Private equity and the job cut myth

NEW YORK (CNNMoney.com) -- Amid all the criticism of private equity, none perhaps has been as scathing as this: Buyout firms above all want to enrich themselves and their investors - and often cut thousands of jobs in the process.

The Service Employees International Union, which represents about 1.8 million workers in the U.S. and Canada, published a report last week that criticized the private equity industry for not doing more to measure the impact buyouts have on jobs and communities.

United Auto Workers union President Ron Gettelfinger has blasted the buyout firms circling Chrysler, criticizing them for "stripping and flipping" companies.

Private equity firms, which buy mature companies and typically load them up with debt, are notorious for slashing jobs. In order to make their debt payments, they have to increase revenue or cut costs, or both.

"Typically it's easier to decrease costs quickly by cutting heads, which is why buyouts have typically been accompanied by layoffs," said John Adler of the SEIU.

The SEIU report pointed to the buyout of Warner Music Group (Charts) as an example. When a group of private equity firms bought the company from Time Warner (Charts, Fortune 500) in 2004, it cut 1,000 workers, or about a fifth of its work force, the report said. (CNNMoney.com is a unit of Time Warner.)

But Scott Sperling, co-president of Thomas H. Lee Partners - one of the private equity firms involved in the deal - defended the buyout. Speaking at a conference last week, he said Warner Music was burdened with an "unsustainable business model" and had too many layers of decision makers.

Industry groups like the Private Equity Council argue that buyouts generate, rather than destroy, employment over the long term and point to reports like the one recently issued by consulting firm A.T. Kearney, which found that private equity created about 600,000 jobs in the United States between 2000 to 2003.

Private equity's impact on employment has become a hot-button issue as buyouts have boomed. Private equity firms have been on a buying spree, inking deals of unprecedented scale at quick-fire pace.

But private equity scholars say it's difficult to gauge the impact of buyouts on employment, largely because there's a lack of good numbers. Once companies are taken private, they aren't required to disclose details of their operations.

"It's very hard to get a good answer because it's virtually impossible to get data on firms once they've gone private," said Steven Kaplan, a professor at the University of Chicago's Graduate School of Business who studies private equity.

Some studies, like the one from A.T. Kearney, have to be weighed carefully because they use a broad definition of private equity that includes venture capital and doesn't focus solely on buyouts, experts say.

One study that does track the impact of buyouts on jobs was conducted by the Center for Management Buyout Research at the Nottingham University Business School in the United Kingdom.

That study, one of the few larger-scale studies that tracked 1,350 buyouts in the U.K., found that employment dips in the first year after a management buyout. But four years afterward, employment levels rise above to where they were the year before the buyout.

Similar data isn't available for the U.S., but the evidence from Europe suggests that while employment may fall initially after a buyout, it increases over time, said Douglas Cumming, a professor of finance at Rensselaer Polytechnic Institute and an author of the study.

But it's tricky to draw inferences from the research because it's difficult to know what employment levels would have been at the company if there were no buyout. "You just don't know whether the company would be doing better or worse if the buyout didn't occur," Cumming said.

Unions like the SEIU are pushing the private equity industry to provide more information on the deals they do. They want data to track how buyouts are affecting the lives of everyday workers.

But that isn't necessary, according to the University of Chicago's Kaplan, who said private equity's impact on jobs may be an emotional issue, but it's largely a moot point.

"Private equity is both a job creator and job destroyer," Kaplan said. "Part of what private equity does is make companies more efficient - which may mean cutting jobs. But you can create value by growing faster or doing things better, which can increase jobs."