January 18, 2021

A More Honest Assessment of Private Equity

Posted on 09. Jun, 2012 by Stephan Helgesen in Economy

Last week, Jack and Suzy Welch published a no-warts-at-all ‘defense’ of private equity (“Mr. Biden, here’s the truth about private equity”, Reuters, 5-30-12, http://blogs.reuters.com/jack-and-suzy-welch/2012/05/30/mr-biden-here%E2%80%99s-the-truth-about-private-equity/), which was little more than an ad hominem attack on the administration and an endorsement of Governor Romney.

Jack Welch had a stellar 21-year-long run as CEO of General Electric, which ended in 2001 when he became a senior adviser to the large private equity fund, Carlyle Group.

I admire him greatly but for three missteps: his penchant for excessive executive compensation; his stated belief that the best manufacturing environment would have every plant placed on a barge and towed to wherever the labor costs are the lowest; and frankly his latest op-ed.

Take my word for it, Jack, private equity has plenty of warts, and I say this from first-hand experience dating back to 1988, when I started one of the first PE funds exclusively committed to the media industry.

The primary objective of private equity funds is to earn profits for themselves and their investors.  There is nothing wrong with making money.  But since Governor Romney claims his private-sector experience uniquely qualifies him to create jobs as president, it is fair to ask whether his track record demonstrates that experience.

But the managers of these funds  who continue to defend the outrageous and intellectually fraudulent way that they – me included – are individually taxed on the bulk of their income, should immediately be taken to the woodshed.

In America, we believe strongly in investment as the backbone of economic growth and job creation.  This is why President Obama and the Vice President have been strenuously arguing for a National Infrastructure Bank that would greatly expand investment in our country’s infrastructure and help restore our global competitiveness.

Similarly, most of us believe that a person who invests his money in an enterprise should pay lower taxes on any gains he makes because he is taking on risk and providing capital that makes our economy prosper.  We can debate the rate at which capital gains should be taxed – I think it should be much higher than the 15% it is currently – but the principle of a lower tax rate on such gains is sound.

Yet since the mid 1980s the tax code has – very unfairly to all other taxpayers – given the capital gains tax break to a select group of individuals who manage other people’s money in either limited partnerships or limited liability companies.

Specifically, while these private equity and hedge fund money managers are paid salaries, by far most of their compensation comes in the form of a large share of the net gains earned in the entities they manage, which share is called “carried interest”.

But even though carried interest is no different in substance than the performance or incentive fees which hundreds of thousands of other managers in the economy earn every day from the results of the businesses they oversee, carried interest is taxed as a capital gain.  Everyone else’s performance or incentive fees are taxed as ordinary income.

And because the 15% capital gains tax rate is less than half the 35% maximum ordinary income tax rate, the benefit to the U.S. Treasury and all other taxpayers if this inequity was resolved will be on the order of $10-plus billion a year.  (See “Carried Interest: A Very Big Wolf in Sheep’s Clothing”, Huffington Post, 9-20-11, http://www.huffingtonpost.com/leo-hindery-jr/carried-interest-a-very-b_b_971542.html.)

Yet nowhere in the Welch op-ed that attacked Vice President Biden was there any mention of this huge inequity and of the massive loss in government revenue at a time when every dollar is precious.

And then there are clear examples of the times when private equity funds and their investors – including Governor Romney’s old firm Bain Capital – succeeded simply by manipulating existing companies, not by building businesses and creating jobs.

At its worst, this manipulation takes three consistent tacks: first, leverage up the companies with layer upon layer of debt, which when the economy turns adverse become guillotines on the necks of the employees and their communities; second, pay out egregious fees to the managers and return equity capital long before the companies become more profitable; and third, reduce labor costs as quickly and as much as possible, often by off-shoring jobs to those overseas barges of which Mr. Welch seems so enamored.

It’s not a criticism of capitalism – the system which has made America the greatest country in the world – to say that there is something definitely wrong with unfair and undeserved tax benefits, with deliberate over-borrowing of the sort which GE would never have tolerated, and with treating employees as chattel, with no organizing protections and protections against off-shoring.

It’s also wrong that all too often the underlying premise behind a private equity investment in a particular company is that after it’s been milked once, the company will simply be sold onward to another PE fund for further milking – and further fees payments.

And it’s certainly not a criticism of free enterprise to question and examine Mitt Romney’s experiences – as a private equity manager, businessman and Governor – which he says support his claim to be a great job creator.

We need to keep manufacturing jobs here in this country – our workers and our businesses can compete with any worker and any company anywhere in the world, as long as we have government which will stand up and demand a level playing field for all.

And we need to be looking for ways to strengthen industry, rather than manipulate its capital structures to generate management fees and short-term gains.

A generation ago, leaders in business, government and labor all understood that national prosperity depends on a vibrant middle class growing from the bottom up.  And as Reginald Jones, Jack Welch’s esteemed predecessor at GE, very publicly demanded, corporate responsibility should flow equally to investors and workers.

Our economy and society were much stronger for these views.

This article was submitted by Leo Hindery, Jr. who is chair of the U.S. Economy/Smart Globalization Initiative at the New America Foundation, co-chair (with USW President Leo Gerard) of the Task Force on Jobs Creation, founder of Jobs First 2012, and a member of the Council on Foreign Relations.  He is the former CEO of AT&T Broadband and its predecessors, Tel-Communications, Inc. (TCI) and Liberty Media, and is currently a private equity investor in media companies.  He began his business career at Utah International Inc., and was later at General Electric Company after those two companies merged.


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