By Benjamin Balint-Kurti
Private equity is increasingly prevalent in conversations about the economy, featuring (and often being blamed) in media coverage of everything from the housing crisis to healthcare. But despite how often it's mentioned, how it works and its effects on actual people remain largely mysterious to those who are not directly involved. We recently hosted journalist Megan Greenwell, author of the book Bad Company: Private Equity and the Death of the American Dream, in a conversation with Rohan Sandhu, Director of the Reimagining the Economy Project. In Bad Company, Greenwell details how the distinctive practices of private equity (PE) firms actually affect the people who fall into their orbit, the personal stories that ensue, and what can be done to mitigate these harms.
The discussion was framed by a case study of a hospital in Riverton, Wyoming that had been taken over by a private equity firm. The firm’s management promptly cut services at the hospital that weren’t profitable, including procedures for appendicitis and even labor and delivery: a pregnant Riverton resident would have to traverse a perilous route to the next hospital over, half an hour away. This general template for PE takeovers – cutting costs, rather than exploring new sources of revenue – was explored further in case studies of the internet blog Deadspin and Toys R Us.
Here are three takeaways from the event:
- Private equity, and finance more broadly, does not prioritize the welfare of communities.
When a company thrives and is making a profit, it has positive effects not only for the shareholders that own the company, but for the people that the company employs. Stepping back to the level of the entire community, too, a company that sells goods and services, even if not profitable, is still often making the community better off through the goods, services, and jobs it provides.
But private equity is not incentivized to preserve these positive externalities. Greenwell put this in the context of Milton Friedman’s “shareholder theory,” an influential doctrine that says a company has an obligation to its shareholders and, importantly, no one else. Greenwell claimed that this doctrine is implicitly or explicitly at work in PE firms, as well as most large firms of any kind in our economy. This means that whatever good that institutions controlled by PE bring outside of profits – jobs, services, community wellbeing – will disappear if they don’t serve the profit motive.
This often leads to a direct tradeoff between the good of the community and the PE firm: in many cases, minimizing consumer surplus – the excess value a consumer gets from a good above what she paid for it – is part and parcel with maximizing profit. Take Deadspin: as a free website, readers could get valuable content for free. The cost of producing this content evidently exceeded what the site’s visitors paid for it, as Deadspin was losing money each month. But Deadspin’s loss was largely just the readers’ gain. By eventually shuttering the company, and selling it off for profit, private equity converted what was once a consumer surplus into an investor surplus – in other words, profit. The same logic applies to the hospital in Riverton, Wyoming, which prior to PE, provided services for a price that, while perhaps unprofitable for hospital ownership, gave many people crucial medical care.
PE will be especially harmful to communities if they are more likely to follow this doctrine than the previous owners of the companies they buy: ignoring any obligations to the community outside the profit motive. This seems to be the case with Apollo Global Management (the PE firm that acquired the hospital in the case study). According to Greenwell, “it does not seem that anybody from Apollo Global Management ever set foot in Riverton, Wyoming.” In general, while previous management may reside near the portfolio company, benefitting themselves from its operation and being socially connected and obligated to those who rely on it, PE executives have none of these incentives to keep it operational.
- When incentives are misaligned, bad things happen – even when individuals don’t have bad intentions.
Greenwell emphasized that, in her opinion, the issues of private equity were primarily a result of the system, not the ill-intent of PE firm employees. Indeed, the people that work at PE firms often come from low-income families and places, the specific communities that get hurt most by PE. But, says Greenwell, having mentored many of these would-be PE employees via a program at Princeton and hearing about their desire to make money to give their families financial security, “it’s hard to condemn anyone too much for taking that deal.”
On Greenwell’s thinking, if we want to think about how to fix this, we need to change the incentive structure, not morally condemn individuals. This applies both to the incentives individuals face, as in this example of the labor market, and those of corporations. For instance, that a PE firm can borrow money to acquire a portfolio company but put the debt on the portfolio company’s books effectively incentivizes taking actions that risk bankrupting the portfolio company. If legislation against this practice were passed, we might see fewer portfolio companies like Deadspin and Toys R Us going under.
- We need to be intentional about how we organize our society – it is not enough to just trust the free market.
These examples of private equity illustrate that the free market, while possessing many desirable qualities, is not an automatic ticket to a healthy society. If we want institutions that serve the public good but do not necessarily generate profit for their owners, we need to take action to ensure they exist. This applies to hospitals, newspapers, and even municipal water treatment and fire departments, all of which Greenwell noted are increasingly controlled by private equity.
But even if private equity were to be curbed, it may not be sufficient. Greenwell also noted that “everything is private equity now – even if not technically, everything is operating that way.” The logic of private equity has permeated the “common sense” thinking of business executives even outside of PE. This suggests that policymakers hoping to solve some of these issues may need to think more broadly than just private equity.
In this vein, Greenwell ended on a positive note: “what gives me hope is that there are so many people thinking about this from so many different angles right now.” These include several state legislatures that have passed laws that take steps like allowing for more scrutiny of PE firms’ activities (in Massachusetts) and limiting their ability to invest in healthcare (in Oregon). Philanthropy, too, can be a powerful tool. In Riverton, community members came together, against all odds, to create their own community hospital to replace the PE-decimated one. Said Greenwell, “One of the reasons I really like that story is because it… points you to some of the countervailing forces that can be leveraged to address this challenge.”
