Private equity (PE): Investment partnerships that buy and manage companies before selling them. Private equity firms operate investment funds on behalf of investors. has emerged as a dominant form of financial investment. PE firms typically raise or borrow money to fund short- to medium-term acquisitions, with plans to exit in 5-10 years and return the proceeds to investors. In the United States in 2020, companies owned by PE firms employed nearly 12 million (up from about 3 million in 2018), generating 6.5% of the country’s gross domestic product (GDP), or $1.4 trillion.
The emergence of PE is not without controversy. PE’s business model, which is focused on quick turnarounds, has attracted scrutiny among industry stakeholders and regulators. The tension between seeking a short-run payout and the long-run viability of the acquired company raises challenges akin to what economists call principal-agent problems: The principal-agent problem is a conflict of interest that occurs when one person or entity acts on behalf of another person or entity. It can arise in many situations including, for example, from the relationship between a client and a lawyer to the relationship between stockholders and a CEO. , or conflicts that arise when one person or group acts on behalf of another. In this case, short-run financial gains may induce PE firms to discount long-run metrics. On the other hand, PE can increase a firm’s near-term financial capability and inject new managerial expertise through managerial hires.
So, is PE good or bad for an economy? This question is not easy to answer empirically, given the broad impact of such funding and the need for detailed data across multiple dimensions of firm production and performance. However, the question of PE’s efficacy and effects matters as the performance of PE-funded firms can have powerful implications. Take, for instance, the healthcare industry, where increasing PE involvement may adversely impact patient welfare. This concern has led policymakers to consider federal and state legislation to strengthen oversight over or even curtail PE investments.
To address this question, this research investigates one of the most extensive leveraged buyouts (LBOs): A financial transaction where a company is acquired using a large amount of borrowed money, rather than the buyer’s own capital. The buyer uses debt, or leverage, to finance a significant portion of the acquisition, often with the assets of the company being acquired as collateral. in financial history, which occurred within the $4 trillion US healthcare sector, an industry not only notable for its size, but for its direct impact on the welfare of individuals. Since 2000, healthcare-focused PE investments are up 20-fold, involving approximately 8,000 separate transactions, culminating in nearly $1 trillion of healthcare targeted financing. The authors focus on the 2006 PE purchase of the largest for-profit hospital chain in the United States (Hospital Corporation of America, HCA). PE ownership lasted about 4.5 years before the hospital chain returned to public markets. The authors conduct a detailed examination over 10 years of the more than 100 hospitals spread across much of the United States that were affected by this transaction. They find the following:
- The average affected hospital has a 20-30% relative increase in Medicare patient volumes, which translates to a commensurate increase in Medicare revenues. This effect persists for years after PE ownership ends.
- Hospital stays shorten, consistent with an operational emphasis to improve the hospital’s bottom line.
- There is no evidence that patient health outcomes, as measured by mortality, worsen.
- There is a quick and approximately 10-15% relative reduction in the number of full-time workers that outlasts PE ownership, with less-than-expected increases in part-time workers. Overall, a smaller workforce persists, including among critical sources of labor—nurses. The estimated decline in full-time nurses is driven by restrained labor growth, as opposed to sweeping cuts, under PE ownership.
- Despite that the acquisition occurred during a period of rapid growth in health IT products and spending, PE owners restrain the degree of growth in health IT going forward. Implementation of new health IT solutions drops by as much as 10%, with the effect growing to roughly 25% in the years following PE divestment.
- Following the reductions in employment and IT spending, affected hospitals’ net income and operating margins––two key performance indicators for the industry––are improved by 50-100%.
- The number of a hospital’s unique vendors expands by as much as 25% when the hospital chain is under PE direction, consistent with a strategy of avoiding legacy suppliers when entering new contracts.
These findings are not necessarily indicative of excessive PE short-termism; rather, they could reflect a more disciplined approach to firm-level cost containment and could translate to improved financial performance. Importantly, there is likely no one-size-fits-all PE playbook, even within industries from the same sector of the economy. Managerial and operational changes are likely tailored to the targeted firm(s) operating in differing markets, all of which have varying long-run implications. For policymakers and regulators, this suggests a heterogeneous approach: rule makers should first consider existing heterogeneity in estimated PE effects within the healthcare sector, and second, they should consider whether PE owners’ observed actions diverge from what would be expected by other owners, considering existing business opportunities as well as challenges.