Friday, January 13, 2012

Private Equity: Capitalism's savior or devil?

In light of Mitt Romney's success in the Republican primaries, and his former career running the private equity firm Bain Capital, private equity is again a hot topic. A private equity firm is a firm that buys equity in faltering firms and attempts to return them to profitability and then usually sells them. These efforts often involve layoffs and reductions in pensions and benefits. The critics of private equity include Romney's opponents and Warren Buffett.

The current top ranked video on WSJ currently shows a discussion of Warren Buffett's position (5 minutes).  Towards the end of the clip, valid complaints about private equity firms are raised. These mainly involve implementation and not the concept in general. The case is made that we need "business undertakers".

Jonathan Macey (Yale professor) wrote an article in today's WSJ opinion page that comes to the defense of private equity.  Macey relies on the classic argument first provided by the economist Joseph Schumpeter (8 February 1883 – 8 January 1950).  Schumpeter argued that "creative destruction" is necessary for economic growth. As firms get older, unwieldy, and unproductive they need to fail or be restructured. Economic super heroes, a.k.a. entrepreneurs or private equity, come to the rescue and, phoenix like, resurrect healthy firms from the ashes. 

WSJ (1-13-2012) How Private Equity Works by Jonathan Macey

Click on the video tab to see the associated video (8 minutes)

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