critical Analysis”, reported by Ieke van den Burg and Poul Nyrup Rasmusen.


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 sover-eign 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 draft-ing 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 com-pany 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 in-

vestment funds on industrial change in Europe

1.2.2 Compiling, evaluation and presentation of existing data and sources

Due to the uneven degree of transparency regarding the three types of funds, the com-prehensiveness 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 in-vestment, characteristics of the target company (and, in most cases for larger invest-ments, 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 re-gistered 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 in-dustrial companies, either through drawing on the databases of individual regulatory au-thorities at national level or, more conveniently, through the Thomson ONE Banker Own-ership 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 govern-ment 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 accessibil-


ity 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).

1.2.3 Analysis 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 lit-erature on PEFs is most extensive, with the oldest studies already some decades old. Al-though 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 in-vestors 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 litera-ture here is quite thin, particularly on econometric studies on the impact of SWF invest-ments. In general, the econometric studies have focused on trying to asses the overall or aver-age affect of specific types of investors on companies and various outcomes (e.g. employ-ment levels). An issue that has been largely unexplored here has been heterogeneity be-tween different funds within each fund group, i.e. some types of PEF may have very dif-ferent investment strategies than other PEFs, with correspondingly different types of out-comes. Furthermore, the impact of different national regulatory regimes (e.g. worker in-formation and participation rights) on the way these funds restructure companies has been largely unexplored.Given this background, our analysis had to separate the issue of functioning of capital funds from the impact analysis: While with regard to the former, empirical data and fig-ures are available, the latter mainly has to rely on qualitative evidence and other sources.With regard to the functioning of the three types of funds this study analyses in particular the following aspects for the period 2003 – 2008:First, the relative importance and role of the three funds in European financial markets are assessed based on our evaluation of existing data and other sources.Secondly, a deeper analysis of the functioning and impact of private equity, hedge funds and sovereign wealth funds covering the period 2003 – 2008 has been carried out on the basis of the following indicators and aspects:1. Number of volume of transactions in absolute terms 2. Main sectors of activity of the acquired companies3. Duration of involvement4. Financing instruments to complete the transaction (equities, LBO, others)5. Ways of termination of the transaction


Given the limited empirical data available our analyses faces several methodological problems. Our approaches to deal with the different conditions with respect to the three types of capital funds are presented in the following overview.Methodological approach to analyse the functioning of fundsIndicators Private Equity Funds Hedge Funds Sovereign Wealth

Funds

0) Relative importance of private equity, hedge and sovereign transac-tions within the financial markets

Calculation of relative im-portance takes into account multiplication through use of leverage (typically 2-3 times equity investment) plus con-centration in certain markets (primarily M&A)

Calculation of importance takes into account use of leverage plus shorter aver-age duration of investment

Calculation of importance takes into account not only asset size but also concen-tration in M&A activity and also concentration in sectors like energy and financial ser-vices

1) Number and volume of transactions in absolute terms

Summary data from EVCA (European Private Equity and Venture Capital Associ-ation)

We calculate a “minimum” figure on significant equity participation in listed com-panies for the past two years based on the Reuters Thomson ownership data.

We calculate a figure based on all the deals we find in Zephyr, SDC Platinum and Reuters Thomson owner-ship data

2) Main sectors of activity of the acquired com-panies

EVCA summary data (plus analysis of raw data on indi-vidual PE deals)

Own analysis for last two years based on significant holdings in listed companies (Reuters Thomson)

Own analysis based on indi-vidual deal data from the above data sources

3) Duration of involvement Estimate from Davos 2008 study on the characteristics of private equity

Own analysis based on cal-culation of portfolio turnover based on quarterly data for the last 2 years.

Own analysis based on the individual deal data from the above sources

4) Financing instruments to complete the trans-action (equities, LBO, others)

Standard and Poor’s LCD summary data

Hedge funds directly pur-chase the equities, however, they generally leverage their own capital by a certain mul-tiple

SWFs generally purchase equities directly – however, they often purchase a minority stake

5) Ways of termination of the transaction

EVCA summary data HF typically take minority shareholdings in listed com-panies, and exit through sale of these shares on sec-ondary markets

Own analysis based on indi-vidual deal data listed above

1.2.4 Structure of this report

Chapter 2 presents an overview of our data collecting work and the assessment of differ-ent data sources of the three type of funds (2.1 and 2.2). Also included in this part of the report are major findings from our work on the relative importance and role of the three funds in European financial markets based primarily on our evaluation of existing data and other sources (2.3).More details on the strategies and functioning of the three types of funds along the five indicators are presented in chapter 3, focusing on the largest investors in each fund type. At the end of this chapter our study presents a summary of findings with regard to the different business models connected to the three types of funds as well as a SWOT as-sessment focussing on likely impacts on industrial change.


This assessment should also be regarded to a detailed evaluation in chapter 4 of existing knowledge and empirical evidence on the impact of the three investment fund types on industrial change. According to our major research tasks we focus mainly on the micro level, i.e. industrial change at the company level presenting findings of relevant surveys in particular with regard to firm performance and value creation, employment develop-ment, wages and working conditions. Furthermore, this part of our study also discusses other aspects such as the impact of short-term versus long-term investment strategies and the impact of increased risk orientation on company development. Finally, in order to address impacts beyond company level industrial change (particularly in the context of the current economic situation), chapter 5 provides the results of an own analysis, focusing on the developing crisis in the private equity industry.


2 Private Equity, Hedge Funds and Sovereign Wealth Funds – their role in European financial markets 2003 - 2008

2.1 Overview and assessment of data sources

As a general statement it can be said 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 (as a rule quite expensive) data bases is uneven (see below for a discussion of this). On the company level (i.e. level of the firms that funds invest in) the reporting re-quirements 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 trans-action. As a result, it is virtually impossible (the only partial exceptions here are the U.S., and to a lesser extent the UK) to download a large and comprehensive dataset of private companies with more information than sector, address, date of investment, etc. from the typical online data services – quite unlike the case for other kinds of studies, such as of listed companies, for which detailed information is available due to extensive publicity re-quirements. Some of the most important methodological problems related to the available sources and findings are as follows:Sampling issues: The issue that is currently most discussed is the effect of buyouts of companies which are listed on a stock exchange (public companies). This is a different category of company from portfolio investment in small start-up companies. It is well known, and not contentious, that start-up companies which survive will show significant growth. A number of surveys however include data on both buyouts and venture capital investments, but then use the data to draw conclusions about buyouts. Such data may however reflect the positive impact of venture capital, and within the total, the impact of buyouts may be negative.Data issues: Many industry surveys rely on data provided by respondents in the portfolio investment-owned companies themselves, which is not checked or verified, or use re-spondents’ own judgments and opinions as raw data. This kind of data is less robust than verifiable public data.Interpretation issues: Any study of the effects of a specific phenomenon, such as portfolio investments, needs to establish what difference that factor makes. Data on the employ-ment changes in portfolio investment companies therefore needs to be compared with data on other similar companies which have not changed ownership. Such comparisons are sometimes made with trends in the whole economy, but should be made between portfolio investments and non- portfolio investment companies in the same sector – oth-erwise the comparison may simply reflect the fact that portfolio investment companies are in faster-growing sectors, for example.


2.2 Overview of relevant financial databases

Source Title Character Accessibility Completeness/Reliability

1 EVCA EVCA Yearbooks

Annual reports in-cluding statistics on number and value of PE invest-ments, by country and sector

Printed reports can be ordered. Sum-maries available online from the German private equity and venture capital association.

Comprehensive overview of overall PE investment, fundraising and exit activ-ity, with breakdowns by country, sector, and type of transaction.

2 Standard and Poor’s

Leveraged Commentary and Data (LCD)

Summary reports on number of buy-outs and financing structure, by year. Online database with detailed data on individual trans-actions.

Summary reports available by re-quest. Access to online database restricted to in-vestors due to concerns about confidentiality.

Good overview of LBO activity in Europe. Detailed data on individual in-vestments, particularly where Standard and Poor’s issues a credit rating (i.e. a high percent of the larger investments).

3 Thomson Reuters

VentureX-pert

Online Data Base By subscription for summary data and a selection of vari-ables for individual investments and funds. More de-tailed data on indi-vidual funds must be negotiated with the provider.

Considered the most comprehensive commercial data base on private equity. Has detailed information on portfolio companies, including date of initial investment, follow-up investment rounds, sector of activity, identity of in-vestor, etc. However has gaps (espe-cially for smaller firms) and has limited data regarding exits and financing structure.

4 Thomson Reuters

Thomson ONE Banker Ownership Module

Online Data Base By subscription Comprehensive online database for significant shareholdings in listed com-panies (including by HF, SWF and PE). Comprehensive data goes back two years. Data going back further (as far back as 1997) is available through an additional module, but at additional cost.

5 SWFs Annual re-ports

Report on invest-ment activities

Online or by re-quest

Transparency of SWFs varies greatly

6 Bureau van Dijk

Zephyr M&A activity in-formation (sum-mary reports and individual transac-tions, including PE and SWF).

By subscription Most individual transactions are listed, but there are many data gaps, particu-larly regarding financing.

7 Thomson Reuters

SDC Plat-inum

Data on M&A transactions and new securities is-sues

By subscription Data on many SWF and PE invest-ments. Follow-up data (e.g. on exits) not linked.

8 Online fin-ancial press

Online searches

Investment activity by SWFs and ma-jor hedge funds

Quite open, but subscription ac-cess to some me-dia

Varies according to size and location of investment


Source Title Character Accessibility Completeness/Reliability

9 PEREPAnalytics

Platform for Private Equity data in Europe

Detailed data on individual PE in-vestments. Used to gener-ate summary reports for EVCA

Through negotia-tion with the Euro-pean Venture Capital Associa-tion. Data on indi-vidual deals not disclosed

Comprehensive summary of activity for recent data

10 SWF Institute

Fund Rank-ing

Overview of size of SWF

Online Comprehensive list of larger SWFs

11 SWFInstitute

Linaburg-Maduell Transpar-ency Index

Rating of De-gree of Trans-parency

Online Comprehensive rating of larger SWFs

12 Dealogic Dealogic Detailed data on many M&A transactions, in-cluding PE

By subscription Fairly comprehensive, particularly on larger deals

13 Standard and Poor’s

CapitalIQ Detailed data on many M&A transactions, in-cluding PE

By subscription Fairly comprehensive, particularly on larger deals

14 National fin-ancial regu-latory au-thorities

Large share-holding re-gisters

List of share-holdings above the minimum threshold defined by na-tional law.

Varies greatly by country, e.g. cur-rent German and historical Italian data are online versus UK data which is only avail-able by subscrip-tion to a financial news service.

Comprehensive for direct equity holdings. Generally does not cover short equity positions, indirect voting rights (empty voting) or equity op-tions.

15 Prequin Prequin HF and PE data bases

Data on finan-cial returns and basic data on HF and PE

By subscription Fairly comprehensive for the larger PE and HF

16 Centre for Management Buy-outs re-search, Not-tingham Uni-versity Busi-ness School

CMBOR buy-out database

Database on European buy-outs, including PE sponsored deals

Individual data is confidential, how-ever summary re-ports are compiled by CMBOR and custom analyses can be negotiated.

Good coverage of PE deals in UK, partial coverage for rest of Europe

Source: Own compilation.


2.3 Role of different forms of private investment in European financial mar-kets 2003 - 2008

2.3.1 Overview

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 following table shows the relative importance of different investor types, at a global level.Global assets under management

Note: Around one third of private wealth is incorpo-rated in conven-tional in-vestment manage-ment (Pension funds, Mu-tual funds and Insur-ance as-

sets). Source: International Financial Services London.

2.3.2 Private Equity

PricewaterhouseCoopers data suggests that Europe accounts for just somewhat less than one third of global PE activity. Overall world PE investment for 2007 was estimated at USD 297 billion, with a breakdown by country indicating that Europe accounted for about USD 85 billion (PwC Private Equity Report 2008: 41-42). Although global data from Price-waterhouseCoopers for 2008 was not available at the time of writing of this report, data from the national and European levels indicates that fundraising and investment activity decreased dramatically in 2008, however. Global Trends in PE Investment and Fundraising Activity (US$bn)

Source: PricewaterhouseCoopers, Private Equity Report 2008: 41.

Rank

Fund type billions USD Figures as of

— Private wealth $ 40,000 20071 Pension funds $ 28,228 20072 Mutual funds $ 26,200 20073 Insurance companies $ 18,836 20074 Real estate $ 10,000 20065 Foreign exchange reserves $ 7,341 February 20086 Sovereign wealth funds $ 3,300 20077 Hedge funds $ 2,300 20078 Private equity funds $ 2,000 20079 REITs $ 764 2007


Similarly to the case of HF, PE is concentrated in certain types of activities, such as mer-gers and acquisitions (M&A). PE has accounted for up to 28 percent of M&A quarterly deal volume in Europe (4Q03). Over the years we are examining, PE has accounted for about one sixth of M&A activity (see table on the following page). PE accounts for an even greater proportion of buyout activity. Stroemberg’s study for the Davos 2008 PE (2008: 16) report shows that, historically, PE has financed 80 percent of buyout deals by number and 92 percent by financial value.EU M&A Activity (Overall and PE-Driven), 2003-2008

Overall EU M&A Europe PE M&AFinancial Year

Value ($mil) Deals

Value ($mil) Deals % of Total

2003 504,009.1 10,076 83,707.9 757 16.612004 839,838.2 12,675 149,640.9 1132 17.822005 992,496.7 10,715 171,949.5 1206 17.32

20061,320,256.

7 12,603 280,361.4 1725 21.24

20071,592,773.

9 14,647 247,004.1 2081 15.51

20081,140,204.

6 13,541 96,774.9 1551 8.49Source: Thomson Reuters

According to the statistics of the European Private Equity and Venture Capital Association (EVCA), investments by European PE and venture capital firms amounted to €73.8bn in 2007, and approximately 5,200 European companies received private equity invest-ments. Compared with 2006 European private equity investment grew slightly (reaching €71.2 billion in 2006), but grew much more strongly compared to 2005 (€47.1 billion). Around 75% of the total funds raised were earmarked for buyout investment. The share of venture capital in fundraising was only €17.5 billion, or 15.5% of total funds raised.5

European leveraged buy-outs in 2006 amounted to 160 billion Euros, an increase of 42% on 2005. With the usual leverage ratio of 1:3 or 4, this corresponds to a buy-out capacity of 640 billion Euros in 2006.6 Preliminary data for 2008 from EVCA suggest that invest-ment activity decreased by about 27 % relative to 2007. The US funds are still the major investors in the worldwide PE business. US funds like Texas Pacific Group, Blackstone and KKR, together have a capacity equalling more than 30% of worldwide private equity.7 Thus these funds are important actors in Europe. Al-though a complete list of the most important funds concerning investment volume or total investment activity with a focus on Europe is not available, some statistics which al-low a rather good estimation of the most important funds in Europe. According to the Centre for Management buy-outs research at Nottingham University Business School the table below show the biggest PE-deals in continental Europe and Great Britain in the years 1999 to 2008.Largest PE-Deals by Year in Continental Europa 1999 – 2006

5 Machado, C.D. and Raade, K. (2008): “Recent Developments in the European Private Equity Market”, in: European Commission: Economic Papers No. 319 (April), p. 3.

6 PSE (2007): p. 14. 7 Ibd. p. 15.


Source: Centre for Management buy-outs re-search, Notting-ham University Business School.

Largest PE-Deals by Year in Great Britain

1999 - 2007Year Company Name Value/£m PE company1999 Avecia 1,400 Cinven2000 MEPC/Leconport 3,500 Hermes Private Equity2001 Yell Group 3,100 Apax, Lion Capital

2002 Unique Pub &Voyager Pub 2,000 Terra, Cinven

2003 Spirit Amber 2,500 CVC, Merrill Lynch

2004 The Automobile Associations/AA 1,800 CVC, Permira

2005 Warner Chilcott plc 1,600 Bain Capital, Thomas H. Partners, JP Morgan

2006 United Biscuits 1,600 Blackstone, PAI Partners2007 Alliance Boots 11,100 KKR

Source: Centre for Management buy-outs research, Nottingham University Business School.

In addition to the biggest US players like KKR and Blackstone, most of the European in-vestments are carried out by European PE companies -- in most cases from Great Britain, with the exception of the French PAI Partners. Nevertheless companies like Permira, Apax, CVC, Terra and Cinven belong to the 50 biggest PE companies worldwide.8 The fol-lowing list shows the biggest players in merger & acquisition deals in Europe.9

8 Measured by raised capital between 2002 and 20079 PSE (2007): p. 71.

Year Company Name Country Value/€m PE company1999 Friedrich Grohe Germany 1,372 BC Partners

2000 North Rhine Westphalia Cable Germany 2,966 Callahan Invest Limited

2001 Eircom Ireland 4,810Goldman Sachs Group, Providence Equity Partners, Towerbrook Capital and Warburg Pincus

2002 Legrand France 5,130 KKR

2003 Seat Pagine Gialle Italy 3,030 BC Partners, CVC, Permira, Investitori Associati

2004 Celanese Germany 3,100 Blackstone

2005 Wind Telecommunications Italy 12,100 Consortium under the leadership of Naguib Sawiris

2006 TDC Denmark 13,000 Blackstone, Permira, KKR, Apax, Providence


Biggest M&A deals in Europe (December 2006)

Fund Volume in $bn. Number mergers & acquisi-tions deals Origin Ranking worldwide

(2007)10

Kohlberg Kravis Roberts (KKR) 27.5 5 US 2

3i 25.9 25 GB 13AplInvest Partners 20.8 3 NL 38Apax Partners 19.7 11 GB 7Goldman Sachs Int. 17.3 3 US 3Carlyle 14.9 8 US 1Cinven 12.4 6 GB 11Hellmann & Friedman 12.2 3 US 16Contracted Services 11.3 1 ? ?Thomas H. Lee Partners 11.3 1 US 30Source: Centre for Management buy-outs research, Nottingham University Business School.

The US investment company KKR again is one of the mayor players. The biggest PE firm worldwide (the Carlyle Group) must also be added to a list of the most important PE com-panies, together with the British 3i. Out of this a list of the eleven most relevant PE actors in Europe results (see table below). Due to missing data concerning the total investment activities and the volume of such transaction in Europe, the following list should be understood as an underestimate of total activity. 11 most relevant PE actors in Europe

Fund Headquarter Foundation Capital Rank PEI 50CVC Capital Partners London 1981 $36.84 bn11 512

Profile and investmentcharacteristics

At the moment CVC funds own 52 companies worldwide employing approximately 447,000 people. CVC investments are concentrated mostly in Western Europe and to a lesser de-gree in Asia. Only a few investments are undertaken in the US. The most significant invest-ments include Evonik Industries, the Flint Group, the Elster Group (all Germany), Cortefil (Spain), Saga/AA, Formula One (both Great Britain), SEAT Pagina Gialle (Italy) and Kappa Packaging (Netherlands).

BC Partners London 1986 $9.26 billion 33Profile and investmentcharacteristics

Since 1986 BC Partners have invested in 68 companies with a total value of $64 billion. At the moment BCP have investments in 16 companies, mainly in Western Europe. Significant investments are Unitymedia, Brenntag (both Germany), Fitness First (Great Britain), SEAT Pagina Gialle (Italy), Picard (France), Amadeus (Spain). Significant exits in the past were Grohe, Techem (both Germany), Galbani (Italy), KTM (Austria), Sanitec (Finland) and Gen-eral Healthcare Group (Great Britain).

10 http://www.peimedia.com/resources/Conference/downloads/PEI50_Brochure_final.pdf.11 Capital raised over five years from 1 January 2003 to 15 April 200812 http://www.peimedia.com/resources/PEI50/PEI-50_executivesummary.pdf.


Fund Headquarter Foundation Capital Rank PEI 50

Kohlberg Kravis Roberts (KKR)

New York 1976 $39.67 billion 4


At the moment KKR have investments in 47 companies worldwide. 15 companies are based in Europe. Significant investments in Europe are Alliance Boots (Great Britain), Pages Jaunes Group, Legrand Holdings (both France), KION Group, ATU, ProSiebenSat1 Media (all Germany) and TDC (Denmark).

Permira London 1985 $25.43 billion 8Profile and investmentcharacteristics

Permira has a strong focus on the European market. Following the 2007 annual report Per-mira have investments in 23 companies with a total firm value of €70 billion and approxim-ately 220.000 employees. 20 of these companies are based in Europe with a focus on Great Britain. Significant investments are DinoSol, Cortefiel (both Spain), Saga/AA, Birds Eye Iglo, Gala Coral Group (all Great Britain), Debitel, Cognis, ProSiebenSat1 (all Germany), Valentino Hugo Boss, SEAT Pagina Gialle (both Italy), Maxeda (Netherlands), TDC (Den-mark).

Blackstone New York 1985 $23.3 billion 10Profile and investmentcharacteristics

At the moment Blackstone have investments in 55 different companies worldwide. In the be-ginning Blackstone concentrate their investment activities on the US but meanwhile they also undertake significant investment in Europe. Significant investments in Europe are United Biscuit, Merlin Entertainment, Center Parks (all Great Britain), TDC (Denmark), Deutsche Telekom (Germany), Orangina (French), Nielsen (Netherlands).

Providence Equity Part-ners

Providence (Rhode Island)

1989 $16.36 billion 16


Providence focus on media, entertainment, communication investments. Since 1989 the firm has invested in more than 100 companies worldwide. Providence is mainly active in the US but also undertake significant investments in Europe. Due to their specification invest-ments of Providence in Europe are limited to companies in the telecommunication and tele-vision sector, like Canal Digitaal (Netherlands), Grupo Corporativo Ono (Spain), Kabel Deutschland (Germany), Volia Cable (Ukraine), TDC (Denmark), MobileServ (Great Britain), Com Hem (Sweden). Significant exits in the past are ProSiebenSat1 (Germany) or Eircom (Ireland).

Terra Firma Capital Partners

London 1994 $17 billion 14


Since 1994 Terra Firma has invested approximately €11 billion mainly in Europe. At the mo-ment Terra has investments in eight companies which are all based in Europe, mainly in Great Britain and Germany. Prominent investments are Annington, EMI, Odeon/UCI (all Great Britain), Tank & Rast and Deutsche Annington (both Germany). In the past Terra Firma undertake investments in the British Unique Pub Company and the hotel group Le Meridian.

3i Group London 1984 $17 billion 12Profile and investmentcharacteristics

The 3i group arose from a corporation of several British banks with the aim to undertake lar-ger investments in companies. 1984 the banks sold off their stakes and 3i became a public limited company, which today is listed on the London Stock Exchange. Currently 3i has in-vestments in more than 100 companies globally but with a clear focus on Western Europe, especially Great Britain (45 investments). The second largest target county is Spain (15 in-vestments) followed by Germany (14 investments). In most cases 3i invest in SMEs with a enterprise value up to €1 billion. Their portfolio contains a relatively large number of smaller investments rather than very large companies.


Fund Headquarter Foundation Capital Rank PEI 50

Cinven London 1977 $11.93 billion 26Profile and investmentcharacteristics

Cinven originally based on three British pension funds which are still important partners of Cinven. Cinven concentrate on the European private equity market and at the moment are invested in 19 European companies. Prominent investments are Amadeus (Spain), Springer (Germany), Dutch Cable/Ziggo (Netherlands) and Gala Coral (Great Britain). In the past Cinven undertook major investments in the Dutch Kappa Packaging, Unique Pub Company and Avecia.

Carlyle Group Washington 1987 $52 billion 1Profile and investmentcharacteristics

The Carlyle Group holds 30 PE funds which invest globally in companies with generate $109 billion in revenue and employed more than 350.000 people. In the buyout sector Carlyle has three special funds with a volume of $8.2 billion which invest in Europe. Famous investments are the British Hertz Corporation or the German Storck GmbH. Carlyle also has a huge real estate section which also invests in Europe. In comparison to European PE companies the investment activity in Europe is relatively small; their main focus still lays on the US. Due to their huge absolute investment volume and their diversified investment port-folio the group nevertheless is an important player in the European PE business.

Apax Partners London 1969 $25.23 billion 9Profile and investmentcharacteristics

Apax Partners as it exist today is a merger of the 1969 founded company Patricof & Co. and the 1972 founded Venture Capital firm MMG. Apax Partners invest in five business sectors; Tech & Telecom, Retail & Consumer, Media, Healthcare, Financial & Business Services. Famous investments in the past were Versatel, Sulo, Kabel Deutschland (Germany), Yell Group, New Look, Inmarsat, Somerfield (UK), TDC (Denmark), NXP/Semiconductor Divi-sion of Philips Electronics (Netherlands).

Source: Wilke, Maack and Partner based on information of the companies websites.

2.3.3 Hedge Funds

The OECD estimated the degree of leverage used by hedge funds in 2006 to be over 3, implying the use of loans of ca. USD 5.5 trillion, or a total investment capacity of ca. USD 7 trillion.13

The nature of HF activity also leads to this type of investor accounting for a very high market share in certain types of trading activities. Although similar figures are not avail-able for Europe, HF share of trading activity in equity and other markets is likely to be similarly high here. Assets under management (AUM) by HF grew rapidly until mid-2008. It is estimated that hedge funds in 2006 managed some $ 1.3 trillion with around 6,400 single hedge funds worldwide.14 According to estimates in 2007 hedge funds managed some $ 1.7 trillion with around 6,900 single funds worldwide.15 A more recent estimate suggests that HF AUM grew to a peak of about $2.7 trillion in the middle of 2008, before declining sharply to $1.8 trillion due to declines in asset values and redemptions.16 Similar to PE the US is still the dominant region for HF activities. HF based in the US counting for more than 68% of the total capital under management. Nevertheless HF activities in Europe are becom-ing more important and accounted for 25% of the global HF industry in 2007.17

13 Blundell-Wignall, Adrian (2007): „An Overview of Hedge Funds and Structured Products: Issues in Leverage and Risk“, OECD.

14 Figures are based on the HF database, managed by HF Research INC.15 PSE (2007): p. 14. 16 Hedge Fund Intelligence press release, 5 March 2009, "Global Hedge Fund Assets Drop More than 30% in 2008 to

$1.8 trillion."17 Ibd.


Following the “Hedge Fund Asset Flow & Trends Report 2006 – 2007”, “Europe continued to be the fastest growing major investment region for most hedge funds. Total assets in funds which invest primarily in European markets increased at a rate of 46% in 2006 to $276.5 billion - 64% of the $87 billion increase was from new allocations”. The following table on the geographical distributions of HF shows that approximately one third of HF assets are accounted for by HF based in Europe (total of UK, EU and Switzer-land, from above table, of ca. USD 480 billion).Geographical Distribution of HF, by Assets Under Management(mid-2006)

Source: IOSCO, and OECD ques-tionnaire on Hedge Funds, taken from Blundell-Wignall 2007: 42.Neverthe-less con-crete state-ments about in-vestments

in Europe are difficult because there is no unified and comprehensive database about such actions. However the US requires investors which exceed a certain threshold to make this information publicity available through filing a form with the US security ex-change regulator (SEC). When a person or group of persons acquires beneficial ownership of more than 5% of a class of a company's equity security registered under Section 12 of the Securities Exchange Act, they must file a Schedule 13D with the SEC. In Europe, EU member states have a minimum disclosure requirement (as required by EU directive) – however, every member state has its own regulation and share register, and 23 different languages make an analysis more difficult. Due to this it is not surprising that most stud-ies dealing with the influence of HF on industrial change have focused on the US, based on information that is publicly available and in a common language.Shares of Hedge Fund Trading in US Markets

Source: Greenwich Associates, cited in Blundell-Wignall (2007: 42).

The follow-ing table identifies the largest

10 HF by size (assets under management, or AUM). One interesting observation is that, in some cases, the identifiable equity holdings are only a small fraction of the total AUM. This can be attributed to a number of factors, such as concentration on other markets (bonds, derivatives, etc.), concentration on very small shareholdings in countries where the disclosure requirements are not very strong, and concentration on short-term strategies including day trading and the exploitation of very short term pricing anomalies. A second interesting observation is the massive reduction in identifiable equity holdings by some HF, in a couple of cases reaching almost 75 percent of the portfolio value. This

Country Mid 2006 Estimates, $bnUSA 870UK 320EU 118Australia 47Non-Japan Asia 34Switzerland 23Cana 11Japan 7Total 1,430.55

%Cash equities 30Credit Derivatives (plain vanilla) 60Credit Derivatives (structured) 33Emerging Market Bonds 45Distressed debt 47Leveraged loan trading 33High Yield bond trading 25


decrease in value is in all likelihood attributable partly to the de-levering phenomenon (i.e. forced liquidation of assets due to reduction in bank credit availability) but also partly due to the shift from long to short equity positions (the latter of which is undisclosed ex-cept under very limited circumstances, e.g. new disclosure rules in the UK). Top 10 HF by Assets under Management and their equity holdings

Fund Name Assets June 2008

Identifiable Equity Holdings (billion USD)

CurrentChange from 2nd Half 2008

Highbridge / JP Morgan Asset Management 18 48.1* / 5.7** 4.0 -4.2Bridgewater Associates 43.5 1.3 -1.9D.E. Shaw Group 37.1 18.0 -7.8Paulson & Co 34.9 6.5 -0.6Och-Ziff Capital Management 33.3 2.5 -6.5Farallon Capital Management 33.0 1.9 -6.2Renaissance Technologies 29.0 27.6 -8.4Goldman Sachs Management 26.9 NI NIHarbinger 24.0 2.3 -7.1Barclays Global Investors 19.0 NI NI

The next table shows the top 10 HF with headquarters in Europe (in fact all ten are located in London). Unless otherwise noted, figures for 2009 refer to 1 January 2009.

Top 10 HF by Firm Capital with HQ in Europe, 2008

Source: Institutional Investor (www.iimagazine.com) 18 Highbridge was purchased by J.P. Morgan Asset Management in 2005.


2.3.4 Sovereign Wealth Funds

The distinguishing feature of SWFs from other investment funds is that they are state-fun-ded. While some are more than fifty years old, over the past decade they have rapidly grown in importance to become an important source of investment and market liquidity at a time of difficult access to capital. Today, more than thirty countries have SWFs, with twenty new SWFs created since 2000. Typically, SWFs portfolios include a wide range of financial assets, including fixed-income securities but also equities, real estate and altern-ative investments. The assets managed by SWFs today are estimated at $ 2 – 3 trillion, equivalent to about half of global official reserves, or the combined capital of all hedge funds and private equity firms. According to the IMF assets managed by SWF could reach $ 6 – 10 trillion by 2013. Other commentators also project rapid growth over the next five to ten years. For example, Morgan Stanley projects that SWFs’ assets could exceed offi-cial reserves by 2011, and Standard Chartered projects SWFs’ assets to reach US$13.4 trillion over the next decade.19

In the past few years more and more SWFs act as global equity investors. Most of these investors were established in countries that are rich in natural resources like oil, for ex-ample countries from the Arab Gulf region, Ex-Soviet Union countries or Norway. A second category of SWF relates to the accumulation of foreign currency as a result of sub-stantial net exports, especially in the cases of China, Singapore and other East Asian ex-porters.Prominent examples of SWF investments are the acquisition of the British P&O by the Saudi-Arabian Dubai Ports or the recent investment of the Dubai Ipic Fund in the German enterprise Daimler Benz. Despite frequently voiced concerns that sovereign wealth fund investments serve political objectives and conflict with national interests, little is known about the investment allocation of sovereign wealth funds. This is because most SWFs do not disclose details about their investments. This lack of transparency is one reason that SWFs have generated such controversy in re-cent years regarding their operations and investments. Few SWFs outside the industrial-ized democracies provide lists of their portfolio companies to the public. One commonly-used instrument for rating the disclosure policies of SWFs is the Linaburg-Maduell Trans-parency Index. According to this index SWFs can receive scores of between 0 and 10 (lowest to highest disclosure practices). Low scores can be received through the fulfil-ment of relatively simple criteria, such as management of own web site or provision of basic contact information.

19 Morgan Stanley (2007): “How Big Could Sovereign Wealth Funds be by 2015” and Gerard, Lyon (2007): “State Capitalism: The Rise of Sovereign Wealth Funds”, in: Journal of Management Research Vol. 7 (3).


Scoring Criteria for the LM Transparency Index

Source: SWF Institute, www.swfinstitute.org.

The largest three SWFs currently have scores of only between two and three on the LM Transparency Index. Most SWF equity investments can therefore be identified mainly only by triggering of minimum disclosure limits for ownership of listed companies (between 3-5 percent of shares in many industrialized democracies), through acquisition of major stakes in private companies, or through press reports.Furthermore, SWFs are increasing much of their exposure to European equities indirectly, through investments in HF and PE. Ernst & Young estimate that SWFs account for 10% of all PE investment in recent years, and that this share is expected to grow (Ernst & Young: InterChange Vol. 23, March 2009, p. 11). Prequin reports that the average current SWF al-location to HF is 7 percent, and that the average target allocation is 9% (Prequin 2009, p.3). SWF impact on industrial change in Europe is thus increasingly being indirectly channeled through these other paths.Comparable to PE and HF a list of the most relevant SWF actors and their investment activities in Europe is not available. Nevertheless some data is accessible which allow an approximation. Trueman provide a list of the financially strongest SWF worldwide.20 Lead-ing funds are managed by UAE, Norway, Singapore and Kuwait. Fotak et al use a combin-ation of the Zephyr and SDC database to identify the target countries of these SWF in-vestments. The “Zephyr Sample” is drawn from the Zephyr Mergers and Acquisitions database, provided by Burea van Dijk Electronic Publishing, and covers global mergers and acquisitions (including acquisitions of minority equity stakes) from 1997 through July 18, 2008. The “SDC Sample” is drawn from the Securities Data Corporation Global New Is-sues database, covering the period 1970 through June 15, 2008, and Fortak et al sample principally involves share offerings by target firms directly to funds. Following Fortak et al the most active SWFs in direct equity investments are funds from the UAE (43 invest-ments in Europe), Singapore (22 investments), Kuwait (15 investments), Libya (13 invest-ments), Canada (8 investments) and Qatar (5 investments). A breakdown of total invest-ment activity in Europe is not covered. Nevertheless this overview gives an estimation of the most relevant SWF direct investors in equity worldwide (thus narrowing down the list of candidates for Europe).

20 Trueman, Edwin (2007): “A scoreboard for Sovereign Wealth Funds”, Peterson Institute Washington, p. 10.

Point Principles of the Linaburg-Maduell Transparency Index+1 Fund provides history including reason for creation, origins of wealth, and government owner-

ship structure+1 Fund provides up-to-date independently audited annual reports+1 Fund provides ownership percentage of company holdings, and geographic locations of hold-

ings+1 Fund provides total portfolio market value, returns, and management compensation+1 Fund provides guidelines in reference to ethical standards, investment policies, and enforcer of

guidelines+1 Fund provides clear strategies and objectives+1 If applicable, the fund clearly identifies subsidiaries and contact information+1 If applicable, the fund identifies external managers+1 Fund manages its own web site+1 Fund provides main office location address and contact information such as telephone and fax


Due to the fact that some countries manage multiple SWFs and Fotak et al only list the managing countries but not the single funds, a concrete identification of the investing fund is difficult. For example the Singapore and the VAE manage two respectively three different funds.21 Which of these funds finally undertake the investment can not be said with absolute certainty. More simple is the situation in the case of countries which only manage one SWF. Additionally we add the second largest SWF worldwide and only European SWF, the Norwegian Government Pension Fund-Global. Taking these considera-tions into account we identify the following ten SWFs as most relevant for investment in Europe. The 10 most relevant SWF investors in Europe

Fund Origin Foundation CapitalAbu Dhabi Investment Au-thority

Abu Dhabi/United Arab Emirates

1976 $627bn


According to estimates the ADIA is the largest SWF worldwide. The main funding source is surpluses out of the oil production of the Abu Dhabi National Oil Company. Its PE activ-ities are mainly carried out by the Abu Dhabi Investment Company.

21 Ibd.


Fund Origin Foundation Capital

Mubadala Development Company

Abu Dhabi/United Arab Emirates

2002 $10bn


The Mubadala Investment Company is totally owned by the Abu Dhabi Emirate. As is the case for other SWFs based in the gulf region, the main funding source of Mubadala is oil. According to the SWF-Institute Mubadala has a tendency to invest in high technology and aerospace firms. Additionally the firm has invested in oil fields, real estate and hospitals. Prominent European investments are Ferrari and Piaggio Aero Industries (both Italy).

Istithmar World Dubai/United Arab Emirates

2003 $4bn


Istithmar World is the investment arm of the government owned Dubai World. According to Dubai World the equity portfolio of Istithmar (Istithmar World Capital) has invested in 35 companies with total capital deployed in excess of $3.5 billion worldwide. European invest-ments mentioned include the Pension Insurance Corporation Holdings and the Spa com-pany ESPA .

Kuwait InvestmentAuthority

Kuweit 1953 $202.8bn


Based on oil revenues the KIA invests in local, Arab and international markets. Prominent investments in Europe are minority stakes in the German Daimler AG, the GEA Group (also Germany) and British Pertroleum (BP).

Qatar InvestmentAuthority

Qatar 2003 $62bn


In order to be less reliant from their oil and gas revenues in the future the QIA have several investment vehicles which are active globally. Beside equity investments QIA also carry out real estate investments via their investment company Qatari Dia. Significant European investments are the equity stakes in the London Stock Exchange, Barclays and the super-market group Sainsburys (all in Great Britain).

Alberta HeritageSavings Trust Fund

Canada 1976 $14.9bn


The fund was created with several goals in mind. It should be an investment for future gen-erations, should strengthen and diversify the Canadian economy, improve quality of life and, finally, the fund should provide insurance for rainy days. According to the SWF Insti-tute the fund was originally designed for economic development, but now primarily it is a long-term savings and investment fund. The Trust Fund invests worldwide through their in-vestment vehicle the Alberta Investment Management Corporation. In addition to direct equity investments with a focus on the Canada and the US, the investment fund also use PE companies as partners. Through companies like Cinven, CVC or Apax the Alberta Her-itage Fund is also active in Europe.

Libyan InvestmentAuthority

Libyia 2006 $65bn


The main investment vehicle is the Libyan Arab Foreign Investment Company, which was founded in 1981. The firm focuses on industrial, commerce, agriculture, tourism, and real state sectors and invests globally. In Europe the company has a clear focus on Italy. Signi-ficant investments are the football club Juventus Turin, UniCredit and Telecom Italy (all Italy). Outside of Italy the fund was active in a buyout of the Luxemburg subsidiary of the Kaupthing Bank and investing in the Belgian-Netherlands bank Fortis.


Fund Origin Foundation Capital

Government of Singa-pore Inv. Corporation

Singapore 1981 $247.5bn


The main funding source of the Government of Singapore Investment Corporation (GIC) is the large currency reserves which Singapore saved during the 1970s. As other SWFs the GIC has a diversified investment portfolio including private equity as well as real estate activ-ities. GIC has a strong focus on the Asian and US market but also has some significant in-vestments in Europe. One significant investment was the infusion of capital in the Swiss bank UBS during the subprime crisis. The first annual report of GIC (published in 2008) mentioned 35 investments in Europe, however it did not provide a list of the target compan-ies. Furthermore GIC didn’t distinguish between PE and real estate. According to GIC it has stakes in the British Airports Authority as well as the Associated British Ports Holdings.

Temasek Holdings Singapore 1974 $85bnProfile and investmentcharacteristics

The second SWF of Singapore also is also funded by huge currency reserves but tradition-ally focused on local Singapore business, with a recent diversification of holdings to sur-rounding Asian countries. To a lesser degree they have investments in the US, Australia and Europe. Temasek mainly invests in financial services, telecommunications and in the transport and logistic branch. In Europe investments in the British banks Barclay and Stand-ard Chartered are public.

Government Pension Fund-Global

Norway 1990 $326bn


The Government Pension Fund Global invests the profits from Norwegian petroleum in-come. The fund is the largest SWF in Europe and the second largest SWF in the world. Of note is that the Norwegian fund is the most transparent SWF concerning their investments and holdings. Furthermore, potential target companies must fulfil ethical guidelines concern-ing business behaviour. To monitor the invested companies the fund has a special council to check compliance with these guidelines. In the past several prominent European companies were removed from the investment portfolio due to noncompliance, e.g. the French-German EADS, the Italian Finmeccanica, the French Thales SA (all because of producing controver-sial military components) or the British companies Rio Tinto and Vedanta Resources (be-cause of environmental damage). Most of the excluded companies are based in the US. Ac-cording to the annual report 2008 the fund is shareholder in almost 7900 companies around the world. The largest European holdings in 2008 include Royal Dutch Shell, BP, HSBC Holdings, Vodafone Group (UK), Nestle, Novartis, Roche (Switzerland), E.ON AG (Ger-many) and Total (France).


3 Functioning and Business Models of Private Equity, Hedge Funds and Sovereign Wealth Funds

3.1 Introduction and overview

After having presented basic data on the relative role of the three types of capital funds in Europe today, the basic aim of this chapter is to present information and available data on the functioning of the three types in more detail before concentrating the analyses on the issue of the impacts on industrial change in the following chapter of this report.Before describing major aspects with regard to the functioning of the three types of in-vestments funds it is important to summarize certain characteristics and differences in the respective business models:Here, it is important to stress that Private Equity, Hedge Funds and Sovereign Wealth Funds in general are following different business models which also influence their behav-ior and specific expectations as investors and/or owners. As the following overview illus-trates, there are important differences with regard to the aspects such as main invest-ment focus and the investment horizon/duration. While for example Hedge Funds are sim-ilar to Private Equity Funds in the way they obtain finance and using the leverage instru-ment, both types of funds differ significantly in the type of investment made and in the investment time horizon. In the case of Hedge Funds the time horizon tends to be much shorter-term and focused to a greater extent on liquid financial assets. In contrast to both these types of funds Sovereign Wealth Funds generally follow a long-term agenda which pursues not only financial but also national economic policy goals. With regard to Sover-eign Wealth Funds it is also important to note that these institutions not only invest in company stakes but also invest money in other funds, including Private Equity and Hedge Funds.Beside these general differences between the funds it is also important to stress differ-ences 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 these forms of business development all either follow or result in industrial change at the enter-prise 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.Finally, it is important to differentiate between two different styles of investment behavior – passive and activist – which also is not necessarily connected to the different types of funds. Though most Sovereign Wealth Funds are regarded as rather “passive” investors with little direct involvement in management decisions, while Private Equity and Hedge Funds are much more activist investment styles, there are significant varieties within as well as between both types of funds in reality.The following table summarizes major basic aspects of the different business models of the three types of funds.Basic characteristics of PE, HF and SWF business modelsAspect Private Equity Hedge Funds Sovereign Wealth

FundsInvestment focus Primarily private and Broad variety of asset Broad variety of asset


public equity classes, like options, fu-tures, commodities, cur-rencies, and also invest-ment in private equity

classes, including invest-ments in private and public companies

Ownership orientation In most cases majority shareholder orientation

In most cases minority shareholder orientation

Both majority and minor-ity shareholder orienta-tions

Investment horizon Investment periods of 5 years and more (though exit may sometimes be sooner)

Average initial lock up period of 10 months or less

Long term investment

Selection strategies for investments

Undervalued companies with inefficient manage-ment; possibility to pur-chase stakes from large share holders (families, state); free cash flow; break up and sell possib-ilities

Undervalued companies with a story of take-over targets and the potential for profits through break-ing up the company and disposing assets

Large variety – in con-trast to PE and HF not only financial strategies but also national (eco-nomic) policy orienta-tions are important in this context

Different stages of company develop-ment

Early, medium as well as late stage investments

Large variety – HF are also the largest buyers of distressed securities

Focus on medium stage investments

Exit strategies Important and part of the investment strategy

Possibility of short term exit important/ dominant

Not defined

Reward system for fund manager

High performance based compensation

High performance based compensation

Not known

Determination of per-formance

Final valuation at exit, based on the final cash flow from the investment portfolio

Periodically, based on the net asset value of the investment via marking to market and on di-vidend paid

Periodically and long term, based on dividend payment and long term market value

Investment beha-viour / influence on management de-cisions

Activist investor in most cases

Generally rather indirect influence but also cases of activist investors

“Patient” capital – in gen-eral passive type of in-vestor

Strategies for the company invested

In most cases clear strategy, e.g. growth, turn-around, restructur-ing

Clear strategic orienta-tion only in cases of act-ivist investors

Strong interest in long term competitive and fin-ancial base of the com-pany

Using of leverage in-struments

Yes, often used Yes, possible Less important

Return objectives Strong Strong Only weak

Source: own, based on Achleitner, Betzer, Gider, Investment rationales of Hedge Funds and Private Equity Funds in the German Stock Market, December 2008, p.33.

Due to the fact that the different business models of the funds and the different invest-ment styles also will determine and influence the behaviour of the funds as investors and owners it is very difficult to draw “simple” general conclusions with regard to the impact of the three types of funds on industrial change and restructuring.

3.2 Private Equity

3.2.1 Evolution of transaction volumes

The most comprehensive overview of PE activity in Europe is provided by the European Private Equity and Venture Capital Association (EVCA) – although this database also has


its limitations. The data has been gathered primarily through the national affiliates of EVCA, which in turn relies on voluntary disclosure from member PE firms. Due to the in-creasing public controversy surrounding the operation and impact of PE, EVCA has set up an institute (PEREP_Anlaytics) with an academic advisory board in order to compile and analyze the data. EVCA estimates that about 60 percent of PE funds in Europe provide them with data, but since larger funds are more likely to respond, one can assume that the percentage of deals covered is much larger. A second point to note is that, up until 2007, the data covered investments by PE firms based in Europe. Since there is some activity by non-European PE funds investing in Europe, and some investing activity by European PE funds outside of Europe, these figures do not exactly add up to PE invest-ment in companies based in Europe. The following table illustrates the rapid growth of investments by PE in Europe until 2007 and recently in 2008 a sharp decline in the volumes invested and the number of invest-ments.PE Investment Activity Overview, 2003-2008

Investment Activity

Volume (EUR bill)No. of

CompaniesNo of

investments2003 29.1 7,446 10,3752004 36.9 6,985 10,2362005 47.0 7,207 10,9152006 71.2 7,536 10,7602007 73.8 5,684 8,4112008 52.4 4,593 n/aSource: EVCA. Note: 2008 data is preliminary. Number of investments is greater than number of companies, since some companies have multiple rounds (and also may have multiple investors).

3.2.2 Main industry sectors of activity

The following tables provide some data on the distribution of PE investment activity, by sector. Detailed data for 2008 was not yet available as of this date. Due to a change in sectoral classification systems, the data for 2003-5 and 2006-7 are presented in different formats.The data show that PE activity is spread over a wide range of sectors. It is interesting that the greatest investments are not in a single industry branch but in communications and in consumer related business like retail. Additional computer related industry and med-ical/health related companies attracted a large amount of investments. Companies in high tech sectors like life sciences, communications and computers received at least EUR 1 billion in each of the years between 2003-2007. However, less R&D-intensive sectors such as business service-oriented sectors such as retail and business services also re-ceived substantial investment, particularly in the latter years.Distribution of PE Investment Activity, 2003-2005

2003 2004 2005

SectorAmount (mill EUR)

# compan-ies

Amount(mill EUR)

# compan-ies

Amount

mill EUR)

# compan-ies

Communications 4924.4 1192 4924.4 806 7247.1 718Computer Related 1732.6 1323 2350.6 1273 2438.5 1252Other Electronics Related 553 318 457.5 322 620.1 339


Biotechnology 681.6 740 686.6 507 868.3 620Medical/Health Related 1755.1 675 2801.2 749 3498.2 767Energy 351.2 90 677.8 109 961.5 166Consumer Related 5649.3 736 8546.6 801 12951 924Industrial Products and Services 1989.6 503 1949.7 486 4163.9 543Chemicals and Materials 663.1 227 1003.5 209 911.7 185Industrial Automation 474.4 128 219.4 128 1171.6 93Other Manufacturing 2238.9 364 2623.9 347 2885.5 285Transportation 1550.3 123 892.9 113 1012.7 120Financial Services 683.5 178 1524.1 140 1620 123Other Services 2845.9 471 5070.7 456 2563.4 472Agriculture 56.2 38 140.4 35 161 53Construction 982.4 162 816.9 199 1446.2 161Other 1964.7 573 2233.6 309 2479.8 386

Total investment 29095.9 7446 36919.8 698547000.4 7207

Source: EVCA.

Distribution of PE Investment Activity, 2006-20072006 2007

SectorAmount (mill EUR)

# compan-ies

Amount (mill EUR)

# compan-ies

Agriculture 78.5 63 448 37Chemicals & Materials 2055.7 171 2706.7 127Life sciences 7638.5 1368 7403.1 971Computer & consumer electronics 6297 1624 3792.3 959Communications 9848.8 634 9007.1 585Consumer goods & retail 10958.6 790 9485 445Consumer services, other 8432 361Business & industrial products 11494.2 1119 10298.4 662Business & industrial services 10920.3 664 8382.7 447Transportation 2047.6 117 3432.4 116Construction 1554.3 183 2527.1 97Energy & equipment 1655.6 199 3350.6 281Financial services 2376.7 206 3511.4 129Real estate 125.4 11Unknown 4238.6 398 884.4 456Total investment 71164.5 7536 73787.6 5684

Source: EVCA.

3.2.3 Duration of involvement

Due to the length of many PE investments, the task of calculating the average duration of involvement of a PE fund in a target firm is more complex. One of the studies included in the first set of working papers for the Davos Globalization of Alternative Investments pro-ject22 attempted to calculate the holding period for individual LBO transactions going back to 1970. One complicating factor is that only a relatively small proportion of investments in our target time period (2003-2008) have actually been exited. Another is that some in-vestments that have been failures are still being held on the books even there is no chance to exit them (“living deads”). This study calculates a number of measures to at-tempt to capture the duration of involvement – in addition to mean and median time to exit (among investments that are actually exited), the proportion of investments that are actually exited within specific time lengths after the initial investment are also calculated.

22 Stroemberg, Per (2007): “The New Demography of Private Equity”, Swedish Institute for Financial Research.


This study calculates a median duration of investment of approximately 50 months for in-vestments that were made in the 1990s and subsequently exited (one can presume that almost all LBOs that were initiated in the 1990s and not yet exited are probably failures). For LBO investments undertaken between 1995-2002, approximately 40 percent were ex-ited within 60 months of the initial investment. As of late 2007, the author of the study claims that the experience with LBOs initiated between 2003-2007 (i.e. within our time frame of interest) has not been out of line with these historical precedents. These findings are in line with the general business model of PE investors, which is to start a restructuring process in the company they bought with the aim of improving prof-itability. By improving profitability a higher price can be achieved when the company is sold again.

3.2.4 Financial instruments to complete the transactions

When examining the financing structure of PE investments, it is important to distinguish between buyout and VC. Due to the riskiness of investment in start-up companies, VC in-vestments (particularly seed and early stage) are generally 100 percent equity financed. (In some countries this finance may have been supplemented by state programs that either provided supplemental loans or loan guarantees, particularly during the technology bubble phase). Later stage investments, which are considered somewhat less risky, may have some private debt financing which is not guaranteed by the state. So-called mezzanine financing is a form of financing which has a mixture of characteristics of equity and debt – on the one hand interest payments (or payments in kind, PIK) according to a contractual schedule are expected, on the other hand some kind of participation in the potential increase in value in the equity of the target firm (e.g. warrants) is frequently included. The higher risk of investing in these firms is compensated for through interest rates considerably higher than the market rate and/or the equity participation mechan-isms. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range. LBOs are typically financed through a combination of direct equity investment by the PE fund (either alone or together with a small number of other PE funds) and debt finance (direct loans, syndicated loans, or securitized finance) provided by external investors (banks, hedge funds, pension funds, etc.). Management may or may not take an equity stake in the company. The use of debt finance in LBOs has been a subject of major con-troversy, and there are a number of studies on financing structure as well as summary statistics available from commercial data providers such as Standard and Poors’ LCD. Over the period of examination for this study (2003-2008) the average equity contribu-tion has been roughly one third of the deal financing, with the proportion of equity finan-cing (and especially the non-PE equity contribution) decreasing up until the beginning of the financial crisis. In 2008, the increasing risk aversion of financial investors led to a sub-stantial increase in the equity contribution as illustrated in the following figure.


Average equity contribution to LBOs

Note: Includes only transactions for which Sources/Uses were made available. Equity includes shareholder loans, common equity and preferred stock down streamed to the operating company as common equity as well as vendor note proceeds.Source: Own, based on Standard & Poors: Europe Senior LBO, 4Q8.

A second concern regarding the financing of LBO deals has been the increasing purchase prices paid for the target firms, meaning that a greater proportion of earnings are com-mitted to interest payments. Over the period we are examining the purchase price has in-creased from a multiple relative to earnings (EBITDA) of less than 7 to almost 10 (see fig-ure). Average LBO Purchase Price as Multiple of Pro Forma Trailing EBITDA

Note: Includes only transactions for which Sources/Uses were made available. Equity includes shareholder loans, common equity and preferred stock down streamed to the operating company as common equity as well as vendor note proceeds. Source: Own, based on Standard & Poors: Europe Senior LBO, 4Q8.


A large portion of the debt financing was provided through high yield bonds (particularly for the larger deals) as well as syndicated loans (for the mid-size deals). With the start of the financial crisis, the perceived risk of this debt financing has greatly increased, and the market value of this credit has plunged (see figure). Mark to Market Pricing of Leveraged Loans

Source: LSTA (Loan Syndication and Trading Association)Source: Standard & Poors.

Typical for a PE investment is the usage of a leverage instrument (credit facility) by the PE investor or fund in financing the deal. Once the deal is closed the PE investor will start a whole series of financial operations in the target company to get as soon as possible parts of the invested money back. Such instruments are the transfer of the loans and credits used for buying to the target company. Or operations which free money at the target company. Often used instruments are selling less profitable parts of the target company or sale and lease back of buildings and long term investment goods.

3.2.5 Ways of terminating transactions

EVCA publishes annual summary data on PE exits by year (both volume of sales and num-ber of companies exited), broken down by method of exit. As of the writing of this draft data for 2008 was not yet available. The table shows that the volume of exit activity in -creased rapidly after 2003, but peaked in 2006 and had already dropped by about EUR 6 billion in 2007. Every mode of exit except write-offs increased in volume between 2003 and 2006. In 2007 the drop in divestment activity was particularly strong in the categor-ies of public offerings, sales to financial institutions and sales to management (buy-backs). Divestment through sales to another PE house continued to increase strongly and divestment by trade sales increased slightly between 2006 and 2007 (see table). PE Divestments in Europe, 2003-2007

2003 2004 2005 2006 2007

Volume # of Volume # of Volume # of Volume # of Volume # of


cos cos cos cos cos

Divestment by Trade Sale

2,762 650 4,627 686 6,721 901 7,518 809 7,620 699

Divestment by Public Offering

1,600 281 2,305 338 2,650 490 5,348 439 2,586 239

Divestment by Floatation (IPO)

756 37 1,368 59 1,331 184 2,978 108 1,117 82

Sale of Quoted Equity

8447 244 937.1 279 1,319 306 2,3716 331 1,469 157

Divestment by Write-Off

1,58 774 1,901 703 1,406 628 1,256 494 500 229

Repayment of Preference Shares/Loans

2,150 1112 4,166 935 6,962 954 5,655 787 4,322 717

Sale to Another Private Equity House

2,740 144 2,555 223 5,474 298 5,495 336 8,217 302

Sale to Financial Institution

819 94 577 82 1,207 92 1,784 153 901 93

Sale to Manage-ment (Buy-back)

742 420 942 707 1,589 647 2,025 857 939 240

Divestment by Other Means

1,163 696 2,478 528 3,787 837 4,026 573 1,975 416

Total Divestment 13,554 4,019 19,550 4195 29,796 4824 33,107 4448 27,059 2726

Source: EVCA Yearbooks.

3.3 Hedge Funds

3.3.1 Evolution of transaction volumes

Due to the lack of transparency of HF activities in Europe it is only possible to get a very limited overview of HF activity. The major source of information on equity holdings is the requirement to disclose major shareholdings to national authorities, which by EU regula-tion is a minimum of 5 percent of shares. Some countries have gone beyond this and have a minimum threshold of 3 percent. In addition to these there are some further sources of information which allow us to supplement the large shareholdings to some ex-tent (e.g. some HF have more disclosure of positions, and some companies, particularly listed Nordic companies, list less significant shareholdings on their websites). The main data source we are using here is the equity ownership module included in Thomson Banker One (provided by Thomson Reuters), which attempts to gather as much informa-tion on ownership as possible on listed companies. In many cases (particularly large com-panies with dispersed ownership), Banker One is only able to identify 25-30% of share-holders. This database includes reports on ownership data for listed European companies on a quarterly basis, including name and type of investor, name and main sector of the target company, number and value of shareholdings, and changes in shareholdings. The inform-ation included here starts with a report from 2Q 2007, which includes changes from 1Q 2007 (but appears to be not quite complete for 1Q 2007, since Thomson Reuters only re-cently began historical data through this product). This data shows a maximum figure of HF investments of just short of USD 7 billion (end of 3Q 2007), which is certainly only a fraction of the total long equity holdings by HF in listed


European companies (see Exhibit 3). The number of positions (investments by individual HF in individual listed companies) varies between roughly 1400 and 2800. Summary Analysis of Hedge Fund Ownership Data

HF PositionsValue ($mill)

Shares held (million)

Shares exchanged (in mill)

Time Period Begin Q End Q End Q Begin Q End QNet

sales Net

purchasesTurnover

rate1 Q - 2 Q 2007 1394 1944 6,793.4 384.3 414.6 134.4 446.6 33.6%2 Q - 3Q 2007 1472 2046 6,897.6 414.6 712.1 145.3 442.8 25.8%3 Q - 4 Q 2007 2277 2270 6,606.0 695.0 643.9 335.7 284.6 42.5%4 Q 07 - 1 Q 08 2343 2280 6,729.1 708.6 636.2 357.8 285.5 42.5%1 Q - 2Q 2008 2703 2239 6,227.9 696.9 632.1 333.4 268.7 40.4%2 Q - 3Q 2008 2784 2186 6,019.3 888.9 865.5 359.0 346.9 39.5%3 Q - 4Q 2008 2789 2065 5,431.1 741.9 631.4 384.1 273.6 39.8%

Source: Own analysis from Thomson Banker One Ownership Data.

Here we see relatively stable volumes in 2007 and 2008 until the last quartil of 2008. Ob-viously the financial crisis changed the market opportunities for hedge fund investment. Because we know that many hedge funds are rather opportunistic in their investment style in PE (a kind of hit and run policy without long term investments) this finding is not surprising.

3.3.2 Main industry sectors of activity

Although Thomson ONE reports only a fraction of HF equity holdings in Europe, it does provide a detailed breakdown of the primary sector of the target company. Assuming that the investment activity captured here is representative of the sectoral activity of HF over-all, we can see that activity is concentrated in the financial services area, followed by technology/telco and energy companies (see table). Compared with the PE investments the great influence of investment in banks is obvious. HF Equity Investment Breakdown by Sector - Dec 2008

Micro IndustryNumber of HF Invest-

ments

Total Value of Investments

($mill.) Micro Industry

Number of HF Invest-

ments


($mill.)Aerospace/Defense 9 7.72 Investment Management 22 58.57Agricultural Products 12 15.87 Investment Trust 2 .32

Airlines 8 13.3 Leisure Time (Products/Services) 12 24.96

Auto Parts & Equipment 9 11.29 Lodging-Hotels 10 6.75Automobiles 44 94.88 Machinery 75 109.48

Banks (Major Regional) 115 628.04 Manufacturing (Diversi-fied) 21 40.04

Banks (Money Center) 42 106.33 Manufacturing (Special-ized) 50 140.37

Banks (Regional) 13 43.69 Metal Fabricators 2 6.04Beverages (Alcoholic) 16 164.97 Metals Mining (other) 19 71.01

Beverages (Non-Alco-holic) 4 10.92 Miscellaneous Trans-

portation 3 2.61

Biotechnology 18 29.14 Multi-Industry 35 55.65

Broadcasting (TV,Radio,Cable) 19 48.57 Mutual Funds 63 149.16

Building Materials 34 58.38 Natural Gas-Distr-Pipe Line 7 13.28

Cellular/Wireless Tele-comms 29 121.59 Non-Metals Mining 4 3.77


Chemicals 66 88.03 Oil & Gas (Domestic In-tegrated) 6 8.37

Communications Equip-ment 45 101.05 Oil & Gas (Exploration &

Production) 28 122.38

Computer Hardware 2 10.15 Oil & Gas (International Integrated) 60 240.29

Computer Services 26 65.55 Oil & Gas (Refining & Mktg) 26 58.17

Computer Software 24 85.07 Oil & Gas (Services) 26 27.76Computers (Networking) 4 1.21 Paper & Forest Products 22 31.51Computers (Peripherals) 4 9.61 Personal Care 17 29.62

Consumer (Jewelry/Nov-elties) 8 72.62 Photography/Imaging 1 2.93

Consumer Electronics 12 12.61 Power Producers (Inde-pend) 6 1.99

Containers/Packaging (Paper) 2 3.83 Publishing 20 11.61

Distributors (Durables) 12 18.26 Publishing-Newspapers 11 12.27Distributors (Food & Health) 4 11.78 REIT-Mixed Properties 1 .11

Diversified Metals 17 53.34 REIT-Net Lease 1 .28Electric Companies 55 152.6 Real Estate 44 111.66


Micro IndustryNumber of HF Invest-

ments


($mill.) Micro Industry

Number of HF Invest-

ments


($mill.)Electrical Equipment & Components 14 38.08 Restaurants 2 6.06

Electronics 20 50.21 Retail (Building Sup-plies) 1 2.87

Electronics (Defense) 3 13.22 Retail (Computers/Elec-trons) 1 1.78

Engineering & Construc-tion 39 139.55 Retail (Footwear) 2 .52

Financial (Diversified) 56 184.64 Retail (Home Shopping/Catalog) 1 1.2

Foods 40 154.38 Retail Specialty-Apparel 33 216.95Gaming, Lottery & Par-imutuel 9 46.04 Retail Stores-Dept

Stores 11 56.61

Gold/Precious Metals Mining 8 53.36 Retail Stores-Food

Chains 16 48.91

Hardware & Tools 7 17.3 Retail Stores-Gen Mer Chain 4 5.38

Health Care (Diversified) 3 4.22 Retail-Specialty 3 .91

Health Care (Drugs/Pharms) 78 141.16 Savings & Loan Com-

panies 1 .41

Health Care (Long Term Care) 1 .11 Semiconductors 3 3.28

Health Care (Managed Care) 1 .26 Services (Advertising/

Mktg) 15 23.1

Health Care (Med Prods/Sups 20 17.37 Services (Commercial

Consum) 46 175.3

Health Care (Special Ser-vices) 3 .36 Services (Employment) 8 18.5

Holding Companies 19 31.97 Services (Facils/Envi-romntl) 7 12.1

Homebuilding 1 .57 Services (Rentals) 13 15.43

Household Furnishings & App 6 12.34 Shipping 27 50.09

Household Products (Non-Durables) 7 12.05 Specialty Communica-

tions 4 1.83

Housewares 1 .73 Steel 27 51.79

Insurance (Life/Health) 26 29.34 Telephone-Long Dis-tance 1 3

Insurance (Multi-Line) 17 57.51 Textiles 1 2.59

Insurance (Property-Cas-ualty) 2 5.88 Tobacco 7 6.51

Insurance Brokers 4 2.28 Truckers 4 2.61Integrated Telecom 83 223.06 Trucks & Parts 14 30.29Internet 12 11.07 Waste Management 4 3.63

Investment Banking/Brokerage 20 44.48 Water Utilities 1 .86

Source: Thomson ONE.

3.3.3 Duration of involvement

Using the quarterly data report from Thomson on HF ownership stakes, it is possible to make an estimate of the average holding period or duration of involvement of HF in listed companies. Using a formula based on portfolio analysis, net sales and net purchase over the past quarter are calculated separately, and the lower of either total net sales or total net purchases for reported positions is used as a numerator. The average of total out-


standing shares over the two quarters is used as a denominator. The analysis is based on the number of shares outstanding or turned over (i.e. not weighted by value). The table above (Summary Analysis of Hedge Fund Ownership Data) also includes sum-mary figures for turnover, which shows a turnover of around 40 percent per quarter. This is a turnover rate of approximately 160 percent on an annualized basis, which indicates an average holding period of HF investments of less than one year. Given that turnover may be even higher for small HF not covered by this data (e.g. daytrading HF), the dura-tion of holdings of listed equity may be even lower for HF overall.

3.3.4 Financial instruments to complete the transactions

HF generally make direct cash purchases of listed equity. However, the discussion in the introduction indicates that these purchases are ultimately financed mainly through debt due to the leveraging structure of HF as a whole.


Given that HF equity investments are overwhelmingly in liquid assets (in the case of equity, in shares of listed corporations), and holding periods of relatively short duration, transactions are mainly terminated the way they were initiated, i.e. sales on open equity markets or negotiated sales to other institutional investors.

3.3.6 Other forms of Hedge Fund investments

HF can not only directly invest in companies by buying shares. In some cases they are also investors who will buy debts of companies from banks and other investors. In these cases they will take a role of active investors and interfere in the restructuring process of a company. Partly they will also join other PE investors very opportunistic to make some short term profits in the aftermath of a company restructuring process.

3.4 Sovereign Wealth Funds

The approach here is to in part replicate the methodology used by Fotak et al “The Finan-cial Impact of Sovereign Wealth Fund Investments in Listed Companies” (2008). This ap-proach compiles a comprehensive list of SWFs, and then searches for equity transactions by each SWF in two databases: Zephyr’s database on M&A transactions, and SDC Plat-inum’s database on Global New issues. Our analysis, however, will focus on European in-vestments by SWF, and will also supplement with a search in Thomson One ownership module. It is important to note that SWFs also have indirect impact on European industry through their large stakes in PE and HF – Prequin reports that these holdings are substantial.

3.4.1 Evolution of transaction volumes and main sectors of activity

Fotak et al report a total of 430 transactions in Zephyr and 232 in SDC Platinum, with 42 observations being common to both samples, between 1970 and June 15, 2008. Zephyr reports an average target value of ca. EUR 4 billion, and SDC estimates an average deal size of EUR 600 million. Given that there is a strong home country bias in SWF direct equity investments, and that our period of interest is much shorter than the time period used by Fotak et al, it appears that investments, the figure we will be calculating will be considerably lower. It thus ap-


pears that SWF direct impacts on European industrial change are modest, compared to the impact of HF and PE. With regard to major industry sectors of investment, Fotak et al report a concentration of SWF investments in financial services and in energy companies. Our own analysis of major shareholdings in the top 600 European listed companies indic-ates that SWF now are the largest shareholder in 8 of these companies (see below).Top 600 European Listed Companies in which a SWF is the largest Shareholder Company Investor Name % O/S

OMV AG International Petroleum Investment Company (IPIC) 50.66

Sainsbury J Plc Qatar Investment Authority 27.27

London Stock Exchange Group

Qatar Investment Authority 15.26

Marfin Investment Group Holdings SA

Dubai Investment Group 10.07

Credit Suisse Group Qatar Investment Authority 8.45

Gea Group AG Kuwait Investment Office 8.21

Daimler AG Kuwait Investment Office 7.59

British Land Co Plc Government of Singapore Investment Corp. (UK) 7.11

Source: Own analysis from Thomson Banker ONE data.

Beyond that, the strategies of the Top 10 SWFs vary considerably with regard to equity stakes in European companies. Whereas the norm appears to be substantial non-con-trolling stakes of around 3-10 percent, in some cases this is considerably higher. Some SWFs however have no identified substantial stake in a European company. The Norwe-gian Government Pension Fund (Global) appears to act like a typical pension fund by spreading its investments quite broadly over a large number of companies, taking only small stakes in those companies.


Top 10 SWFs and their Major European Holdings

Country Fund Name Assets $billion Major European Equity Holdings

UAE - Abu Dhabi

Abu Dhabi Investment Au-thority

627 Piaggio Aero (35%), Ferrari (5%)

Saudi Arabia SAMA Foreign Holdings 431 Banca Intesa (undisclosed minority stake in 2004)

China SAFE Investment Company 347

Norway Gov't Pension Fund Global 326 holds less than 5 percent in numerous listed companies

Singapore Government of Singapore Investment Corporation

248 British Land Co Plc (7.1 %), Liberty In-ternational Plc (4.97%), Great Portland

Estates (4.8%), Brixton (10%)

Russia National Welfare Fund 220

Kuwait Kuwait Investment Authority 203 Daimler AG (7.6%), Gea Group AG (8.2%), European Islamic Investment

Bank Plc (3.7%), Victoria-Jungfrau Col-lection (55%)

China China Investment Corporation

190 N.N.

China - Hong Kong

Hong Kong Monetary Au-thority Investment Portfolio

173 N.N.

Singapore Temasek Holdings 85 Standard Chartered (14.1%),Intercell AG (8.4%)

Source: Own analysis.

3.4.2 Duration of involvement and financial instruments to complete the transactions

The financial instruments used by SWFs to complete transactions are overwhelmingly cash purchases – SWFs have large cash reserves financed mainly through revenue from commodities. Prequin reports that the use of leverage by SWFs is limited to indirect lever-age, i.e. through investments in HF and PEF, which in turn use leverage for their equity in-vestments.The table below shows that the investment styles of major SWFs with regard to listed Eu-ropean companies vary widely. The number of investments ranges from almost 1600 (Norges Bank) to only one or two investments (the case for four SWFs). Some SWFs prefer to take very small positions (three SWFs had average positions of less than one percent of the outstanding shares of individual listed companies), whereas the Qatar Investment Authority and the Mubadala Development Company prefer to take large minority stakes in a small number of companies. Overall the portfolio turnover rate was quite low (espe-cially in comparison with hedge funds), but for three SWFs the quarterly turnover rate was around 15 percent (i.e. somewhat more than half the portfolio would be turned over on an annualized basis.


Summary Data on SWF Holdings in European Listed Companies(End 2008)SWF Name Nr. Investments in

Listed European Cos.

Average posi-tion size (% shares in port-folio co.)

Value ($mill) end 2008

Portfolio Turnover Rate (last quarter)

Abu Dhabi Investment Company 108 0.6 2163.5 5.3%Istithmar World Capital 1 7.7 57.0 16.0%Kuwait Investment Office 122 0.8 1837.2 3.7%Libyan Arab Foreign Investment Company (Lafico)

1 7.5 13.7 0.0%

Mubadala Development Company 1 22.7 7.6 0.0%Norges Bank 1588 0.9 74250.0 6.3%Qatar Investment Authority 5 20.0 9598.3 3.1% Government of Singapore Invest-ment Corp. (UK) Private Ltd.

59 0.6 3420.5 15.4%

Temasek Holdings Pte. Ltd. 2 4.0 4,621.31 18.7%

Source: Own analysis.


Fotak et al report that termination of transactions for investments in private companies is similar to the acquisition method, i.e. through negotiated sales directly with other large purchasers. For SWF investments in the listed companies analyzed in this report, exits oc-cur through stock sales on the open market or negotiated sales of blocks of shares with other large purchasers.

3.5 Fund-specific SWOT assessments and initial conclusions regarding the im-pact on industrial change

Any assessment of the impact of the three types of funds which also should include the assessment and evaluation of differences between private equity funds, hedge funds and sovereign wealth funds should start from certain characteristic features of the capital fund specific business models and investment strategies. Arising from the specificities of the respective business models it might be possible to draw the following conclusions with regard to the impact of the three types of funds on industrial change.

3.5.1 Private Equity Funds

In contrast to the two other capital funds, the Private Equity business model is exclusively based on the pooling of capital from individual and institutional investors in order to pur-chase a share in existing productive enterprises. The target companies are for the most part not or no longer publicly traded on the stock market. Private equity funds are en-gaged in a broad variety of investment activities at different stages of the business devel-opment from early stage (start-up and expansion) to different situations of later stage en-terprise financing.


Since Private Equity Funds show a strong bias towards the provision of seed and venture capital as well as acquiring distressed securities and financing buyouts, this type of in-vestment capital is an important agent of industrial change at the company level.The sharp increase in private equity fundraising between 2004 and 2007 also had signific-ant impacts on industrial change in Europe, in particular by providing capital in the con-text of leveraged buy-outs, financing mergers and acquisitions as well as the purchase of distressed securities.There are both positive as well as negative impacts of the private equity business model from the perspective of the targeted company as the following SWOT assessment illus-trates: One of the most important potential strengths of PE is the ability to provide risk capital to companies at the very beginning of the innovative process (seed and start up capital). PE firms can also provide capital where most other investors would not be willing to (e.g. turnaround or restructuring phases). Most PE firms also have extensive networks of ex-perts and managers that they can draw upon to advise companies, obtain independent advice on new products, and hire new managers to expand or replace existing manage-ment teams. Successful PE firms also have experience in introducing formal governance structures, which are important as companies grow in size beyond the founder-based startup. Also on the positive side for PE are the potential wider impacts (i.e. opportunities) for the economy as a whole, including the creation of value, increase in innovativeness, adapt-ability and competitiveness, and economic growth and job creation.On the weakness side at the micro level for PE is the potential presence of externalities, i.e. the possibility that PE firms will reap financial rewards at the cost of others. PE has also been criticized for having an overly high profit expectation which is not sustainable in the long run, for sometimes having too short of an investment horizon (some industries need more than a 4-5 year perspective). The financial orientation of PE may also lead to a neglect of technical and organizational needs of a company. The need for high profits may also lead PE firms to push for overly risky strategies in its portfolio firms. Potential negative impacts at the macro level (threats) result mainly from the extensive use of leverage in PE deals. If financial targets are not met (e.g. if sales decrease because of a downturn), the potential of bankruptcy and job loss increases because the company is un-der a heavy debt burden. This threat is accentuated if many deals were driven by the ex-pectation of returns through financial engineering rather than. Finally, PE may detract from the competitiveness and innovativeness of an economy insofar as investments which only pay off over a longer-term horizon (e.g. 8-10 years) are neglected.

SWOT assessment Private Equity Funds

Positive impacts Negative Impacts


Mic

ro D

imen

- Strengths- Seed money- Expertise/network knowledge- Governance structure- Financial resources for mergers and ac-

quisitions and growth strategies

Weaknesses- Often exaggerated profit expectations- Financial costs / externalities- Middle-term orientation only- Strong financial/shareholder orientation- Often high risk strategy

Wid

er D

imen

- Opportunities- Value creation- Increase in competitiveness- Growth and job creation- Increase in adaptability

Threats- Leverage strategy- Financial re-engineering- Risk for stable development- Employment and labour conditions- Lack in long-term orientation- Bankruptcy

3.5.2 Hedge Funds

Though there are similarities in the way of obtaining money and using leverage the busi-ness model of hedge funds differs from private equity significantly: Investment in equity only is one focus of these funds along a broad spectrum of other investment instruments (commodities, options, futures, derivates, debt etc.). Furthermore, the investment horizon of hedge funds is much shorter-term and the focus is much more on liquidating financial assets rather than by active restructuring the target companies. This also results from a further difference between private equity and hedge funds: While private equity in most cases is aiming at controlling a company by majority stakes, hedge funds in most cases only buy minority stakes, typically in “event-driven situation”, i.e. exploiting investment opportunities in the context of restructuring processes such as mergers and acquisitions. Another example of event-driven investment strategies of hedge funds are investment in “distressed securities”: Before the current economic crisis hedge funds were the largest buyers of distressed securities and thereby functioning as “last resorts” of firms facing crisis situations or even bankruptcy. Though often, only a small and speculative invest-ment is made, there are also significant and “activist” investments where one or more hedge fund(s) (“herding” behaviour) is playing a significant role in accelerating restruc-turing and change at the company level.Positive impacts of activist HF investors at the micro level (strengths) include the poten-tial to increase the value of listed companies through pushing for more efficient gov-ernance structures or organizational structures (e.g. spinning off non-core areas). Espe-cially recently HF have been one of the most significant actors as a "buyer of last resort" willing to purchase risky/distressed securities. At a macro level, HF may increase liquidity in markets by their willingness to buy and sell over very short periods of time. HF may also help overcome macro-level market failures in governance through their activity as active investors on a wide scale. HF have also been credited with support for innovation in financial products, e.g. through their willingness to trade in derivatives markets. Potential negative impacts at the micro level (weaknesses) include a very short term ori-entation, which in the case of some funds can be measured in months or days and min-utes. The simultaneous pursuit of short term strategies by a multitude of HF can lead to herding behavior, which can distort incentives at the micro level. The lack of transparency of many HF can also make it difficult if not impossible for investors to evaluate the risks they are facing. Finally, HF may achieve short-term profits by shifting costs to others


without any additional value creation (externalities). At a macro level, threats through HF include systemic risks caused by leverage (particularly to banks providing loans to HF), which can be accentuated through the pursuit of high-risk strategies or a focus on finan-cial engineering. HF may also have strong incentives for market manipulation due to an orientation to short-term returns. Activist HF strategies on a large scale for special divi-dends and share buybacks may also lead to an exhaustion of companies' financial re-serves overall.SWOT assessment Hedge Funds


Mic

ro D

imen

- Strengths- Value increase of listed companies- Orientation towards efficient markets- Buyer of “last resort”- Purchase of risky assets / distressed se-

curities

Weaknesses- Short-term orientation- “Herd mentality”/”herding” behaviour- Transparency of risks- Externalities

Wid

er

Opportunities- Liquidity in financial markets- Overcoming market failures (in the case

of active investors)- Financial innovations

Threats- Leverage/system risks- Manipulation of markets- Exhaustion of financial reserves- Focus on financial engineering- High risk strategy

3.5.3 Sovereign Wealth Funds

Both with regard to ownership, investment horizons as well as major objectives of invest-ing in company stakes, the business model of Sovereign Wealth Funds differs significantly from both private equity as well as hedge funds (though sovereign wealth funds also in-vest in these two capital funds types): As state-owned financial institutions Sovereign Wealth Funds operate on a long-term agenda aiming not only at stable long-term finan-cial returns but also following wider national economic policy goals. Furthermore, invest-ments of sovereign wealth funds in most cases are not leveraged and the strategy as a stakeholder is rather “patient” in contrast to the often aggressive and activist strategy of private equity and hedge funds.Against the background of a rapid expansion over the last decade, sovereign wealth funds have become a financing source for investments and market liquidity which is gen-erally highly welcomed by companies as well as national economic actors in situations of difficult economic framework conditions. In particular in the context of the current crisis, sovereign wealth funds play an important role in easing financial problems of many larger companies.A potential positive impact of SWF at the micro level (strength) is the longer-term orienta-tion of SWF compared to many other financial investors. SWF are also increasingly the buyers of last resort for many companies, particularly in the financial sector during the current financial crisis. Their sheer size as well as their willingness to take significant equity positions in large companies means that they are one of the few investor types capable of providing significant new capital to large distressed banks. They may also help


deal with imbalances in the global flow of funds by returning capital from countries with surpluses to deficit companies. Finally, SWFs can potentially help strengthen industrial links between developing and developed countries through merging companies in the same sector. At the macro level SWF offer opportunities insofar as they take a longer-term stakeholder orientation towards investing and also avoid leveraged strategies. They may also help en-trance to and the development of new markets through their role as pioneer investors. At a micro level SWFs however have potential negative impacts (weaknesses) insofar as they threaten the autonomy of national stakeholders and increase the potential of conflict due to cultural differences. This conflict potential may be increased due to the lack of transparency in the activities of many SWF. At a macro level, SWF may represent a poten-tial threat insofar as they pursue strategic national and political interests, rather than purely financial interests, in their investment activity. Furthermore, many SWFs are based in countries with weak democratic traditions, raising the threat of wealth concentration outside of democratic control. Sovereign Wealth Funds


Mic

ro

Strengths- Long-term orientation- Buyer of “last resort”- Increase in financial resources- Strengthening the link to industrial mar-

kets

Weaknesses- Lack of autonomy of national stakehold-

ers- Lack of transparency

Wid

er D

imen

- Opportunities- Stakeholder orientation- Sound financial engineering- Entrance to new markets

Threats- Focus on political objectives - uncertain

long-term intentions- Wealth concentration outside demo-

cratic control

4 The impact of Private Equity, Hedge Funds and Sovereign Wealth Funds on industrial change

Already the brief SWOT assessment in the previous chapter revealed a rather divergent picture of likely impacts of the three types of capital funds on industrial change at the company level but also in the wider context. This mixed picture is also displayed in the debate and literature available on this issue.On the one hand, reports and surveys undertaken by institutions closely connected to the capital fund industry consistently claim that companies which have been bought out by private equity for example create more jobs and generate faster growth in employment than other companies. On the other hand, literature and case studies carried out by trade union sponsored research institutes and more critical authors stress the negative impact in particular of private equity and hedge funds on employment and working conditions


resulting from the objective of these funds to generate high returns to owners and fund managers in a short-period of time.Against this, the main purpose of the following chapters is to address on the basis of a comprehensive review of relevant literature and data available the simple question of what we know and what we don’t know with regard to the impact of the three types of capital funds on the various dimensions of industrial change.

4.1 Dimensions of industrial change and the impact of alternative investments

There are many dimensions of industrial change depending on the specific point of view of the observer: industrial change not only occurs at the company level but also beyond, by affecting certain industry sectors, regions and localities differently. Industrial change also affects certain company types in different ways and has different effects on certain model of industrial and labour relations as well as specific national or transnational tradi-tions and models of social dialogue, corporate governance and/or employee participation.With regard to the impact of capital funds on industrial change, in the context of this re-port a dual concept is applied focusing in particular on the impact on industrial change at the company level.First, the impact on business reorganization and employment both in quantitative (num-ber of jobs) as well as qualitative terms (wages, working conditions, labour relations). This dimension today often is defined as “restructuring” and the permanent need of compa-nies to adapt to changes in demand, the introduction of new processes or the entrance of new companies which are necessary to remain competitive. Here, many companies fail: According to the EU Commission23, every year, 10% of European enterprises are set up and destroyed. It is estimated that between 5 000 and 15 000 jobs are created and des-troyed every day on average in each of the Member States. At the same time there are opportunities as evidenced by the creation of over 12 million new jobs across the EU from 2000 to 2007.24

There is also a second dimension of industrial change which is important to address since it also influences industrial change at the enterprise level: The economic, financial as well as socio-political environment enterprises are acting in, i.e. financial markets and their stability, regulatory regimes as well as frameworks of corporate governance and indus-trial relations which affect more or less directly the ability and potential of companies to adapt to change and stay competitive. Both dimensions of industrial change will be ad-dressed in the following chapters: The issue of industrial change at the company level in this chapter and the issue of financial stability and business environments in chapter 5. The following table summarises major topics and issues of concern reflected in the de-bate on enterprise level impacts of the three types of capital funds – however, the public debate very much concentrated so far on the private equity and hedge fund industry.Impacts of capital funds on industrial change at company level

Company performance

Employment and labour relations

Other impacts

23 European Commission (2005): “Restructuring and employment”, Communication of the Commission of 31st March, COM(2005) 120 final.

24 European Commission (2008): “Restructuring and employment the contribution of the European Union”, Com-mission Staff Working Paper, COM(2008) 419 final, p. 2.


- Efficiency and profitability- Value creation- Financing for growth

strategies- Availability of financial re-

sources- Adaptability and innovation

capacity- Management capacities and

corporate governance

- Employment growth- New opportunities for employ-

ees in terms of career devel-opment, training and compet-ence

- New forms of employee parti-cipation (including financial participation)

- Acceleration of necessary industrial change

- Increasing economic effi-ciency and competitive-ness of companies as well as industry sectors

- More efficient models of corporate governance and management

- No “real” value creation- Lack of long-term objectives- Wrong decisions due to

single minded profit orienta-tion

- High financial burden / ex-ternalities

- High risk strategy and danger of insolvency due to the use of leverage

- Job losses due to accelerated restructuring (also in profit-able firms)

- Wage cuts and extending working time resulting from higher profit goals and trans-fer payments

- Lack of longer-term invest-ment in human resources

- Weakening of employee in-formation and consultation

- Lack of information and trans-parency

- Weakening of national models and traditions of labour rela-tions

- High social burden due to accelerated restructuring

- Decrease in national autonomy and weakening of national patterns of value creation and eco-nomic development

- Increased instability of the financial market due to the use of leverage

- Shareholder value orient-ation instead of taking into account stakeholder and further interests

Source: Own

4.2 Overview of existing research and analyses

Estimates of the “real” impact of funds investment on companies (employment and other impacts such as wages, profits) vary widely, from quite positive to very negative. The most positive studies have been produced by the venture capital industry (associations or consultants for the industry).The literature on Private Equity 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, includ-ing returns for investors in Private Equity, and the employment, sales and profitability outcomes of Private Equity investments in portfolio companies. Beside literature with a broader scope there are also studies which focus on concrete case studies.Relevant literature on Hedge Funds is less extensive, and due to the lack of transparency regarding most Hedge Funds investments, focuses mainly on returns to investors. Some recent econometric work, however, has looked at significant shareholdings by Hedge Funds in listed companies. There is only very limited literature regarding the influence of Hedge Funds on employment issues. Similar to the PE literature most work concentrates on the US or Great Britain. E.g. for Germany only one recent study exist dealing with the effects of activist hedge fund activities on industries.25 More extensive is the literature concerning regulation of Hedge Funds. Nevertheless both categories complain a lack of sufficient data. In the past few years Hedge Funds increased their activities in equity-fo-cused investments. Research about hedge fund activism and effects on industrial change, i.e. restructuring and employment is still not very extensive. Most studies focus on the 25 Holler, Julian and Bessler, Wolfgang (2008): “Capital markets and corporate control: Empirical evidence from

hedge fund activism in Germany”, Discussion Paper University of Giessen.


U.S. (and to a lesser degree the UK) due better availability of data. One study is known which focuses on both the U.S. as well as Europe.26 For the German case also only one general study is known.27 Admittedly these studies focus mainly on the companies' stock market value and their share price development after the Hedge Fund's acquisition. Un-like the research on PE, quantitative data or surveys about the influence of Hedge Funds on industrial change like restructuring and employment issues are missing.Finally, scientific interest in Sovereign Wealth Funds, has been quite recent. The literature here is quite thin, particularly on econometric studies on the impact of Sovereign Wealth Funds investments. Due to the uncertainty of the effects of Sovereign Wealth Funds on the international finance system or on the economy respectively companies, a wide range of literature is concentrating on possible dangers of these investment vehicles. In the case of Sovereign Wealth Funds this is relevant because some of the biggest funds are managed by states which enjoy full confidence in the international community of state. Due to this there is also literature dealing with international relations and the influence possibilities of states they gain by their funds. At the recent point of research no studies are known dealing with effects of Sovereign Wealth Funds on employment topics or in-dustrial change in general.In general, most existing studies focus on the issue of employment development and little research have been done on the impact of funds on wages and working conditions or on the influence of such investments on the coordination with worker representation. Con-cerning such issues most results can be drawn from case studies because large-scale em-pirical studies have not been done .

4.3 Methodological problems and other limitations of analyzing the impact of funds on industrial change

In assessing the impact of the business models of the three type of funds on companies taken over or invested in and their employees, nearly all data sources and studies face significant problems in providing feasible and “neutral” conclusions. As a further general note, large-scale quantitative studies on the economic and social im-pact of Private Equity and Hedge Funds have been rendered quite difficult due to the lack of transparency of the industry. Finally, it has to be noted that research into private equity and other alternative invest-ments is at an early stage and there is still a significant lack of studies using large num-bers of cases. This situation becomes more difficult still when considering the problems of data availability and reliability.On the fund level Private Equity Funds are generally not forced to publish data accessible to the public at large, and the quality and accuracy of information that can be gained through (as a rule quite expensive) data bases is questionable. On the company level (i.e. level of the firms that PE funds invest in) the reporting requirements for private (non-lis-ted) 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 they change ownership in the context of a Private Equity transaction.

26 Stockman, Nick (2007): “Influence of hedge funds activism on the medium term target firm value”, Working Paper University of Rotterdam.

27 Holler / Bessler (2008).


As a result, it is virtually impossible (the only partial exceptions here are the U.S., and to a lesser extent the UK) to simply download a large dataset of PE-related companies with more information than sector, address, date of investment, etc. from the typical online data services – quite unlike the case for other kinds of studies, such as of listed compan-ies, for which detailed information is available due to extensive publicity requirements.This lack of large-scale quantitative data has forced empirical studies of private equity to follow one of these three strategies:

(1) Using standard databases while accepting the accompanying danger of biased results,

(2) Relying on self-reported or “private” data from funds and/or institutional investors in Private Equity Funds, or

(3) Carrying out case study based qualitative fieldwork.The first two strategies run the danger of providing overly-optimistic estimates of the im-pact of Private Equity (as the more scientific studies in this group of studies admit), due to a number of systematic biases: firstly, the “survivorship bias”, since failed portfolio companies (in the worst case involving a total loss of jobs) are as a rule excluded from the analysis; second, there may be additional “selection bias”, as the better firms among the survivors are overrepresented. Finally, in the case of self reported data, there is a strong danger of “reporting bias”, since the reporting PEF firms understand the potential public policy impact of the study and their self-interest in exaggerating the positive im-pacts of Private Equity Funds.The third strategy also runs the danger of examining non-representative cases, particu-larly when there is quite a small sample size.Also a further methodological problem has been stressed: The “question of the counter-factual”: “What would have happed to the company concerned, or the economy more generally, in the absence of PE involvement. Where we have data on company performance, against what benchmark should it be meas-ured? How do we account for the fact that the companies taken over by PE are far from being a random sample?”28

Any study of the effects and impact of a specific phenomenon, such as alternative invest-ment funds, would need to establish what difference that factor makes. Information and data on industrial change in companies with alternative investments therefore need to be compared with data on other similar companies which have not changed ownership. Such comparisons are sometimes made with trends in the whole economy, but should be made between companies in the same sector – otherwise the comparison may simply reflect the fact that companies with private equity investors for example - are in faster-growing sectors.Against this, an analysis of empirical findings on the influence of private equity financing on industrial employment comes to the following conclusion:“The major surveys suffer from a number of flaws, both in sampling and in data quality, rendering their es-timates of employment impact effectively worthless. Most of the assertions made by commentators, and some made by the reports themselves, cannot be justified on the basis of the evidence from existing surveys. The most reliable results suggest that buyouts generally depress wages but there is no clear overall effect on 28 Hall, David (2007): “Methodological issues in estimating the impact of private equity buyouts on employ-

ment”, PRISU, Department of International Business and Economics, Business School of Greenwich.


employment compared with other forms of ownership. Problems of self-selection and the difficulty of veri-fying data on employment arise from the information opacity which is a systematic feature of private equity buyouts”29

With these methodological problems in mind, the following sub-chapters review the avail-able quantitative evidence on the major issues of concern of our research: firm perform-ance and value creation, employment development, wages and working conditions, social dialogue/information and consultation as well as corporate cultures and governance. At the end of this chapter we also summarize research findings and results from case stud-ies with regard to non-quantifiable aspects such as the likely impact of short-term versus long-term investment strategies.

4.4 Empirical evidence on the impact on industrial change at company level

4.4.1 Firm performance, profits and value creation

Since the basic aim of private equity is to make profits, it should be obvious that private funds – at least in the aggregate - try to add value to the target companies. This assump-tion is confirmed by extensive anecdotal evidence about massive financial gains over rel-atively short periods of time and the ability of Private Equity Funds to raise the capital value (sale price, share capitalisation) of the firms invested in. However, this evidence leaves open two important questions which have been addressed in a recent overview of available evidence:30

First, evidence of adding value to a target company might not (only) result from genuine value creation by improvements in the performance of the target company itself (for ex-ample by better management, new investments, restructuring, higher productivity and other value-enhancing measures resulting in high sales and profits) but (also) from trans-fers from other sources such as: Transfers from national governments, in particular the replacement of equity by debt, transfer of profits abroad and/or the taxation of income as capital gains. Most controversially, there might be also a transfer of financial resources and value from employees by cuts in employment, increased intensity of work, cuts in pay and benefits etc. Secondly, value adding may also be due more to the ability to spot under-priced compan-ies and/or to “hoodwink” buyers into over-paying than to genuine value creation.31

One has to take these open questions into account when assessing the results of a grow-ing number of surveys covering the value creation and effects of private funds on the per-formance of target firms. A study carried out by Ernst & Young on large private equity deals in the EU and US32

finds faster growth in ‘enterprise value’ than in firms considered comparable. In particular with regard to this comparison group the study shows significant weaknesses (for more details see sub-chapter on employment effects below).The British Venture Capital Association (BVCA) is publishing annual reports on the eco-nomic impacts of private equity of which the latest version was published in 2008 (BVCA

29 Ibd. 30 Watt, Andrew (2008): “The impact of private equity on European companies and workers: Key issues and a

review of the evidence”, Industrial Relations Journal, Vol. 39(6), p. 548-568.31 Ibd. 32 Ernst & Young (2008): “How do Private Equity investors create value? A Study of 2006 Exists in the US and

Western Europe”. Available on www.ey.com


2008). The study analyzed 1,013 answers from a survey of 6,100 potential respondents from buyout-financed or venture-capital financed companies. This study estimated recent average sales growth at PE-backed firms at 8% per year. Employment growth in these companies was also found to be an average of 8% per annum. However, there are signi-ficant methodological problems with the BVCA impact studies. In addition to the survivor-ship and potential self-reporting bias, another major weakness in this study is that the methodology used was not revealed in detail.Many recent studies on the impact of private equity on firm performance and value cre-ation have been carried out with the involvement of the Centre for Management Buyout Research in Nottingham (CMBR), which is financed by the private equity industry. Some of the studies have relied at least in part on self-reported data from Private Equity Funds gathered under conditions of confidentiality. A plant-level study of UK based Management buy-outs found that productivity increased substantially - 70% in the short run, 90% in the long run, together with an output reduction of about 50% and also a significant reduc-tion in employment (see below).33

Regarding the German situation, a study by PriceWaterhouseCoopers in cooperation with the German Venture Capital Association BVK is overall positive on the impact of private equity, in particular with regard to the effects coming from venture capital. The effects of buyout investments are described more critically.34 According to the study, the profitabil-ity (EBIT) of companies in the case of buyouts excluding “turnaround situations” (i.e. companies that make significant losses when they are purchased) actually decreased by 1.9% per annum. In contrast, for buyouts involving turnaround situations, profitability on average improved considerably. Resulting from these results it can be concluded that profitability in “normal”, i.e. non-turnaround situation of buyout situations has according to empirical evidence not been improved. Here, the question arises in contrast to the res-ults of the other studies arises whether the studies on the impact of Private Equity in the UK and Europe are too optimistic, or whether the impact of Private Equity in Germany is less positive than in the UK and Europe as a whole.A major conclusion with regard to survey results on Private Equity Funds' effects on aver-age value added to target firms is that the results do not explain to which extent the value creation monitored is arising from “genuine” creation processes of rather due to “value appropriation”.Surveys and research projects trying to overcome this knowledge gap come to much more cautious conclusions with regard to value creation resulting from private equity activities. Based on a survey of almost 500 “reverse” LBOs (i.e. the sale to the public of firms that had previously bought under an LBO) a study35 found out that these performed significantly better than other IPOs and the market as a whole. However, the authors are extremely cautious in drawing general conclusions from this since the sample is not re-garded as representative. Furthermore, the survey revealed a significantly larger variety in the longer-term performance of former LBOs than those in other IPOs.

33 Harris, Richard / Siegel, Donald S. / Wright, Mike (2005): “Assessing the impact of management buyouts on economic efficiency: Plant-level evidence from the United Kingdom”, in: The Review of Economics and Statistics (87), p. 148–153.

34 PriceWaterhouseCoopers (2005): „Der Einfluss von Private Equity Gesellschaften auf die Portfoliounternehmen und die deutsche Wirtschaft“.

35 Cao, Jerry and Lerner, Josh (2006): “The performance of reverse leverage buyouts”, Working Paper, Swedish Institute for Financial Research Conference on The Economics of the Private Equity Market.


In a report for the European Parliament, various measures of private equity performance have been examined and compared with a control group.36 Though the report reveals en-hanced average performance in terms of sales and profitability, the author again is very cautious in drawing general conclusions mainly for the following reasons: The variance again is significantly greater and the analysis was based – for reasons of data limitation, not on a large sample but on just around 60 buyouts. Therefore, the study concludes that at least no evidence was found that buyouts have a negative impact on performance and profitability. The problem with drawing clear and evident conclusions is becoming even more evident in the case of Hedge Funds and Sovereign Wealth Funds:With regard to Hedge Funds, a survey at the University of Rotterdam on the basis of 188 Hedge Funds activism events was carried out in order to analyse the influence of Hedge Funds activism on the medium term target firm value of 94 companies each in the US and Europe.37 According to the study equity-focused hedge fund assets rose 30%, or $173 bil-lion, in 2006 to $743 billion. This development causes new challenges for the affected companies as well as for their employees. In contrast with the popular view that Hedge Funds have no positive effects on the companies value, the survey came to the conclu-sion that the investment of Hedge Funds lead to an increase in shareholder value for the target firms. Similar findings are reported in another study about Hedge Funds activism and firm performance in the US:“Hedge Funds target profitable and healthy firms, with above-average cash holdings. The target firms earn significantly higher abnormal stock returns (…) than a sample of control firm. However, they do not show improvements in accounting performances in the year after the initial purchase. Instead, hedge funds extract cash from the firm through increases in the target’s dept capacity and higher dividends.”38

These findings are especially interesting because literature on other institutional in-vestors than Hedge Funds finds little proof of systematic wealth creation as a result of activist investors.Similar results are arising from empirical evidence analysed in Germany. A recent survey here concluded that the engagement of activist shareholders such as Hedge Funds in-crease shareholder value in the short and in the long run. The survey was based on the evaluation of a sample of 324 events in Germany between January 2000 and June 2006. The survey also concluded that the increase in value is stronger in the case of companies that are subject to more information asymmetries prior to the event. Moreover, the study shows that there are some indications that the identity of the investor matters in the short run.Despite the increased interest in the effects of Sovereign Wealth Funds, little research has been done according to the impact of Sovereign Wealth Funds on industrial change. There are few studies focusing on the impact of Sovereign Wealth Funds on firm perform-ance and the stock market price. The most comprehensive one analyzes firm profitability, proxied by stock returns, over two years subsequent to the initial Sovereign Wealth Funds investment.39 The study finds evidence that Sovereign Wealth Funds are associated with

36 Gottschalg, Oliver (2007): “Private equity and leveraged buyouts”, Study for the European Parliament (IP/A/ECON/IC/2007-25).

37 Stockman, Nick (2007): p. 4. 38 Brav, Alon / Jiang, Wei / Randall, Thomas S. / Partnoy, Frank (2006): “Hedge Fund Activism, Corporate Gover-

nance and Firm Performance”, Working Paper, p. 2.


deteriorating firm performance: The survey concludes that due to negative buy-and-hold returns Sovereign Wealth Funds investment have a negative impact on firm profitability. A more differentiated conclusion is documented in another study40 which concludes that, although Sovereign Wealth Funds investments may lead to poor performance because political aims may be more important than profit maximization, the firm’s market value rises after the Sovereign Wealth Funds investment announcement. Furthermore the study finds that investors react negatively to the announcements of Sovereign Wealth Funds exiting the firm.

4.4.2 Impact on employment development

The effects of private equity and other funds on employment levels in target firms is probably the most controversial issue of the current debate on these funds. Speaking about hedge funds and private equity groups in April 2005, Franz Müntefering, then chair-man of the German Social Democratic Party publicly compared these investors with lo-custs “who feasted on German firms for profit before spitting them out”. With view on employment he remarked: “Some financial investors don’t waste any thoughts on the people whose jobs they destroy”.41

Contentions like these have not gone unchallenged. Private equity associations and other groups have released several recent studies that claim positive effects of private equity on employment. Examples include studies by the European Venture Capital Association42, the British Venture Capital Association43 or A.T. Kearney.44

A recent review of these studies summarizes major limitations and problems of these studies:45

Reliance on surveys with low response rates, giving rise to concerns that the data do not accurately reflect the overall experience of employers acquired by private equity groups.

Inability to control for employment changes in comparable firms. When a firm backed by private equity sheds 5% of employment, the interpretation depends on whether comparable firms grow by 3% or shrink by 10%.

Difficulties in disentangling organic job growth from acquisitions, divestitures and re-organizations at firms acquired by private equity groups. The prevalence of complex ownership changes and reorganizations at these firms makes it hard to track employ-ment using only firm-level data. Limiting the analysis to firms that do not experience these complex changes is one option, but the results may then reflect a highly select-ive, unrepresentative sample.

Inability to determine where jobs are being created and destroyed. Policy makers are not indifferent to whether jobs are created domestically or abroad. Some view foreign job creation in China, India and other emerging economies with alarm, especially if ac-companied by job cuts in the domestic economy.

39 Fotak, Velkjo / Bortolotti, Bernardo / Megginson, William L. (2008): “The Financial Impact of Sovereign Wealth Fund Investments in Listed Companies”. The study focuses on financial impact and wealth effects of sovereign wealth fund investments in the stock of listed companies around the world.

40 Kotter, Jason and Lel, Ugur (2008): “Friends or Foes? The Stock Price Impact of Sovereign Wealth Fund Invest-ments and the Price of Keeping Secret”, FRB International Finance Discussion Paper No. 940.

41 The Economist (20.10.2007): “Locusts in Lederhosen – Business in Germany”.42 EVCA (2005): “Employment Contribution of Private Equity and Venture Capital in Europe”, EVCA. 43 BVCA/IE (2006): “The Economic Impact of Private Equity in the UK”, BVCA. 44 AT Kearney (2007): “Creating New Jobs and Value with Private Equity”, AT Kearney.45 Davis, Steven J. et al. (2008): “Private Equity and Employment”, in: World Economic Forum (Eds.): The Global

Economic Impact of Private Equity Report 2008, p. 43.


In general its is very difficult to distinguish between jobs created through growth, jobs transferred to other companies by splitting companies and selling part of the holdings and jobs lost by restructuring processes. Therefore it is no surprise that the studies men-tioned above and further ones not only emphasize the positive effects of capital invest-ments on employment development but also show a large variety of concrete results.The studies carried out by the British BVCA for example estimates an employment growth in buyout-financed companies at an average of 7% per year in the period under examina-tion, i.e. five years up to 2005/2006.A survey of Ernst & Young (2008) on buyout-backed firms in Europe observed an estimate of 5% employment growth per year in the 200 largest Private Equity exists in North Amer-ica and Europe in 2006 (100 largest in each of the two regions).46 The survivorship bias in this study is exacerbated by serious selection bias: The largest (by deal value) exits were chosen, leading by definition to an overrepresentation of the most successful deals in this sample.With regard to Germany, a study of PriceWaterhouseCoopers/BVK observed an average 4.4% employment growth “per financing round” in the sample of buyout cases excluding “turnaround situations”. Since buyout financing rounds often lasts considerably more than a year, this average employment growth range would be in the 1–2% p.a. range. In contrast, for buyouts involving turnaround situations, an average of 29% of employment was lost. Similar to the results with regard to profitability, this study therefore suggests that employment is not increased in buyout-financed companies in Germany.With regard to employment effects also the CMBR studies - although financed by the equity industry – came to mixed results: Parallel to the reduction in outputs in MBOs the plant-level studies observed significant employment reduction of about 61%.47 In contrast to this a firm-level survey of MBOs in the UK and the Netherlands came to much more positive conclusions.48

Another firm-level study of MBOs and MBIs in the UK found that employment relative to non-buyout firms increased on average for MBOs (0.51% p.a.) but decreased for MBIs (-0.81% p.a.).49

One million jobs created by European private equity and venture capital-financed companies between 2000 and 2004?

The European Private Equity & Venture Capital Association EVCA published a research report in 2005 on the em-ployment contribution of private equity and venture capital in Europe which had been prepared by an academic research institute.50 The research paper concluded with some remarkable results regarding the employment con-tribution of private equity in Europe. The report in particular highlighted the following impacts of private equity:

- Private equity and venture-backed companies according to the report employed close to 6 million people in Europe in 2004 – this represents 3% of the economically active population in Europe.

- European private equity and venture capital-financed companies created around 1 million new jobs between 2000 and 2004.

- 420,000 new jobs were created by buyout-financed companies in this period of time, net of any reduction in headcount in the years following the buyout investment.

46 Symptomatic of transparency problems in the Private Equity industry is the fact that Ernst & Young were able to get detailed financial information on only 112 of these 200 transactions, even though they were all rather large.

47 Harris / Siegel / Wright (2005). 48 Bruining, Hans et al. (2005): “The impact of business ownership change on employee relations: Buyouts in the

U.K. and Netherlands, International Journal of Human Resource Management”, in: ERIM Report Series Reference No. ERS-2004-021-ORG, p. 345–365.

49 Amess, Kevin and Wright, Mike (2006): “The Wage And Employment Effects Of Leveraged Buyouts in the UK”, in: International Journal of Economics and Business Vol. 14(2).

50 Achleitner, Ann-Kristin and Klöckner, Oliver (2005).


- Venture-backed companies between 2000 and 2004 created 630,000 new jobs according to the study.- Employment in buyout-financed companies grew by an average rate of 2.4% annually over the period

between 1997 and 2004. This is nearly four times the annual growth rate of total employment in the EU-25 (0.7%) between 2000 and 2004.

- 67% of those buy-out financed companies surveyed either kept their headcount the same or increased the number of employees overall.

Underlying these impressive figures presented as “key findings”, there are some severe methodological and data problems, some of which are already noted in the annex to the report itself and others noted in a critical review of the findings.51

Some of the most significant problems in the context of assessing the employment impact are in particular the fol-lowing: The overall figures, which are most commonly quoted, include venture capital companies; figures on em-ployment levels are only estimates based on assumptions, not observations; the figures of employment growth are based on unverifiable data from a small and self-selected sample of companies; and the full results of the comparisons with non-PE companies are not published.

The first limitation is that the data on employment levels are not based on the study of actual employment of even a sample set of companies – the study is based on a survey of 99 buyout companies and 102 venture capital fi-nanced companies. They are calculated from (a) data on the distribution of buyout companies by bands of num-bers employed (b) assumptions about the average size of companies within each band, and then (c) multiplying these estimates by the number of companies in which PE funds have invested. These employment estimates are then split between buyouts and venture start-ups, not on the basis of any data about actual companies, but by a simple rule of thumb assumption that companies with more than 200 employees are buyouts and companies with less than 200 are start-ups.

The second limitation is that the data on employment growth came entirely from PE groups themselves. The PE groups decided which companies they wanted to include – worse performing companies may be less likely to be included, thus skewing the sample. The PE groups also decided whether to answer themselves, or ask the com-panies to answer – in either case, the data submitted by the groups was not publicly verifiable.

The third weakness lies in the comparisons between buyout companies and other companies in the same sector. This sectoral comparison is important because buyouts are likely to concentrate on growth sectors, and growth companies within these sectors, and so are likely to show a faster growth profile than the economy as a whole. There is a general weakness, because the set of non-PE companies chosen for comparison were the largest companies in each sector, and therefore not necessarily the fastest growing group in each sector. As the report it-self acknowledges, the buyouts do not perform better than the largest listed companies in every sector: indeed, transportation and computing may be the only two out of ten sectors in which buyouts do better.

In contrast to the impressive figures presented in surveys sponsored by the private equity industry more independent research is drawing much less spectacular or even contrarily conclusions with regard to the employment impact of private equity. Probably the most comprehensive study to date on employment effects of Private Equity was commissioned by the World Economic Forum (WEF) presented in the 2008 World Economic Forum meet-ing in Davos. The study was led by senior researchers of Investment Banking at Harvard Business School.52 One impressive conclusion of the study is that private equity invest-ments experienced larger job losses than was the case for companies in the control group. The study observed that, particularly in the first five years after investment, job losses are higher than in the control group. This appears to be generated via higher gross job reductions as the new Private Equity owners shed presumably unprofitable segments of the target firm. However, one can argue that Private Equity funds often take over weaker companies whose employment situation before the takeover was not sustainable and therefore redundancies, i.e. restructurings where either way necessary.53

Methodology of the Davos study

The study is based on used the Longitudinal Business Database (LBD) at the US Bureau of the Census, which covers all non-farm private companies, to follow employment at PE-backed companies in the US between 1980 and 2005, before and after PE takeover. The study looked at employment changes in actual workplaces owned

51 Hall, David (2007). 52 World Economic Forum (2008): “Globalization of Alternative Investments. The Global Economic Impact of Pri-

vate Equity Report 2008”, p. 43-64: “Private Equity and Employment”.53 Watt, Andrew (2008).


by these firms – factories, offices etc – as well as employment changes resulting from new establishments, the closure of existing establishments, and further takeovers or disposals by the firms. It identified about 5,000 PE-backed firms, covering 300,000 US establishments, and also a control group of 1.4 million other establishments and firms, selected for being of comparable industry, age, and size to the PE-backed establishments and firms at the time of their takeover. The study looked at employment changes for 5 years before and after the PE takeover. This approach does not suffer from the methodological problems of the private equity association surveys. It provides data on changes in employment in actual workplaces, and, separately, employment changes in the firm as a whole, including the effects of acquisitions and disposals. It excludes venture capital companies and man-agement buyouts where private equity was not involved. It covers all private equity buyouts in the USA since 1980, not a selected sample. It provides a set of ‘control’ firms with similar characteristics for meaningful compar-isons. The main limitation is that it covers only the USA.

In particular the following results are arising from the survey:Employment shrinks more rapidly in target establishments than in control establishments in the wake of private equity transactions. The study shows that employment shrinks more rapidly in establishments after a PE takeover, than in control establishments. The study found that the actual change in employment in the establishments subject to PE takeovers was about 7% worse after 3 years, and 10.3% worse after 5 years, than it would have been without the takeovers.The study found significant differences in the impact between sectors. The cumulative effect after 5 years was lowest in manufacturing (-2.4%), around 10% in retail and ser-vices, and highest of all in finance, where the report only states that the effect is ‘very large’.54 At the same time employment also grows more slowly at target establishments in the year of the private equity transaction and in the two preceding years. The average cumulative employment difference in the two years before the transaction is about 4% in favour of controls. In short, employment growth at controls outstrips employment growth at targets before and after the private equity transaction.Gross job creation (i.e. new employment positions) in the wake of private equity transac-tions is similar in target establishments and controls, but gross job losses are substan-tially greater at targets. In other words, the post transaction differences in employment growth mainly reflect greater employment reductions at targets. However, the study also stresses that the pattern of employment growth and decline are similar for both the PE workplaces and the comparators, as shown in the graph. The report points out that this shows the importance of having a matched sample, to avoid the false conclusion that the pattern is special to PE. It also points out that the broad pattern is typical of all employ-ment data (“if one randomly observes establishments at some fixed point in their life-cycle, they will, on average, exhibit growth up to the point and will, on average, exhibit decline from that point on”). So the decline by itself shows nothing about the effect of PE. It is the gap between the two lines at the end, after 5 years, which shows the impact of PE.

54 World Economic Forum (2008): pp. 50-51, footnotes 17 and 19.


Employment: targets vs normalized controls before and after event

Source: World Economic Forum 2008: Globalization of Alternative Investments. The Global Economic Impact of Private Equity Report 2008, p. 57.

In the manufacturing sector, which accounts for about a quarter of all private equity transactions since 1980, there are virtually no employment growth differences between target and control establishments after private equity transactions. In contrast, employ-ment falls rapidly in target establishments compared with controls in Retail Trade, Ser-vices and Finance, Insurance and Real Estate (FIRE).Greenfield job creation in the first two years post-transaction is 15% of employment for target firms and 9% for control firms. That is, firms backed by private equity engage in 6% more greenfield job creation than the controls. This result says that bigger job losses at target establishments in the wake of private equity transactions are at least partly off-set by bigger job gains in the form of greenfield job creation by target firms. However, we have not yet performed an apples-to-apples comparison of these job losses and gains. As mentioned above, our firm-level analysis – including the part focused on Greenfield job creation – relies on a restricted sample.A further major result of the Davos study is related to more qualitative impacts with re-gard to enterprise level restructuring which is referred to in the report as “creative de-struction”: As the report points out, the rate of acquisitions, sales, new plants and clos-ures are all about twice as high in PE firms as in others. Though described as “creative” the acceleration of industrial change inevitably will result in an increase in insecurity for workers. In 2 years following a PE takeover, 24% of employees will have experienced their workplace being closed, sold, or reduced – double the uncertainty compared with a firm which has not been the subject of a PE takeover.In the context of the 2009 World Economic Forum a follow-up study was conducted by the authors of the 2008 study.55 This study involves a massive effort of matching data on 5,000 US PE deals with data on millions of business establishments in the US (Longitud-inal Business Database). The major results of this survey are: As in the 2008 studies (which reported an average net employment loss of 7 percent

over 3 years in PE target firms), this study confirms net employment loss at PE firms. Whereas the control group had employment growth of 2.6 percent over two years, PE target firms had a loss of 1.9 percent (i.e. net negative difference of 4.5 percent for PE firms)

55 World Economic Forum (2009): “Globalization of Alternative Investments. The Global Economic Impact of Pri-vate Equity Report 2009”, Working Papers Volume 2.


The average productivity gain from PE investment is not impressive (two year produc-tivity gain of 1.98 percent relative to the control group).

Wages also appear to suffer somewhat under PE investment. Whereas wages are 1.1 percent higher (relative to the control group) at PE target firms at the time of acquisi-tion, two years later the wage premium over the control group is reduced to zero.

Interestingly enough, on average the companies acquired by PE have HIGHER produc-tivity and higher wages than the control group – whereas the expectation would be that it is the underperformers that would be disproportionately bought up by PE

Lack of similar impact surveys on Hedge Funds and Sovereign Wealth Funds

Both with regard to Hedge Funds as well as Sovereign Wealth Funds there are no studies known so far analysing the effects of these funds or specific deals with regard to employ-ment effects or other aspects of industrial change at the firm level.

4.4.3 Wages and working conditions

When a company is affected by a private equity-backed buyout or by the entrance of other forms of alternative investment in a situation of change, everything from high-level management strategies to day-to-day operational procedures at the workplace is subject to change. In the section above findings with regard to a general acceleration of restruc-turing and insecurities at work have already been noted.However, 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. As in the case of the employment development issue, industry sponsored studies come up with overall positive messages:A recent survey amongst 190 private equity-owned companies that were subject to a buyout between 2002 and 2006 conducted by the Centre for Management Buyout Re-search (CMBOR) on behalf of the European Private Equity & Venture Capital Association (EVCA) has drawn an overall positive conclusion with regard to the impact of private equity on working conditions and labour relations:“This study demonstrates that the interests of employees are given the same or greater weight under private equity ownership than was the case under the previous owners. For the majority of respondents, private equity investment meant a greater likelihood of access to a corporate pension scheme, higher earnings, more consultation across a number of issues and representation by trade union bodies.”56

Beside the methodological problems already mentioned with regard to these type of sur-veys, a major limitation of the EVCA/CMBR survey on employee relations of course is that the survey is not based on employees responding to the questionnaire but only on replies received by senior management representatives (CEO or HR director).Similar problems are characterising also other surveys, e.g. the Ernst & Young study which reports an expansion of financial incentives for employees.57

56 EVCA/CMBR (2008): “The Impact of Private Equity-backed Buyouts on Employee Relations”, Research Paper, p. 29.

57 Ernst & Young (2008).


Also suffering from management self-reporting of data, a firm-level study of MBOs in the UK and the Netherlands claimed that MBOs in both countries lead to improvements in working conditions, including wage levels, with these effects being stronger in the UK than in the Netherlands.58

In contrast to this, the UK survey of MBOs and MBIs cited above59 concluded that, in com-parison to a relative to a non-buyout control group, the impact of Private Equity invest-ment on wages was negative for both MBOs (-0.31%) and MBIs (-0.97% per year). The study shows that, particularly when external management is brought in, the LBO “will lead to management breaking implicit agreements and transferring wealth from employ-ees to new owners” (Amess/Wright 2006: p. 22). An evaluation of empirical evidence and research findings on HR practice and workplace labour relations in private equity backed companies in the UK draws quite negative con-clusions with regard to the situation in these companies as compared to others: “Greater stress, job insecurity, a lack of collective communication, low trust, and markedly hostile attitudes towards trade unions (de-recognition rises after entering PE), appear to features of life at work in PE-owned businesses.”60

However, until today there has been little systematic study on the development of wages and working conditions in PE, HF or SWF backed companies trying to avoid the well-known methodological limitations mentioned above. Against this, we have to rely on case study evidence mainly (see below chapter 4.5) which have been carried out during this decade in particular by trade unions and other “critical” institutions, e.g. the Hans-Boeck-ler-Foundation in Germany. 61 In these case studies as well as in most of the cases re-ported in the context of the analyses of hedge funds and private equity undertaken on behalf of the Socialist Group in the European Parliament,62 it is reported that workers have been forced to accept pay cuts and other reductions in working conditions.However, the representativeness of such case studies always is a problem and with re-gard to case study findings the lack of any counterfactual is of course limiting the results of individual case studies.

4.4.4 Social dialogue and information and consultation at firm level

Similar to the issue of wages and working conditions there has been hardly any signific-ant research on the impact of PE, HF and/or SWF investments on social dialogue and in-formation and consultation practice at the company level. Since the capital fund industry itself has shown no real interest in this issue, our knowledge on this topic mostly relies on reports by trade unions, works councils and (trade union orientated) case study work.Most of the case studies carried out on behalf of the Hans-Boeckler-Foundation are partic-ularly critical of issue regarding the respect of workers representation and co-determina-tion rights (see Faber 2006).

58 Bruining, Hans et al. (2005): p. 345–365.59 Amess, Kevin and Wright, Mike (2006).60 Thornton, Phil (2007): “Inside the Dark Box – Shedding a Light on Private Equity”, The Work Foundation, p. 5.61 Faber, Oliver (2006): „Finanzinvestoren in Deutschland. Portraits und Investitionsbeispiele“, Hans-Böckler-

Stiftung Arbeitspapier 123. Further case study reports and company statements are available on the homepage of the Foundation. www.boeckler.de

62 PSE (2007).


Also the IUF Private Equity Buyout Watch provides company cases and repeatedly identi-fies cases where trade unions, collective bargaining structures and worker participation are not respected by new owners.63

A problem frequently reported by employee representatives and trade unions is the fact that the European Acquired Rights Directive, which protects workers’ terms and condi-tions in the case of takeovers, does not apply in the case of PE, HF or Sovereign Wealth Fund acquisitions – this of course results from the fact that the capital fund merely takes over the share with the identity of the employer not changing. However, from the point of view of trade unions and works councils, this creates a situation of “invisible employers” were it is extremely difficult to carry out any consultation and negotiation process, as the following quote from an IUF handbook on Private Equity illustrates:“This has far-reaching consequences for unions, since the absence of any legal recognition of a change in ownership allows private equity firms to evade responsibility at an employer in the collective bargaining process. When pushed by unions to enter into collective bargaining negotiations, private equity funds have claimed that they were only involved in ‘refinancing’ the company and are just another ‘shareholder’.”64

However, there is also evidence that the concrete economic situation as well as the posi-tion and role played by the works council or trade union structures at the company level to a large degree also determine the development of social dialogue and management-employee relations after a capital fund takeover or majority investment. Where trade uni-ons and/or works councils have a strong organisational position, they often can bargain effectively with new investors. This chance improves in the context of favourable eco-nomic conditions. Also, national traditions are likely to be relevant as case study ex-amples in Germany illustrate. Even in the case of corporate turnarounds, there are cases where private equity funds have regarded works councils as a positive resource and actor in restructuring situations.65

4.4.5 Management practice, corporate cultures and governance

A review of management practice in private equity backed companies in the UK carried out by the “Work Foundation” summarizes the empirical evidence and relevant research results on the specificity of private equity with regard to changes in management prac-tice and HR as follows:66

PE backed companies favour a distinct cocktail of human resource practices – stress-ing performance-based reward, and regular performance appraisal.

Other favoured practices are broadly consistent with ‘hard HRM’ – self managed teams, individual communication, delayering, training, and making workers respons-ible for their own jobs and advancement.

At its best, these practices are able to contribute to enhanced performance and pro-ductivity. However, some aspects of this highly geared PE people management cul-ture may not be consistent with the notion of ‘good work’.

In the context of the 2009 World Economic Forum meeting in Davos, a second set of stud-ies on the impact of private equity was released in January 2009.67 Like the first set of

63 http://www.iuf.org/buyoutwatch. 64 IUF (2007): “A Workers Guide to Private Equity Buyouts”, International Union of Food, Agricultural, Hotel,

Restaurant, Catering, Tobacco and Allied Workers’ Associations, p. 18.65 Scheytt, Stefan (2006): „Glück im Unglück“, in: Die Mitbestimmung, No. 6, p. 10-15. The article describes the

experience of the employees at MTU Aero Engines in Bavaria with the Private Equity Fund KKR.66 Thornton, Phil (2007).67 World Economic Forum (2009).


studies (released in 2008), this volume, entitled, summarizes research coordinated by the respected PE academic Josh Lerner (Harvard Business School) and carried out by respec-ted academics in financial, industrial and labour economics. One of the four studies con-ducted focussed on comparing the management practices in firms with different types of ownership structures (PE versus listed firms, family-owned firms, etc.).This study is based on a large-scale telephone survey of managers in over 4,000 compan-ies in a number of countries. A critical review of this study would pick out the following points: Management practices (as defined by the study) are not significantly better at PE tar-

get firms than at listed companies with dispersed ownership (here: no blockholder with at least 25% of the shares) or, on most measures, than family-owned firms with an external CEO (summarized in Table 2, p.14 of the study)

The higher score for management practices in PE firms relative to firms owned by the state, managers, founders, private individuals, and families (with an internal CEO) is explained by a larger proportion of companies with very low scores in the other own-ership categories, rather than worse performance of “typical” firms (displayed in Fig-ure 3, p. 12 of the study)

In general the “positive effect” of management practices in PE is much lower when control variables (industry, size, etc.) are included (summarized in Table 3, p. 15)

A breakdown of the individual management practices examined shows that PE firms had higher scores on only 8 of the 18 practices examined, and that the significance level was weak in 3 of the 8 significantly different practices.

PE firms were not significantly better in management practices such as: modern man-ufacturing, management of human capital, attracting, retaining and managing human capital, and promoting high performers

PE firms had strong significantly higher scores only in the following five practices: pro-cess documentation, performance tracking, performance review, performance dia-logue, and removing poor performers

Overall a careful reading of the study seems to suggest that the major impact of PE on management practices is to heighten monitoring of performance and to remove em-ployees and plants that do not reach performance benchmarks. PE owned firms’ higher scores overall are explained by the lack of portfolio companies that have very low management practice scores, rather than better practices at “typical” firms

With regard to the debate on “shareholder versus stakeholder” orientation and the pre-valence of the Anglo-Saxon corporate model against more socially balanced models (“Rhineland Capitalism”) it is important to bear in mind that financial investors and fund managers do not operate on an “ideological” basis. In this regard any conclusions with re-gard to direct impact of the three types of funds on corporate governance models or in-dustrial relations models should be made very cautiously. Reflecting on existing evidence, a senior research of the European Trade Union Institute in this context has drawn the fol-lowing conclusion:“The evidence, which seems plausible even if anecdotal, suggests that PE, with its narrow focus on obtain-ing its operating goals, is ‘unideological’, if unsentimental, in its approach to issues such as collective bar-gaining and worker participation. Worker representation institutions will come under threat, and may be des-troyed if they are perceived, rightly or wrongly, as inimical to PE’s goals. But the fund will carefully weight the likely costs of such action.”68

68 Watt, Andrew (2008): p. 548-568.


4.5 Evidence from case study research

There are a growing number of case studies carried out by academic researchers and oth-ers on the background, effects and impact of private equity in the context of concrete single cases. For the purpose of our core research interest – providing an overview of ex-isting knowledge on the impact of the three types of funds – both case study documenta-tions and analyses are highly interesting, since most case studies directly address the im-pact on industrial change, employment and work. At the same time there are some traps to be avoided when interpreting case study findings.Considering the methodological shortcomings of relying on case studies summarized above (see chapter 4.3, in particular the generalisation of non-representative, individual case study findings and the lack of matched-pair comparisons), the representivity of case study finding is always an issue. In this context the following presentation of results should be regarded as an overview of the impressive variation in findings with regard to industrial change at the company level as it arises from case study fieldwork.For the purpose of our study, the results of approximately 80 case studies on the effects of private equity buyouts and hedge fund activism on enterprise development were taken into account.69 With regard to sovereign wealth funds no case studies were identified. There is significant variation in these case studies with regard to the depth of information provided, ranging from the presenting of available information and a purely descriptive character to comprehensive case studies on enterprise development and restructuring based also on primary information such as interviews with key actors.

4.5.1 Evidence on the impact on industrial change at enterprise level

Any change of company ownership has an impact on economic change within this com-pany – this is simply a commonplace. Will this change will be positive for the short, me-dium and/or long term economic performance of the company or not, and will this change be positive for owners and shareholders mainly at the cost of employees (e.g. due to wage cuts, redundancies, outsourcing etc.)? These are questions which very much de-pend on the one hand both on the economic situation of the company and the challenges it is facing at the time of ownership change and on the other hand on the business strategy of the new owners.It is important to have this general relation in mind which relates to any change of owner-ship, not only to change resulting from PE, HF and SWF investment and ownership. As in all cases of ownership transfer the basic motive of investors and new owners generally is to increase the value of the company.However, as we have seen in the context of comparing the different business models of the three types of investments analysed here, there are significant differences between PE, HF and SWF with regard to concrete expectations of value creation as well as with re-gard to the practice of actively influencing/managing industrial change at the company level. There are also significant differences in the timeframe of investment horizons, with a stronger focus on short-termism at hedge funds and private equity and a much longer time horizon at sovereign wealth funds.

69 In particular the following sources contain case study documentations: Kamp/Krieger 2005, Blome-Drees (2006), Faber (2006), Scheytt (2006), Thornton (2007), Kaserer et. al (2007), van den Burg/Rasmussen (2007), World Economic Forum (2008), IUF (2007).


The available case studies illustrate both findings with regard to the principal features and differences in the business models of the three types of funds.70 At the same time, case studies replicate the broad and controversial debate about the overall impact of private equity takeovers/buyout investments on industrial change at the company level. This debate, which broadly is divided in two major strands, is also mirrored in the avail -able case study evidence.The first strand stresses the positive impact of private equity investments and activist hedge funds on industrial change. In particular, case study evidence provided by the PE business community itself and sponsored research, as well as case studies carried out by research institutions which are regarded as being more critical, find many individual “suc-cess stories.” These cases illustrate how PE and/or HF driven takeovers, buy-outs and ma-jority investments contribute to a successful management of change and increase in profitability, adaptability and reorientation within the enterprise, resulting in an increase in competitiveness, growth and efficiency. Depending on the concrete background and the challenges an enterprise is facing (ranging from management inefficiency, enterprise structure and business orientation to acute crisis situations) exemplary case study evid-ence illustrates that private equity has improved management efficiency, more efficient allocation of capital and greater production efficiencies. As a result, the value of the firm increased through growth and employment creation, which benefitted both shareholders, employees and the society as a whole.Cases illustrating the successful management of necessary change in enterprises facing problems and/or undeveloped opportunities are documented by the PE business itself71

but also in documentations of case studies which have been carried out by independent or even “critical” research institutes.72

What is striking in these case studies is the significant variety of private equity invest-ment strategies and the degree of active involvement of implementing change. The strategies described in the case studies range from rather passive strategies (which focus on providing capital for growth and expansion of business either in the context of interna-tionalisation or the development of new products and services with little of no direct in-volvement in the operational management) to strategies which are very much focussed on internal restructuring processes at the enterprise level with the PE majority investor actively involved. These differences confirm the observation of three basic strategies with regard to industrial change at the enterprise level observed elsewhere: First, growth only strategies; secondly an activist strategy focussing on growth and enterprise restructuring and thirdly strategies concentrating only on restructuring of the enterprise (Gottschlag 2007). These three broad types of strategies follow the single common aim of increasing the value created by the business and have significant impact on micro-economic change

70 It has to be noted here again, that no significant case study evidence with regard to SWF investments are available. Therefore, our knowledge on this type of investment necessarily has to rely on anecdotal evidence as provided in newspapers and/or other sources on SWF investments.

71 For example, around 25 successful cases PE investments and active management of change are described on the website of the German Association of Capital Investmens (Bundesverband Deutscher Kapitalbeteiligungsge-sellschaften): www.wir-investieren.de.

72 For example, the 20 cases presented briefly in the PE/HF report of the Socialist Group in the European Parlia-ment (Van den Burg/Rasmussen 2007) also include examples of active PE investments which have resulted in a successful management of restructuring and change at the enterprise level. Case study analyses prepared by the German Hans-Böckler-Foundation also illustrate positive cases of management of industrial change, growth and/or turnaround triggered by PE investments (see Kamp/Krieger 2005, Faber 2006). Finally, the documentation of cases in the 2008 report of the World Economic Forum contains examples of PE investment strategies contributing to a positive development of the respective enterprises (e.g. Messer Griesheim and New Look).


at the workplace level. Cases here illustrate a wide range of impacts, ranging from hardly any change to significant change for example resulting from outsourcing of parts of the business, relocation, reorganisation of work and production processes, etc. 73

More recently, case study evidence and practical examples illustrating the impact of hedge funds on industrial change at the company level have been published.74 As these cases illustrate, activist hedge fund practice in general follows the three basic strands identified above with regard to industrial change. However, a marked difference might be seen in the character of the situation of the target firm (with a strong bias towards enter-prises in acute crisis situations) and a stronger orientation towards high-risk investments.Depending on the specific situation of the target company and the challenges/problems the enterprise is facing, private equity investments and activist strategies with regard to restructuring may also result in failure, i.e. bankruptcy and closure. Cases of such experi-ences have also been documented in case study descriptions75 but there are only a few case studies focussing in particular on the underlying reasons and the specific impact of private equity and activist investment strategies on failure.In stark contrast to this lack of empirical case study evidence, most case studies finding a negative impact of private equity and hedge fund activism on industrial change at the en-terprise level focus on negative effects on labour relations, working conditions and other employment related issues.

4.5.2 Impact on employment, working conditions and labour relations

In contrast to the success stories with regard to a positive impact of private equity on managing and implementing change at the enterprise level prepared by the industry it-self or sponsored studies, there are many case studies stressing the negative impact of private equity on labour related issues. In particular, case studies sponsored or prepared by trade union organisations stress that restructuring and industrial change triggered by private equity and activist investors is implemented at the cost of employees. The major strategy with regard to restructuring and business reorientation is characterised by a “low road” strategy, i.e. reducing wages, cutting employment, and possibly reducing R&D and capital investment to increase profits in the short run at the expense of long-run in-novation.76

Besides evidence provided by trade union organisations, more in-depth evidence on a worsening of labour relations and working conditions (in particular wages and working time) based mainly on interviews with employee representatives is provided by case studies prepared by the Hans-Böckler-Foundation in Germany (Blome-Drees 2006). The case study examples in the PE/HF report prepared by the Socialist Group of the European Parliament also focuses very much on the impact of PE/HF activist investment on labour relations and working conditions (Van den Burg/Rasmussen 2007).73 A study for the Federal Government in Germany analyzed six cases of PE and HF driven buyouts and came to

the conclusion that, in five out of the six cases, the investments resulted in a positive implantation of change and an improvement of the economic prospects of the respective firms (Kaserer 2007).

74 The documentation of the Socialist Group in the European Parliament already contains some HF examples (Van den Burg/Rasmussen 2007), e.g. Deutsche Börse, DIS. A further documentation of six concrete cases of ac-tivist hedge funds and their impact on the management of the respective companies and changes at the enterprise level was published in 2009 by the IRRC (IRRC 2009).

75 See for example, Blome-Drees/Rang 2006 on Edscha, Van den Burg/Rasmussen 2007 on Märklin and Stork.76 Case study examples illustrating these impacts are presented for example by the “Private Equity Buy-out

Watch” of the IUF (International Union of Food, Agriculture, Hotel, Restaurant, Catering, Tobacco and Allied Workers Association), see IUF 2007; or the PE/HF report of the Social Group in the European Parliament (Van den Burg/Ras-mussen 2007).


In general, the cases presented in the studies mentioned above and other studies docu-ment a decrease in employment levels and a deterioration in working conditions as well as in the in the extent to which employee rights to information and consultation are re-spected when a private investor steps in. While some of the German case studies stress a particular negative impact of re-orientated management strategies on information, con-sultation and co-determination rights at the company level, the IUF Private Equity Buyout Watch also provides many examples of cases where trade union rights, collective bar-gaining structures and information and consultation rights have been disregarded by the new owners. Other case study evidence (e.g. Thornton 2007) also supports the conclusion that private equity driven change in management practice often results in an increase in hostility to trade unions and works councils, including trade union de-recognition.However, with regard to labour relations and employee participation, existing case study evidence is not unanimously negative. The European Parliament report includes some ex-amples illustrating cases of PE takeovers which leave the existing culture and structures of employee participation and industrial relations for the most part untouched, or even result in improved labour relations.77 Similarly, some of the cases documented by the Ger-man Hans-Böckler-Foundation also describe change processes where employee rights of information, consultation and negotiations have been respected by the new owners or even improved.78 And even the rather critical study mentioned above (Thornton 2007) in-cludes case study evidence on positive effects on HR management and labour relations, such as increase in autonomy or increased investments in training and personnel qualific-ations of employees.While the majority of case studies indicate rather negative effects of restructuring pro-cesses in enterprises taken over by PE or activist hedge funds, resulting in a worsening of working conditions and labour relations, it is important to stress that this phenomena of course is not only limited to private equity investment. As many cases throughout Europe illustrate, increasing competition in the context of globalisation and change has also res-ulted in new pressures on working conditions and labour standards in companies of all sectors, sizes and ownership structures.And in this context, both in PE and/or HF controlled firms as well in other companies con-fronted with restructuring, the ability of trade unions and employee representatives to re-tain their rights and influence on management decisions seems to depend in the first place on their organisational position and strength within the company. In those cases where employee organisations have retained such organisational strength they also can bargain effectively with new owners – PE, HF or Sovereign Wealth Funds or other groups of investors.Furthermore, as evidence from some case studies from Germany (but also from Den-mark79) shows, the respective national context of labour relations and industrial relations seem to have an significant impact on the behaviour of PE and other private investors taking over a company. Against the background of a national system of strong employee/trade union involvement through collective bargaining (Denmark) or legal co-determination rights (Germany), private equity investors aiming at implementing a re-

77 See the cases of Eircom, Picard and New Look in Van den Burg/Rasmussen 2007.78 See Scheytt 2006 on the case of MTU Aero Engines.79 See the case of ISS Denmark in Van den Burg / Rasmussen 2007.


structuring process in the relevant company regard worker representatives as an import-ant and positive resource in the change process.

4.6 Conclusions: What we know and what we don’t know

It is not possible to draw a clear-cut résumé of results regarding the impact of private equity and other financial investors covered in our study on industrial change and in par-ticular on employment, working conditions and wages presented in this chapter.Though there are also no clear results regarding the impact of the three types of funds on company performance and value creation it is quite obvious that the emergence of PE, HF and SWF as a European-wide phenomenon has contributed to an acceleration of restruc-turing, performance benchmarking and efforts to increase the competitiveness of com-panies and work.Research findings and in particular available case study evidence – although nuanced – on labour relations, working conditions, wages and bargaining processes at company level suggest that workers in target companies are on average are treated as one source of “value creation” and thus profits for private equity funds. However, one should be extremely cautious to conclude from this that employees in funds backed companies are treated worse or “squeezed harder” against the lack of any matched-pair comparison and/or counterfactual. In particular in the context of the eco-nomic environment and the general acceleration of industrial change and restructuring during the last two decades in the context of globalisation and the entering of new actors onto the world market, there are many examples of a worsening of work conditions and labour relations throughout Europe where capital funds are not playing any role.Given this bankground, a challenge for social sciences research in the future will be to ob-tain and analyse, on the basis of sound methodological approach, comprehensive and re-liable data that shed more light on the impact of capital funds on these topics.This also relates to the interesting question which is only touched slightly in the context of our study: The impact of private equity, hedge funds and sovereign wealth funds on different national social models as well as the European Social Model of labour relations and the relationship between labour and capital. The crucial question here is whether capital funds will contribute to a harmonization of industrial relations with a strong bias towards the Anglo-Saxon model or other developments are more likely to happen. On the basis of results of previous research on the impact of multinational companies on indus-trial relations in Central and Eastern Europe it seems also likely that capital funds are ad-apting to national systems and alter the respective behaviour and management style ac-cording the existing company specific conditions and national frameworks.80

80 See for example: Kluge, Norbert and Voss, Eckhard (2003): "Managementstile und Arbeitnehmerbeteiligung bei ausländischen Unternehmen in Polen, Tschechien und Ungarn", in: WSI-Mitteilungen, Heft 1/2003. Voss, Eck-hard (2006): “Laboratories of the new Europe: trade unions, employee interest representation and participation in foreign investment enterprises in central and eastern Europe, in: Transfer. European Review of Labour and Re-search, Vol. 12, No. 4, p. 577-591.


5 The financial crisis and Private Equity: Implications for indus-trial change

5.1 Introduction

This chapter analyses the impact of the financial crisis on PE and its implications for in-dustrial restructuring. Although much of the analysis of the financial crisis to data has fo-cused on the US subprime mortgage market, problems in other types of credit markets are becoming increasingly apparent. Currently a major crisis is developing in the lever-aged buyout (LBO) industry in Europe, where PEFs have used approximately EUR 500 bil-lion in loans to supplement their own equity investments of EUR 280 in European com-panies. Due to the deterioration in the economic climate many of the companies PE in-vested in will not be able to make scheduled interest payments. Estimates are that com-panies may default in up to half of this LBO debt in the next few years. Furthermore, even many companies that meet interest payments may be in trouble, since PE firms cannot find buyers to sell them to and refinancing is difficult, meaning that the principal on term loans has to be repaid by the target company. Even under favourable macroeconomic conditions PE investment results on the whole in job and wage losses, and this pressure is increasing under the strain of the financial crisis.81 However, this growing crisis threatens not only employment, working conditions and the quality of industrial relations in many companies, but also the goal of regaining financial stability. Large banks hold a significant portion of this LBO debt on their own books (estimates run between EUR 50-80 billion), and this amount is highly concentrated among a few major participants in leveraged loan origination. Further losses on these loans will result in more erosion in the capital of large banks and thus reduced ability to make new loans. Institutional investors (e.g. pension funds) also hold substantial LBO debt, and will have to sell off liquid assets such as publicly traded equities to meet cash obligations, putting further pressure on financial profits. Recent press reports on specific countries indicate that HF are major buyers of distressed debt, and that in some cases SWFs are being called upon to provide equity capital. As more and more target compan-ies cannot repay their loans and/or PE-related loans reach maturity and cannot be paid back, the pressure for industrial restructuring – including a more extensive involvement of HF and SWF – will build.

5.2 The Current Situation in Private Equity

As reviewed in Chapter 2, European private equity activity has been increasing at a very rapid pace over the past two decades. This activity reached a peak of about EUR 74 bil-lion of private equity invested in 2007. By the end of 2007 the total value of the European private equity portfolio was estimated at just short of EUR 260 billion. 82 Since the proportion of LBO deal financing provided by equity is roughly one third, then the value of LBO debt outstanding should be roughly twice the value of the equity portfo-lio. Since this was likely in the neighbourhood of EUR 280 billion by the end of 2008, then a very rough estimate of the face value of European LBO debt currently outstanding is EUR 500 billion. In fact the list of loans issued to finance LBO deals in Europe between 2003-2008 totals USD 627.2 billion – given the exchange rate and the fact that not all 81 See here for example: Watt, Andrew (2008). 82 Although figures for 2008 were not available from EVCA at the time of writing of this report, information from

other sources indicate that investment activity decreased dramatically in 2008.


LBO loans are included in this data base, this comes close to the figure of EUR 500 billion. Given the structure of LBO debt financing, some of this debt would still be held by banks, some by institutional investors as outright loans, and some by institutional investors as CDOs (“collateralized debt obligations”).Since late August/early September 2008, however, the value of much of this outstanding debt has been severely devalued given a sea change in the market perception of risk. In-vestors’ estimates of the probability of default have increased greatly over the past year. Furthermore, the decrease in the value of the stock market by roughly half has made it more difficult for PE to exit target companies at a large profit. Larger packages of lever-aged loans trade actively in a secondary market, and the current market price of this debt is a good indicator of the market perception of the probability of default of the is-suers of this debt. As reviewed in Chapter 2, whereas this leveraged debt was trading at roughly 90-95 percent of face value at the beginning of 2008, the mark-to-market value of this debt had plunged to less than 65 percent by the end of 2008. Based on similar data, a study by the Boston Consulting Group and IESE business school found out that the loans of roughly 60 percent of LBO debt were trading at distressed levels, i.e. at levels re-flecting market judgment of a very high probability of default (operationalized as a 10 percentage point spread above short-term interest rates (see graph). Distribution of Pricing of LBO Debt (end 2008)

Source: BCG-IESE Report (2008: 3).

Based on this data, the study derived the three-year cumulative default probability on the outstanding LBO debt (see graph below). This estimate is that 49 percent of the issuer companies would go into default over the next three years.83

83 BCG-IESE (2008): “Get ready for the private equity shakeout: will this be the next shock to the global econ -omy?”.


Cumulative default probability for 328 portfolio companies

Source: BCG-IESE Report (2008: 4).

Given the estimate of roughly EUR 500 billion of European LBO debt outstanding derived earlier, this would translate to defaults on approximately EUR 250 billion of this debt. In addition, approximately EUR 140 billion in equity investments by PE would have to be written off.

5.2 The crisis in Private Equity and its implications for financial stability

Although some commentators have downplayed the dangers of PE for financial stability, the figures presented in the previous section show 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, institu-tional investors that have purchased LBO debt from originators, and also institutional in-vestors who have invested directly in PE. The LBO debt problem contributes to the cur-rent financial crisis not only directly, through the partial writedown of LBO debt by origin-ating banks. The financial system is also indirectly affected, as institutional investors are not realizing expected cash flow from LBO-related investments and resort to forced selling of other assets in order to meet funding obligations. These risk points are analyzed in turn.Large banks

Large banks in Europe and the US have in large part shifted from a strategy of holding loans on their books until maturity to an “originate-to-distribute” financing model. In prin-ciple this allows banks to focus on generating income from the fees involved in loan ori-gination. In syndicated loans, a particularly large proportion of fees goes to the lead syn-dicator. As a result, originating banks are in principle not faced with the long-term default risks of this debt, and also do not have to tie up capital that would have to be set aside to act as a buffer for loan losses. It is widely understood that the Basle II capital adequacy agreement for banks has contributed to this process by setting low capital requirements for this type of activity.


Europe, Middle East & Africa: Leveraged Loan League Table, 2007Rank

Bank Holding Company Arranged Loans (billion $)

# deals Mkt Share

1 Royal Bank of Scotland 123.4 295 7.70%

2 BNP Paribas 112.1 414 7.00%3 Citi 87.1 232 5.40%4 Barclays Bank 80.5 209 5.00%5 Calyon 76.0 243 4.70%6 Societe Generale 68.7 220 4.30%

7 Deutsche Bank 61.1 138 3.80%

8 JP Morgan 59.8 117 3.70%9 HSBC 53.5 166 3.30%10 ABN AMRO 52.4 169 3.30%

Source: Reuters LPC (Loan Pricing Corporation).

Some large European banks have been very active in this activity, both within and out-side of Europe. Figures from Reuters indicate that eight of the top ten banks in terms of volume of syndicated loan volume in the EMEA (Europe, Middle East and Africa) region in 2007 were based in Europe (see above table). On a global level, seven of the ten top banks were based in Europe.Although in principle risk is shifted to other investors by selling off the loans, in fact ori-ginating banks are subject to “warehouse risk” caused by lags between the time when they make a loan commitment and the time when the loans are actually sold. This time lag is greater for loans that are intended to be securitized, since the bank may have to wait awhile until loans from other LBO deals are available for packaging.84 A survey done by the European Central Bank shows that this risk is concentrated on the balance sheets of a few large banks.85 The net exposure to LBO debt for the top quartile of EU banks by exposure amounted to roughly 25 percent of Tier 1 capital. Furthermore, large banks are highly exposed to a small number of deals. The median exposure to the top five LBO deals in the portfolios of large banks following the “originate to sell” model amounted to 60 percent of the total LBO portfolio (see charts below).

84 Bank for International Settlements, Committee on the Global Financial System (2008): “Private equity and leveraged finance markets”, CGFS Paper No. 30.

85 ECB (2007): “Large Banks and Private Equity-Sponsored Leveraged Buyouts in the EU”.


Source: ECB “Large Banks and Private Equity-Sponsored Leveraged Buyouts in the EU” (April 2007).

Since 2007 the degree of warehouse risk has increased dramatically, since institutional investors have been less willing to buy leveraged loans and banks have built up a consid-erable backlog of this debt on their balance sheets. As the value of outstanding leveraged loans plunged dramatically in the fourth quarter of 2008, banks have written down part of these losses. Due to lack of transparency in reporting, however, it is difficult to ascertain how much of this debt is still on banks’ balance sheets. The BCG-IESE report estimates that this amount is probably somewhere between EUR 50-80 billion, i.e. still a substantial risk to bank balance sheets and thus to financial system stability. Institutional investors

Institutional investors are affected by the developing PE crisis in two ways: as purchasers of LBO debt, and as investors in PE funds. The LBO debt problem contributed to the cur-rent financial crisis directly, through the partial write-down of LBO debt, which reduced the value of institutional investors’ assets. However, institutional investors that invested directly in PE funds were affected in a second way due to the nature of the PE investment model. PE funds are generally established for a fixed period of time (typically for 10-12 years), and during the fundraising process institutional investors make financial commit-ments up to a certain maximum amount. As limited partners (LPs) in the PE fund, institu-tional investors have little control over the timing and realization of PE investments. The firm managing the day-to-day activities of the PE fund (the general partner, or GP) can use this commitment flexibly by require institutional investors to provide cash on an as-needed basis. Furthermore, many investments are realized before the end of the PE fund’s lifetime. This introduces considerable uncertainty for the institutional investor re-garding the timing of cash draw-downs and distributions. Since the financial crisis rendered projections of PE investment cashflows as much too optimistic, institutional in-vestors were forced to sell other assets in order to meet funding obligations. As losses will continue to mount, institutional investors may be forced to continue their selling of these other assets, keeping downward pressure on securities market prices.


5.3 Implications for the Micro Level

In addition to the financial stability concern, another concern regards the impact of PE on employment levels and industrial relations at portfolio companies. Employee relations at many PE portfolio companies have been adversarial. As reviewed in Chapter 4, the most comprehensive study to date on the impact of PE on employment concludes that jobs are lost at many companies, with net employment falling an average of seven percent in portfolio firms in the two years after investment (compared to a control group).86 Given that these figures are averages, the actual job loss at many portfolio firms has been con-siderably higher. An extensive set of case studies has documented that industrial rela-tions at many PE-owned companies has been adversarial, with rights to information and consultation being violated and extreme pressure exercised on employment levels, wages and working conditions in order to achieve profitability goals.87 A recent study by Moody’s of the largest PE firms also confirms the picture of consider-able heterogeneity in financial strategies pursued (see table below). Although this study focused on US investments, many of the PEFs active there are also major investors in Europe. Furthermore, the situation of PE in Europe is similar to that of PE in the US. Some PEFs are less patient and more dependent upon financial engineering than others. In 46 percent of the companies analyzed dividends were extracted from the portfolio company prior to exit. For 20 percent of the companies dividends were extracted from the portfolio firm within one year of the initial investment, and in 28 percent of the companies total di-vidends extracted amounted to at least 80 percent of the value of the initial investment. As a result of this activity, the default probability of many portfolio companies increased, and credit ratings were downgraded at 33 percent of the companies. Given that these are average figures, the record of some PE firms was considerably worse than others. The PE firm Thomas H. Lee extracted dividends in less than one year from 38 percent of the com-panies it invested in, and also extracted total dividends of at least 80 percent of the value of investment in 38 percent of the cases. Not surprisingly, the credit rating was down-graded at a total of 63 percent of the companies this firm invested in. The PE firms Cer-berus and Blackstone extracted total dividends of at least 80 percent of investment value in 57 percent and 40 percent of the firms they invested in, respectively.88

86 Davis, Steven et al. (2008). This study involved matching PE investment data with records for 5 million US firms and comparing employment changes to a control group of companies.

87 See here for example the report of the PSE group as well as the documented case studies sponsored by the Hans Boeckler Foundation (www.boeckler.de).

88 Moody’s Global Corporate Finance (2008): “Private Equity: Tracking the Largest Sponsors”.


Summary Data from Moody’s Study of Large PE Firms

5.4 Upcoming Problems in PE Target Companies

Based on an analysis of data from SDC Platinum, it is possible 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. The SDC Platinum “New Issues” database provides a list of LBO loans indicating the date on which the loans were made, the maturity date of the loan, the characteristics of the loan (term or revolving loan, seni-ority of loan), and the issuing company i.e. debtor. Based on this data, the following amounts of LBO debt for European companies will be coming due over the next decade.In all SDC Platinum identifies USD 627 billion of debt issued to finance LBOs in Europe between 2003-2008 (see table below). For USD 146.6 billion no maturity date was identi-fied. Given that LBO loans typically have a maturity of 5-10 years, the first debt from the 2003-2008 period is starting to come due – in all USD 8.5 billion in 2009, but thereafter rising rapidly to a peak of USD 148.2 billion in 2014.Maturity Schedule for European LBO Debt Issued between 2003-2008Year of Maturity Amount (USD billions)

2009 8.52010 20.52011 41.22012 59.42013 97.42014 148.22015 134.8


Year of Maturity Amount (USD billions)

2016 81.42017 29.82018 6.0not identified 146.6

Total 627.2

Source: SDC Platinum.

Furthermore, the timing of maturity and amount due can be identified for individual com-panies with SDC Platinum. The table below shows companies for which LBO-related loans of over USD 500 million are coming due from now until the end of 2011. Given that LBO debt is typically divided up in a number of trenches, the individual entries in almost all cases represent only a fraction of the total debt outstanding for the company.Maturity Schedule for LBO Debt over USD 500 Million Until Dec 2011 Maturity Issue

DateIssuer Nation Principal

Amount($ mil)

TypeofSecurity

06/30/09 01/16/04 UPC DISTRIBUTION HOLDING BV

Netherlands 1,326.4 Term Loan

09/10/09 09/10/04 QinetiQ Group PLC United King-dom

539.3 RevCred/Term Ln

09/23/09 09/23/08 Securitas Direct AB Sweden 974.3 Term Loan

10/31/09 10/31/06 France Printemps SA France 738.9 Bridge Loan

04/08/10 04/22/05 East Surrey Holdings PLC

United King-dom

825.0 Term Loan

05/14/10 05/14/04 Debenhams PLC UK 556.9 Term Loan A

06/16/10 04/02/05 Arindo Global Netherlands 600.0 Term Loan

06/22/10 03/03/04 Auna Spain 4,241.9 Term Loan

09/06/10 09/06/04 Cholet Acquisitions Ltd United King-dom

1,059.0 Term Loan

09/21/10 09/21/05 National Car Parks Ltd United King-dom

588.0 Term Loan

12/21/10 03/03/04 Auna Spain 1,212.0 Rev Cred Fac

02/18/11 11/30/05 TDC A/S Denmark 2,762.1 Bridge Loan

06/09/11 06/07/08 Angel Trains Ltd United King-dom

1,605.5 Term Loan

06/24/11 06/24/04 Automobile Association United King-dom

730.2 Term Loan

07/23/11 01/16/04 Vivarte SA France 512.0 Term Loan A

08/03/11 08/03/06 SAUR France 550.6 Term Loan


Maturity IssueDate

Issuer Nation PrincipalAmount($ mil)

TypeofSecurity

10/27/11 10/27/08 Porterbrook Acquisition United King-dom

805.0 Term Loan

11/15/11 11/15/04 Automobile Association Ltd

United King-dom

784.7 Term Loan

12/08/11 10/29/04 Saga Holdings Ltd UK 505.9 Term Loan

12/12/11 12/07/06 Wind Acquisition Fi-nance SA

Luxembourg 1,793.3 Term Loan

12/12/11 12/07/06 Wind Acquisition Fi-nance SA

Luxembourg 500.0 Term Loan

12/15/11 12/15/06 Herkules Group Germany 1,151.1 Term Loan

12/21/11 12/21/04 Corleoni Investment LTD

United King-dom

985.2 Term Loan

Source: SDC Platinum.


6 Conclusions

The rapid growth of private equity funds, hedge funds as well as sovereign wealth funds in recent years in the context of the globalisation and in particular the internationalisation of financial markets has caused an increased interest in the question of the impact of these investment vehicles on industrial and economic change in Europe. In particular the practice of activist investors actively involved in restructuring processes and change at the enterprise level has also resulted in research activities and controversial debates on the concrete impacts on employment, labour relations and working conditions. The global financial and economic crisis has resulted in a further debate on the role of private equity and hedge funds in particular both in the context of accelerating crisis and economic downturn as well as with regard to developing suitable solutions for recovery.From the analyses and evaluations carried out in this data collection report some general conclusions with regard to the functioning of private equity funds, hedge funds and sover-eign wealth and their impact on industrial change in Europe can be drawn which are sum-marized in this final chapter.There is a growing importance of PE, SWF and HF as investors amongst industries and economies in Europe. However, the lack of transparency and availability of data hinders sound impact analyses.

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 the use of leverage of 2-3 times own capital and by the concentration of many activities within certain markets. Our analyses of the most important funds of each of the three types reveals a significant vari-ety of investment strategies and targets as well as common features.At the same time the lack of transparency in PEF, HF and SWF reporting is striking, which creates a serious problem for evaluating the impact of these funds. On the fund level de-cision 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 un-even. On the company level the reporting requirements for private (non-listed) compan-ies 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 owner-ship is transferred due to an investment transaction. As a result, it is virtually impossible to present the large and comprehensive dataset of private companies with the detailed information needed for a sophisticated econometric analysis.Likely impacts on industrial change differ according to differences in business models

Private Equity, Hedge Funds and Sovereign Wealth Funds in general follow different busi-ness models which also influence their behavior and specific expectations as investors and/or owners. Differences exist for example in the type of investment made and in the time horizon, which is in some cases very short-term and focusing on liquid financial as-sets. In contrast Sovereign Wealth Funds generally pursue a long-term agenda which fol-lows not only financial but also national economic policy goals. Beside these general dif-ferences 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 situ-ations of business development, e.g. a start-up situation, growth phases, merger and ac-


quisitions, turnaround and crisis situations. Since these forms of business development all either will follow or result in industrial change at the enterprise level it is important to as -sess the role of the three types of funds taking into account these different stages/situa-tions of company development.Private Equity

With regard to investment strategies, our study confirms the general observation that, with regard to micro-economic change, only the private equity business strategy of ma-jority investments and actively managing and influence change of the target companies has a direct impact on industrial change at the operational level in the enterprise.One of the most important potential strengths of Private Equity is the ability to provide risk capital to companies at the very beginning of the innovative process (seed and start up capital). PE firms can also provide capital where most other investors would not be willing to (e.g. turnaround or restructuring phases). Also on the positive side for PE are the potential wider impacts (i.e. opportunities) for the economy as a whole, including the creation of value, increase in innovativeness, adaptability and competitiveness, and eco-nomic growth and job creation. On the weakness side for PE at the micro level is the po-tential presence of externalities, i.e. the possibility that PE firms will reap financial re-wards at the cost of others. PE has also been criticized for having an overly high profit ex-pectation which is not sustainable in the long run and for sometimes having too short of an investment horizon (some industries need more than a 4-5 year perspective). Potential negative impacts at the macro level (threats) result mainly from the extensive use of leverage in PE deals. If financial targets are not met (e.g. if sales decrease because of a downturn), the potential of bankruptcy and job loss increases because the company is un-der a heavy debt burden.Hedge Funds

It is important to stress crucial differences between hedge funds and private equity in-vestments and specificities of the HF business model. Hedge funds generally are not an investment vehicle seeking majority ownership or directly influence management de-cisions and restructuring at the enterprise level. While hedge funds invest in a broad vari-ety of asses classes with investments in private companies only being one optional tar-get, most investments are minority share with buying and selling in a very short period of time without any active influence on economic change. The only HF type of activity hav-ing a direct impact on restructuring processes at firm level are “activist hedge funds” which directly seek to influence economic change by gaining a majority influence on the decision making process.Positive impacts of Hedge Funds at the micro level (strengths) include the potential to in-crease the value of listed companies through pushing for more efficient governance struc-tures or organizational structures (e.g. spinning off non-core areas). Especially recently HF have been one of the most significant actors as a "buyer of last resort" willing to pur-chase risky/distressed securities. At a macro level, HF may increase liquidity in markets by their willingness to buy and sell over very short periods of time. Potential negative im-pacts at the micro level (weaknesses) include a very short term orientation, which in the case of some funds can be measured in months, days or even minutes. The simultaneous pursuit of short term strategies by a multitude of HF can lead to herding behavior, which can distort incentives at the micro level. The lack of transparency of many HF can also make it difficult if not impossible for investors to evaluate the risks they are facing. Fi-


nally, HF may achieve short-term profits by shifting costs to others without any additional value creation (externalities). At a macro level, threats through HF include systemic risks caused by leverage (particularly to banks providing loans to HF), which can be accentu-ated through the pursuit of high-risk strategies or a focus on financial engineering.Sovereign Wealth Funds

Sovereign Wealth Funds differ significantly from both private equity as well as hedge funds (though sovereign wealth funds also invest in these two capital funds types). As state-owned financial institutions Sovereign Wealth Funds operate on a long-term agenda aiming not only at stable long-term financial returns but also following wider national eco-nomic policy goals. A potential positive impact of SWF at the micro level (strength) is the longer-term orientation of SWF compared to many other financial investors. SWF are also increasingly the buyer of last resort for many companies, particularly in the financial sec-tor during the current financial crisis. At a micro level SWFs however have potential neg-ative impacts (weaknesses) insofar as they threaten the autonomy of national stakehold-ers and increase the potential of conflict due to cultural differences. This conflict potential may be increased due to the lack of transparency in the activities of many SWF. At a macro level, SWF may represent a potential threat insofar as they pursue strategic na-tional and political interests.A significant patchwork of empirical evidence on impacts on industrial change

Analyzing the findings of empirical surveys as well as case study evidence one can see that there is not a black or white picture of real and/or likely impacts on industrial change. One can find proof and arguments for a short term negative impact on employ-ment at company level. But there is also proof for a weak positive long term impact on the overall employment level in general.Similar to the issue of job creation, the impact of alternative investment strategies on wages and other aspects of working conditions is highly controversial and there are large variations between conclusions of business-oriented surveys and studies on the one hand and more critical studies on the issue, which are often based on case study evidence. Ad-ditionally 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.Though there also are no clear results regarding the impact of the three types of funds on company performance and value creation it is quite obvious that the emergence of PE, HF and SWF as a European wide phenomenon has contributed to an acceleration of restruc-turing, performance benchmarking and efforts to increase the competitiveness of com-panies and work.Research findings and in particular available case study evidence – although nuanced – on labour relations, working conditions, wages and bargaining processes at company level suggest that workers in target companies are on average are treated as one source of “value creation” and thus profits for private equity funds. However, one should be extremely cautious to conclude from this that employees in fund-backed companies are treated worse or “squeezed harder” against the lack of any matched-pair comparison and/or counterfactual. In particular in the context of the eco-nomic environment and the general acceleration of industrial change and restructuring during the last two decades in the context of globalisation and the entering of new actors


onto the world market, there are many examples of a worsening of work conditions and labour relations throughout Europe where capital funds are not playing any role.This also relates to the interesting question which is only touched upon slightly in the context of our study: The impact of private equity, hedge funds and sovereign wealth funds on different national social models as well as the European Social Model of labour relations and the relationship between labour and capital. The crucial question here is whether capital funds will contribute to a harmonization of industrial relations with a strong bias towards the Anglo-Saxon model, or whether other developments are more likely. On the basis of results of research on the development of corporate culture and la-bour relations in Central and Eastern Europe it also seems likely that capital funds are ad-apting to national systems and alter their respective behaviour and management style according to the existing company specific conditions and national frameworks.In this respect a challenge for social sciences research in the future will be to obtain and analyse on the basis of sound methodological approach, comprehensive and reliable data that shed more light on the impact of capital funds on these topics.Impact of the current crisis

An important question to be addressed in the context of the current economic situation regards the impact of the financial crisis on private equity and other forms of capital in-vestment and the implications for future industrial change in Europe.Based on existing evidence it seems likely 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 effected.On the micro level, the default probability of many portfolio companies is increasing, and credit ratings were downgraded. These facts 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 refinan-cing problems in the next few years.On the macro level the risks for banks who have made these investments is considerable. The amount to write off loans is still a substantial risk to bank balance sheets and thus to financial system stability.Political recommendations

In particular also against the background of the current economic crisis situation the fol-lowing measures should be discussed: The transparency of the PE, HF and SWF industry needs to be increased through the

passage of binding reporting requirements regarding strategies of funds, level of risk, and detailed information on the financial and employment status in each portfolio company.

A binding regulatory framework creating a level playing field for all collective invest-ment vehicles (i.e. including PE, HF and SWF) needs to be created and enforced.

A detailed and immediate assessment of the ownership of LBO debt (as well as other high-risk debt) and the extent of its risk to financial stability needs to be carried out.

The legislative and regulatory environment needs to be reformed to restrict the use of high-risk LBO finance (including covenant-light and high leverage financing models),


to ensure that stakeholders retain a voice in restructuring and recapitalization opera-tions (e.g. special dividends), and to discourage tax-driven LBOs.

A European rating agency should be considered, which would provide objective rat-ings on the financial soundness and default probabilities of issuer companies, as well as on a broad range of environmental, social and governance (ESG) criteria. Ratings should be mandatory for all issues above a certain size (e.g. EUR 100 million). European institutional investors should be allowed to make substantial investments (e.g. EUR 100 million and up) only in foreign companies that have also been rated by this agency.

Finally, with regard to the regulative gap in the context of ownership transfer and em-ployee’s information and consultation practice it seems necessary to adjust informa-tion, consultation and participation rights in Europe according to the need of workers being informed about the economic status of their company and more effective bar-gaining rights before PE deals are consummated, during the restructuring process, and before exit.


7 References

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