Regulating Private Equity

Bobby Bartlett —  11 April 2006

Thanks to everyone here at Truth on the Market for inviting me to guest-blog for the next couple of weeks. As I mentioned during my stint on the Conglomerate, one of my primary areas of research is private equity, so as before, I’ll be focusing a fair amount on developments in the exciting world of buyouts and venture capital.

To begin, I’d like to comment on yesterday’s story in the Financial Times regarding the formation of a “trade body� to represent the interests of the world’s largest buyout firms. The initiative appears to be in the early phases of development and is being spearheaded by four of the major players in the industry— Blackstone, Carlyle, KKR, and Texas Pacific Group. As the story notes, the move appears to be in response to growing concern among public policymakers and journalists about the growth of private equity and a sense that increased regulation of the industry may be a distinct possibility.

The notion that private equity should be subjected to greater regulatory oversight is hardly new. In fact, calls for increased regulation of the industry have been circulating for some time now. Recently, however, it seems the voices have gotten a lot louder. Hardly a week goes by without some reference to it (for last week’s reference, see here), and no less a bastion of capitalism than Forbes has contributed to the discussion in a rather scathing article on the subject last month (article here). Why all the fuss? Part of the clamor seems to echo the concerns voiced during the buyout frenzy of the 1980s that LBOs ultimately harm employees and communities through layoffs that often follow an LBO (this seems especially true of the criticisms voiced overseas in Germany and France). Other critics focus on the secretive nature of LBO firms and their proclivity for keeping their operations under the radar. For many, this is especially troubling considering how much money is being poured into private equity. As Forbes noted, “globally, 2,700 funds are raising half a trillion dollars in cash to invest; this will bankroll them for $2.5 trillion in deals, given their penchant for putting $4 (or more) of debt leverage atop every dollar they put up.� Add to this the occasional bad buyout deal (e.g., TH Lee’s Refco debacle) and the conclusion seems obvious: the industry needs more regulation to avert a catastrophic meltdown.

To be sure, there are definitely some market imperfections in the private equity industry that should be addressed (more on these later). What concerns me with the current discourse is that the primary criticisms almost always boil down to the same thing: buyout firms are raising too much money (much of it from pension funds) to exist without meaningful regulation. The mere fact that buyout firms are raising record levels of funds, however, says little about why this might be a regulatory problem. Likewise, it says nothing about what regulatory response might be needed (if any). Is there a market failure that results in “too much� money going into private equity? If so, it seems we would be better off trying to isolate this problem at its source (e.g., perhaps we need to reexamine our prudent investor standard). Likewise, if there are problems with favored LBO techniques (e.g., dividend recapitalizations, etc.), why not address these transaction structures directly (just as Congress did in the 1980s with two-tiered tender offers)?

In short, before we talk about regulating private equity, we need a lot more precision in understanding exactly what (if any) problems are posed by the current private equity market and the best means to address them. Otherwise, I fear ending up with another set of hedge fund investment advisor regulations: regulations that give the appearance of providing oversight of a growing industry, but which are of questionable effectiveness.

5 responses to Regulating Private Equity


    Government entities are famous for trying to regulated markets they don’t fully understand.


    I think the demands for regulation aren’t actually about oversight, they’re about squashing the competition. The only sense in which “too much money” is going into hedge funds is the sense that all those fees aren’t going to mainline brokerage houses. Tightening the prudent investor standard probably won’t do much to hedge funds, but it will further exacerbate the already extremely difficult time small business owners have in finding equity investors (regulations which, IMO, are archaic and needlessly restrictive). Not that the brokerage houses or hedge funds care, they’re for any regulation that moves money into their hands.

Trackbacks and Pingbacks:

  1. TRUTH ON THE MARKET » Thanks and a Further Note on the Regulation of Private Equity - April 26, 2006

    […] Before departing, I wanted to tie-up a loose end that I left dangling in my earlier post on private equity regulation (I’m sure folks have been up nights awaiting resolution of this issue).  As my prior post discussed, I generally find little merit in the recent calls for subjecting the private equity industry to greater regulatory oversight.  (You can read my prior post here).  I suggested, however, that there are some market imperfections in the private equity industry that may merit some reform.  What are these market imperfections?  In general, they are the information asymmetries that result from the challenge of valuing privately-held corporations. […]

  2. TRUTH ON THE MARKET » Is Sox Encouraging Companies to Go Private with Private Equity? - April 19, 2006

    […] One might think that in the private equity world, there is a “perfect stormâ€? of sorts for a robust going-private market.  As I have noted before, buyout funds have raised record amounts of cash in the last few years which they will need to deploy in a relatively short period of time (a fund generally seeks to invest most of its capital in its first 4-5 years).  The downside is that a significant increase in the amount of private equity capital does not necessarily translate into a concomitant rise in going-private transactions, as the supply of buy-out “candidatesâ€? should remain the same (all other things being equal).  In fact, all of this private equity money could actually create a private equity “bubbleâ€? in which “too much money is chasing too few dealsâ€?  (also known as the “LP-overhangâ€? problem).  […]

  3. Abnormal Returns » Blog Archive » Wednesday links: regulating private equity - April 12, 2006

    […] Bobby Bartlett at Truth on the Market notes the growing talk about regulating private equity is early, but fears a replay of the ineffectual hedge fund regulation recently pushed through the SEC. […]