Select Committee on Treasury Written Evidence

Memorandum from Trades Union Congress


  1.1  The TUC welcomes the resumption of the Treasury Committee's inquiry into private equity and the opportunity to present further evidence on specific issues relating to private equity. Since the Committee's interim report last summer, the financial climate has changed dramatically, with important implications for companies, investors and policy makers alike. The opportunity to understand the impact of the changed economic outlook on private equity funds and their portfolio companies will bring additional value to the Committee's conclusions.


  2.1  For the Committee's information, the TUC is including its submission to the Walker Review as an appendix to this document. The TUC has consistently argued for mandatory reporting requirements for private equity. We were therefore disappointed that the remit to produce a voluntary code given to Sir David Walker precluded even the consideration of mandatory recommendations.

  2.2  It is also important to note that disclosure and transparency is just one aspect of the problems surrounding the operation of private equity. Other areas of concern include areas covered in the Treasury Committee's resumed inquiry, including conflicts of interest, taxation of private equity general partners, the levels of leverage and tax-deductibility of interest payments on debt, the impact of private equity takeovers on the stock market and, most important of all to the TUC, the impact of private equity takeovers on workers in its portfolio companies. The TUC welcomes the breadth of the Treasury Committee's inquiry. The TUC urges the Government to follow the Treasury Committee's lead and to recognise that notwithstanding Sir David Walker's report, there remains a wide range of issues surrounding private equity that still need to be addressed.


  2.3  The TUC believes that effective monitoring is essential for the code of conduct to have any useful impact on the private equity sector. The Walker Report rightly calls for the establishment of a guidelines review and monitoring group that is independent.

  2.4  However, the TUC is concerned that being established by the BVCA, the industry representative body, as recommended in the Walker Report, risks jeopardising its independence. The BVCA has a legitimate representational and promotional role in relation to the private equity industry, but this makes it anything but independent of the sector. The TUC notes the recommendation that the monitoring group should have a majority of independent members and an independent Chair; implementation of this recommendation will be vital for the group's credibility. It is important that the group includes members who are independent not just of the BVCA but of the sector itself.

  2.5  The TUC will judge the monitoring group by its efficacy in raising levels of transparency from the private equity sector and ensuring that private equity funds and their portfolio companies comply with the recommendations in the Walker Report.


  2.6  The TUC welcomes the recommendation that qualifying private equity-owned portfolio companies should publish a business review that substantially conforms to the provisions of Section 417 of the Companies Act 2006, including sub-section 5, which covers forward-looking information and information on the company's employees, environmental matters, social and community issues and suppliers. The TUC supports the recommendation that the financial review should cover risk management, including in relation to leverage.

  2.7  The TUC was very surprised that the original consultation document of July 2007 argued against the disclosure of fees charged by private equity funds to their portfolio companies. The TUC believes that the practice of private equity funds charging their portfolio companies fees such as deal fees to cover the costs of acquisition and exit, monitoring fees, financing fees and so on is seriously flawed and should end immediately. It is far from clear why the portfolio companies should carry the costs of financing arrangements that primarily benefit the general and limited partners of the private equity fund. The charging of such fees is clearly a matter of interest to all those with a stake in portfolio companies, and the TUC believes strongly that full public disclosure of such fees is essential. While the practice of charging fees is clearly beyond the scope of the Walker Review, TUC believes that failing to recommend public disclosure of such fees in its Final Report is a serious omission.

  2.8  The TUC believes that the recommendations for portfolio companies should have included disclosure on remuneration and reward across the company. Given the evidence of job cuts and slower pay growth for workers following private equity buyouts (see section 5 of this submission), it is essential that information that would allow employees to assess their terms and conditions in relation to those of their bosses is disclosed.

  2.9  The only recommendation addressing the failure of portfolio companies to inform and consult employees is aimed at private equity owners. It recommends that private equity firms should "commit to timely and effective communication with employees, either directly or through its portfolio company, in particular at a time of strategic initiative". This is too vague to address the current information gap effectively. This issue is explored further in section 5 below.

  2.10  In terms of disclosure by private equity firms, the TUC believes there are serious omissions in the recommendations. These include full disclosure of the accounts of private equity funds, including the performance of individual funds managed; disclosure of the remuneration of private equity general partners; disclosure of the fees they charge; and disclosure of the identity of their limited partners.

  2.11  The economic significance of the private equity sector and its impact on the companies it buys makes the remuneration of the general partners who are responsible for these actions a matter of public interest. This is not a private matter between general and limited partners, given that the returns from which carry and compensation are calculated are generated from the portfolio companies that they buy. There is a clear matter of public interest in the distribution of the returns from the activities of private equity funds being in the public domain.

  2.12  At present there is no publicly available information that would allow a potential investor in private equity or an interested commentator to compare fees charged across the sector. The failure of the Walker Report to address this and include a recommendation of disclosure of fees charged to limited partners is a serious omission. Given the high level of fees charged, and the debate about the extent to which private equity returns justify the fees charged (see section 4 below), it is clearly in the public interest for private equity funds to disclose the fees they charge limited partners.

  2.13  Given the economic impact of private equity and the legitimate debate about in whose interests it operates, it is important that there is transparency surrounding the beneficial owners of the funds. Regulation of English limited partnerships requires that the names of limited partners are registered at Companies House, but the use of nominee names prevents this from providing a comprehensive list of limited partners. The TUC can see no justification keeping the identify of limited partners out of the public domain.


  2.14  As noted above, the BVCA is a membership body for the private equity industry funded by its members. As a membership organisation, it has an important role in representing and promoting the sector, but is not, of course, independent of the sector any more than the TUC is independent of the trade union movement.

  2.15  Over the past year, there has been considerable controversy over the economic and social impact of private equity. Areas of controversy include the impact of private equity buyouts on employment and long-term value with portfolio companies, and the level of returns generated by the sector. While clear and authoritative information is essential in order to inform this important debate, such information needs to be from an impartial source that can be trusted by all participants in the debate. The TUC believes that it is inappropriate for responsibility for filling this information gap to rest with the BVCA, as recommended in the Walker Report, as the need for complete impartiality is incompatible with its function of representing and promoting the private equity sector. In our submission to the Walker Review, the TUC suggested that this role could be undertaken by an academic institution with an existing research capability in private equity, and we still believe that this would be a more appropriate option.

  2.16  The TUC notes that the Walker Report suggests that the BVCA could be given "appropriate professional support from one or more accounting firms or other independent capability". The TUC believes that this is preferable to the BVCA carrying out the research function alone, but it does not address our concerns about independence as outlined above.

  2.17  The TUC welcomes the recommendation in the Walker Report that the post-exit performance of private equity owned companies should be included in the research exercise.


  2.18  The Walker Report proposes that its enhanced reporting guidelines should apply to private-equity owned portfolio companies which:

    (i)  employ over 1,000 full-time equivalent employees; and

    (ii)  generate over half their revenues in the UK; and

    (iii)  either are valued at over £500 million at the time of transaction in the case of a secondary transaction; or

    (iv)  have been purchased in a public to private transaction with market capitalisation together with premium for acquisition of control of over £300 million.

  2.19  These thresholds do not relate to any other existing thresholds. There is a definition of a large company that is used across the EU that we believe should apply here. This currently stands at companies that meet two of the following requirements: turnover at or above £22.8 million net (or £27.36 million gross); balance sheet total at or above £11.4 million net (or £13.68 million gross); and 250 or more employees. This threshold has resonance within the corporate sector already, as it is the trigger for a range of regulatory requirements. For example, within the business review requirements of the Companies Act 2006, the requirements are fuller for large companies than for medium sized companies, while small companies are exempted from producing a business review at all.

  2.20  The TUC believes that the proposed threshold is set too high, particularly in regard to the employment threshold. A company with 1,000 employees is a very large company; less than 0.1% of companies in the UK have over 1,000 employees. The argument for extending the reporting requirements for large portfolio companies is that these companies have major economic and social impacts. They are major employers, will be significant players in their local communities and are likely to be important customers for their suppliers. While the very largest companies such as Alliance Boots or Sainsbury have a national resonance with customers across the country, customers are not the only stakeholder group whose interests should be considered for wider reporting. In terms of social and economic impact, the TUC believes that the existing definition of a large company is an appropriate threshold at which to require enhanced reporting.

  2.21  The furore surrounding private equity has illustrated the flaws of making ownership structure, rather than economic and social impact, the determinant of disclosure requirements. Throughout many years of engagement on company law reform, the TUC has consistently argued that non-financial reporting requirements should apply to large private companies, in addition to quoted companies. The TUC continues to believe that the Business Review requirements introduced in the Companies Act 2006 that currently apply only to quoted companies should be extended to large private companies. This would ensure a level playing field between all large companies in terms of disclosure regardless of ownership structure, and would address the point raised by Sir David Walker in his report that very large private equity owned companies, if they follow his guidelines, will be embracing a higher level of disclosure than other private companies of a similar size.


The tax treatment of debt and equity

  3.1  The desirability of companies taking on very high levels of debt has been hotly debated. The TUC's concerns about the risks associated with such high levels of debt and how that risk is distributed are set out in its previous submission to this inquiry[35] and will therefore not be repeated here.

  3.2  One factor in encouraging the high levels of leverage seen in private equity buyouts is the tax treatment of corporate debt. Interest payments on debt are tax deductible in the UK, which means that companies can offset interest payments against their tax bill, thus reducing the costs of debt-financing.

  3.3  In March, the then Financial Secretary to the Treasury Ed Balls announced a review into the "current rules that apply to shareholder debt where it replaces the equity element in highly leveraged deals". In the pre-budget report, the Government included just one paragraph reporting on the results of this review. This stated that while the Government was satisfied that the 2005 changes to the Transfer Pricing rules have sufficiently extended the rules to include all private equity transactions, it remains concerned that the rules may be less effective in the context of highly leveraged private equity transactions. It concluded that it will continue to monitor situations where a tax deduction is being claimed for interest on shareholder debt in highly leveraged private equity buyouts. The TUC believes that this very brief response to a significant public policy concern is inadequate.

  3.4  There are two main reasons why this issue raises important issues of public policy. There is strong evidence that the tax-deductibility of interest payments has influenced the economic rationale for highly-leveraged buyouts. As alluded to above, tax deductibility of debt interests payments favours debt over equity as a means of financing buyouts, but in addition, it has been widely suggested that the tax relief on debt payments is a significant factor in the profitability and returns generated by private equity takeovers. For example, a study for Citigroup came to the conclusion that the higher returns for private equity disappeared if the high degree of leverage was stripped out of the model.[36]

  3.5  If the tax regime is influencing the economic rationale for buying up companies and is favouring debt-funded takeovers over equity-funded takeovers, this risks distorting the market for corporate control. The market for corporate control is often argued to be an important discipline on company management and to facilitate the efficient allocation of capital. While the TUC has some doubts about the extent to which the market for corporate control does in reality lead to improved outcomes for companies, shareholders and other stakeholders, this is still an argument against the tax regime acting to encourage buyouts. If gains can be generated from the debt attached to the takeover, rather than from changes relating to the productive capacity of the enterprise, this will lead to buyouts taking place that do not create long-term value and are therefore not in the interest of the wider economy or company stakeholders such as employees. While the current credit crunch has changed the availability of credit and has therefore challenged this model from the supply side in the short-term, credit markets are likely to become more liquid again over time. It is therefore still important to address this issue to ensure that the tax regime is no longer distorting the buyout market in the long-term.

  3.6  The second reason that this is an area of public policy concern is that the tax relief on debt payments deprives the public purse of money that would otherwise be paid in corporation tax. If the Government is giving companies tax relief, it is essential that the country as a whole is getting good value for these concessions. The TUC can understand the argument for tax relief on debt payments when companies wish to borrow in order to invest, or indeed in order to survive in a difficult trading period for example. However, the TUC believes that tax relief going to large, profitable corporations and their new owners just because these new owners have financed their purchase mainly through debt is wholly inappropriate.

  3.7  The Government of Denmark has introduced new laws to address this issue. This followed an investigation by the Danish Ministry of Taxation which examined the taxation records of seven large companies that had been taken over by private equity firms and found that collectively they reduced their tax payments by over 85% after the takeovers. It also found that at least one of the companies would now receive a tax refund because of the increased debt interests that it was servicing.[37] The Danish Government estimated that if it did not act, in a couple of years it would be losing around one quarter of the total revenue generated by corporate taxation.

  3.8  Therefore in April 2007 the Danish Government passed legislation that restricts the tax deductibility of debt payments for companies. Act No 540 limits the amount of tax-deductible interest to a maximum of 20 million Danish kroner ($3.7 million) per company, provided other provisions are met. Previously, there was no limit. In practice, this provision will cover only the largest 1,000 companies in the country. This was part of a wider package of tax changes, which also cutting the rate of corporation tax from 28% to 25%.

  3.9  The German Government has implemented a similar proposal as part of a wider package of measure aiming to simplify the tax system and remove anomalies. The measures, introduced in the spring of 2007, limit the amount of debt service that can be deducted from corporation tax. The package also requires that tax deductions that result from interest payments on debt must be spread over several years. Measures to ease the tax treatment of small venture capital investments were also implemented. The nominal tax rate was reduced, but at the same time many exemptions and allowances were cut. Also in 2007, rules were introduced that require that debt transferred from foreign nationals to German subsidiaries to be taxed. The DGB, the German equivalent of the TUC, supported the proposals, while the German employers' federation was strongly against the changes. The German Government has estimated that while over the first two years the changes may result in lower net corporation tax income, after two years this should reverse.[38]

  3.10  The TUC therefore urges the Government to undertake the following:

    (i)  To publish in full the review that has taken place to date.

    (ii)  To clarify exactly what work is now taking place on this issue.

    (iii)  To work with relevant parties to draw up proposals that will address the public policy concerns outlined above and put an end to the tax regime distorting the market for corporate control.

Capital gains tax and private equity

  3.11  The TUC's position remains that private equity general partners should pay income tax on their earnings. At present, the rewards for general partners of private equity funds are inflated by the fact that their fees are taxed as capital gains rather than income. Even under the changes to capital gains tax proposed in the Pre-Budget Report 2007, private equity general partners are paying a considerably lower tax rate than the standard rate of 22%. Therefore many private equity partners will still be paying less tax than their cleaners. The proposed rate of 18% is still less than half the higher rate of income tax of 40%, meaning that a private equity general partner will pay less than half the amount of someone earning a similar amount in a different sector.

  3.12  The origins of this anomaly go back to 1987, when the Government allowed performance fees to be taxed as capital, rather than income, with the aim of encouraging more venture capital funding for small companies. However, the gains from this were increased dramatically in 1998, when the Government cut capital gains tax from 40% to 10% for people owning shares in their own or unlisted companies, providing they had owned the asset for 10 years. In 2002, this ownership requirement was reduced to just two years. This new "taper relief" encouraged many companies to set up share-based pay schemes to allow highly paid employees take their rewards in a form that would incur capital gains tax rather than income tax. In 2003, the Government moved to address this by introducing new rules requiring employees to declare shares received as part of their pay package as income. The Memorandum of Understanding between the BVCA and HMRC sets out qualifying criteria that, if fulfilled, exempt private equity general partners from the rules requiring share-based payments to be taxed as income and allow private equity general partners to pay capital gains tax on their income.

  3.13  The justification for capital gains tax being lower than standard and higher rates of income tax is that capital gains requires an investment of an individual's own resources that they are risking through their investment. This is combined with a public policy objective of encouraging investment in smaller and start-up companies. However, neither consideration applies in the case of private equity general partners. While private equity general partners generally invest in some of the funds managed by their firm, these investments are only a tiny proportion of the total investment funds. Moreover, in the case of buyouts, the equity injection by the private equity fund is generally dwarfed by the debt component, thus diluting still further the monetary contribution of each general partner. The percentage of the returns generated by the investments allocated to the general partners is therefore much higher than the percentage of their contribution to the investment fund, and even more so when the additional leverage is included. This is very different from a situation where an entrepreneur has been the sole or main contributor of capital to a start-up project.

  3.14  Secondly, buying up major UK companies is not akin to investing in start-ups or providing seed capital to newly formed companies. There is no general public policy objective that is fulfilled by taking major listed companies out of public ownership; indeed, the TUC and many others would argue that the reverse is the case.

  3.15  Therefore the TUC believes that there is no justification for private equity general partners paying capital gains rather than income tax. The TUC believes that whatever the merits of reforming capital gains tax, it is not appropriate for private equity general partners to pay a lower tax rate than the general population and that private equity general partners should pay income tax on their earnings.


Why investors make different demands of public companies compared with private equity-owned companies

  4.1  This question appears to imply that the different regulatory standards applying to public and private companies stem from differential investor demands. However, the TUC does not believe that investor demand has been the only or even necessarily the main factor in determining the higher standards expected of public companies.

  4.2  Over the last 15 years or so the role of investors in corporate governance has been strengthened by successive reviews, codes and legislation. The trend was started by the Cadbury Committee in the early 1990s, and other corporate governance reviews from Greenbury to Higgs followed its lead in attempting to solve problems surrounding how companies were run and governed by strengthening the accountability of directors to shareholders.

  4.3  Since coming to power in 1997, the Labour Government has taken a clear policy decision that strengthening shareholder rights is the best way to address governance issues in companies. This can be seen clearly in, for example, the Directors' Remuneration Report Regulations 2002, which attempted to address the controversial issues surrounding directors' pay by requiring remuneration reports to be put to the vote at company AGMs. This approach came from Government and was informed by a wide-ranging public debate around directors' pay; it was not something that investors were demanding.

  4.4  Indeed, while there has been a change in investor attitudes towards governance over the last decade, some investors have been reluctant to play a larger role in governance and other issues within companies. This can be seen clearly in the debate around executive pay, which many institutional investors at first saw as a matter for management, not shareholders, of the company. Over time, investors have become more active on executive pay issues, and this is now the main issue that investors vote on at company AGMs. However, while voting levels have risen over the last 15 years, the latest figures (for 2006) show that over one third of votes are still not being cast at AGMs. The 2006 voting rate was 61% in the FTSE 350 and 63.8% in the FTSE 100.[39]

  4.5  Thus the TUC does not see investor demand as being the main factor in determining the differential regulatory frameworks surrounding quoted and private-equity owned companies. We believe that the regulatory framework surrounding quoted companies has developed over time in consultation with a wide range of stakeholders, including companies, investors, trade unions, accountants, legal advisors and so on. We would suggest that a key reason for the different regulatory approach taken towards private equity-owned companies is that until recently there was much less focus on these companies. During the Company Law Review there was much less time devoted to the regulatory framework for private companies than public companies, and either very little or no focus specifically on private equity-owned companies.

  4.6  The debate over private equity has changed this, and highlighted the regulatory gap that exists in relation to these companies. As with previous corporate scandals, investors are just one voice in this debate and just one interest to be considered along with others in consideration of an appropriate regulatory regime for the private equity sector. While some issues, such as those relevant to companies with multiple shareholders are not generally relevant to private equity owned companies, other issues, including those relating to transparency and the protection of stakeholder interests are very relevant indeed.

The implications of private equity-funded takeovers for company pension funds

  4.7  The number and scale of private equity takeovers has risen sharply over recent years. At the same time, the UK equity market capitalisation has not grown since the last quarter of 2004, and actually shrank by £46.9 billion in the first half of 2006. The FSA attributes this shrinkage to the impact of public to private transactions, share buy backs and special dividends (sometimes as part of a defence against a private equity bid) and reduced capital flows from the private sector.[40]

  4.8  Reducing the size of the stock market reduces the liquidity of capital, which is seen as vital in ensuring the efficiency of investments. The stock market plays an important role in spreading risk for investors, but the more the size of the stock market is reduced, the less this is the case.

  4.9  Private equity buyouts reduce the number of investors that benefit from the returns generated by UK companies. Once bought by a private equity fund, companies that were previously generating returns for millions of pension fund beneficiaries through the stock market are generating returns for a much narrower group of general and limited partners, which may include a very small number of pension funds. The proportion of returns paid to limited partners is limited by the structure of private equity deals, with general partners frequently extracting a fifth of generated returns as "carried interest". Even when some of the limited partners are pension funds, this is a tiny proportion of those that would previously have benefited from the company through the stock market. The TUC is concerned that scaled up this could have serious distributional impacts, creating a situation where the wealth generated by UK companies is distributed far more unequally than at present.

  4.10  There is also the question of the impact on individual pension funds that are investing in private equity. One of the issues for pension funds and other private equity limited partners is that their investments are illiquid and cannot be retrieved outside the returns of the agreement. This exposes pension funds (and other investors) to greater risk than investing in the stock market, which allows risk to be diversified. In addition, the fees charged to limited partners for investing are generally high. These are significant disadvantages for investors.

  4.11  The private equity sector claims that its high returns justify both illiquidity and high fees. However, repeated studies have concluded that across the sector as a whole, returns to private equity investments are in fact lower than returns to investment in the stock market as a whole while the variation between top and bottom private equity performers is significantly higher, thus increasing risk for investors.

  4.12  For example, a study by academics at the University of Chicago and the Massachusetts Institute of Technology looked at the performance of private equity funds between 1980 and 2001. It found that "on average leveraged buy-out funds returns net of fees are lower than those of the S&P 500"(when fees were stripped out, the returns were, on average, roughly equal).[41] It also found considerable variation between different fund managers. These conclusions were echoed by another study by the consulting firm Watson Wyatt, which examined the performance of private equity funds over the past 25 years. This concluded that while the best private equity managers may be able to generate above-average returns, there is no evidence that the asset class as a whole outperforms publicly-quoted shares.[42]

  4.13  Other studies confirm that when the particular risks of private equity—not least the high degree of leverage in buy-outs—are considered together with its other characteristics, private equity investments actually substantially under-perform the market on average.[43]

  4.14  Paul Myners has questioned whether pension fund trustees are looking sufficiently closely at the costs of investing in private equity against public stocks. His intervention is significant, because in his Review of Institutional Investment in 2001 he encouraged pension funds and other institutional investors to invest in alternative assets classes in order to diversify their investment portfolios. In another significant intervention, David Swensen of the Yale Endowment Fund, one of the most successful investors in private equity, has commented that "the large majority of buy-out funds fail to add sufficient value to overcome a grossly unreasonable fee structure".[44]

  4.15  The wide variation in returns is particularly problematic for investors because of the lack of transparency surrounding private equity funds. This makes it very difficult for pension funds or other investors to be sure that, if they are considering investing in private equity funds, they are investing in a top performing fund, as they will need to do to generate returns that compensate for the high fee structure. Because average returns are lower than average stock market returns, the costs of investing in the "wrong" fund are likely to be high.


The operation of TUPE in private equity takeovers

  5.1  The Transfer of Undertakings (Protection of Employment) Regulations 2006 or TUPE protect workers' interests where an undertaking is transferred from one employer to another. TUPE implements the requirements of the Acquired Rights Directive in the UK. Typical situations where TUPE applies would include company outsourcing where employees performing a particular function are transferred to another, perhaps more specialist, company which then becomes their employer. Another common scenario is a public sector organisation "spinning off" a particular function that it has hitherto been performing to a private sector company, which then becomes the new employer of the relevant staff. In these situations, TUPE applies and requires:

    —  information and consultation of the employees' representatives;

    —  that the terms and conditions of employment are transferred to the new employer with no variation; and

    —  that any dismissals due solely to the transfer will automatically be unfair.

  5.2  However, TUPE does not apply to takeovers that take place through a transfer of shares, including private equity buyouts. This leaves UK workers particularly vulnerable in comparison with their counterparts in continental Europe, because takeovers by share transfer are so much more common in the UK. In addition, workers' rights to information and consultation, for example through works councils, is generally much stronger in continental Europe, and in many countries workers have a direct voice into decision making through their representation on supervisory boards. The particular vulnerability of UK workers in mergers and takeovers is an iniquity that needs to be addressed.

  5.3  The TUC and trade unions have consistently called for TUPE to be extended to apply to share transfers. This would ensure that workers in companies being taken over by private equity funds be informed and consulted about the proposed takeover plans. It would also guarantee that their terms and conditions were maintained after the buyout and that any redundancies carried out solely because of the buyout would automatically be unfair.

  5.4  At present, it is too easy for both shareholders and executives to use mergers and takeovers to gain at the expense of employees. Existing shareholders have to agree a price before a takeover can take place, and managers are frequently offered highly beneficial incentives if the buyout goes ahead. However, employees have no rights for their interests to be protected or even considered in the takeover planning. Too often, employees learn of the takeover through the media and face reduced terms and conditions and/or redundancies as a result.

  5.5  While the problems with the operation of mergers and takeovers in relation to workers' interests apply across the board, there are particular concerns for employees involved in private equity takeovers. There are two main reasons for this: the high levels of debt taken on by the portfolio company as part of the terms of the buyout which transfers heavy debt repayments to its balance sheet; and the limited time horizon of the private equity fund, which may make it less likely that the new owners will seek to invest in positive, long-term employment relationships, despite the mutual long-term benefits of this approach.

  5.6  Recent studies have shown that private equity portfolio companies do indeed tend to carry out deep job cuts in the years after being bought. Two recent studies have used a control group of non-private equity owned companies in order to generate robust comparisons with private equity owned firms. A study carried out at Birmingham Business School and the University of Bologna, found that in comparison with a control group, job losses at UK private equity owned companies were 7% higher one year after the takeover, rose to 23% higher after four years and fell slightly to 21% after five years.[45] In a major study commissioned by the World Economic Forum and led by Josh Lerner of Harvard University, 300,000 US private equity-backed companies from 1980 and 2005 were examined. This research found that employment in private equity owned companies declined sharply in relation to the control group after a buyout, and was 7% lower after two years. Five years after the buyout, employment levels were over 10% lower in the private equity owned companies than they would have been had they developed like the control group.[46]

  5.7  There is also evidence that workers' terms and conditions may be weakened by private equity buyouts. As well as anecdotal evidence, a study carried out by Centre for Management Buy Out Research and Nottingham University Business School found that buy-out firms had significantly lower annual wage growth than non-buyout firms. The downward pressure on wages was particularly great in management buy-ins (as opposed to management buy-outs). The study also indicates that the larger the company, the greater the downward pressure on wages.[47] Given the high returns that private equity funds earn from the firms they buy, a key question is why employees are not sharing in these financial benefits.

  5.8  While the TUC supports extending TUPE to cover all takeovers by share transfer, there are aspects of the way in which private equity buyouts operate that make the case for extending TUPE in these cases particularly strong. When private equity funds buy a company, while nominally the employer remains the same, in practice employees and trade unions have frequently found that under new ownership, the management's approach to running the company so different that it is experienced to them as though there is an actual change of employer. Trade unions have complained of cases where management, despite having a previously positive relationship with the trade union, now refuses to meet them; in other cases, trade unions trying to represent their members' interests have been told by management that they are not in the driving seat in terms of making decisions that the union wishes to discuss. As shown in the research cited above, job losses and worse terms and conditions for employees are a likely consequence of private equity funded takeovers, again making the TUPE protections particularly relevant. In addition, as has been highlighted by commentators such as Paul Myners and FT journalist John Plender, the high leverage associated with private equity buyouts significantly increases risk for employees with no reward for that extra risk. This cannot be justified.

Information and consultation

  5.9  As well as guaranteeing protection of terms and conditions and job security, it is essential that the information and consultation gap that currently exists for employees affected by mergers and takeovers is addressed. At present, employees frequently only find out that their company is being taken over and that their job is therefore potentially under threat when the deals are announced in the press. These "cornflake redundancies"—where workers learn that their company is to make significant numbers of redundancies on the radio over breakfast—have caused deep concern within the trade union movement for many years, and unions have called repeatedly for this information and consultation gap to be addressed.

  5.10  There is existing regulation that should protect employees' right to be informed and consulted when a potential bid for their company is being considered. The Information and Consultation Regulations 2004 state that employers should consult employee representatives on matters that include:

    (i)  The recent and probable development of the undertaking's activities and economic situation.

    (ii)  The situation, structure and probable development of employment within the undertaking and any anticipatory measures envisaged, especially where there is a threat to employment within the undertaking.

  These regulations have been in force for organisations with 150 or more employees since 2005 and will apply to organisations with 50 or more employees by April 2008. They are triggered by a formal request by employees or at the initiation of the employer.

  5.11  In addition, the Collective Redundancies Directive 1975[48] requires information and consultation with employees and their representatives if 20 or more redundancies are proposed. This consultation must take place within 90 days and is triggered by the contemplation that redundancies might occur. Many private equity buyouts are followed by rapid job losses, as the studies quoted above have shown. The TUC believes it highly likely that in many cases private equity funds have already contemplated the possibility that redundancies may follow if their buyout is successful at the time of negotiating the buyout. Thus it would follow that this should be the trigger for consulting employees and their representatives about their proposals. However, currently this is not happening.

  5.12  Company directors sometimes attribute this lack of information and consultation to the requirements of the takeover code. The general principles of the takeover code require that "all persons privy to confidential information, and particularly price-sensitive information, concerning an offer or contemplated offer must treat that information as secret and may only pass it to another person if it is necessary and if that person is made aware of the need for secrecy". This has been interpreted by boards and their advisors as preventing information about a proposed bid being shared with their employees and their representatives.

  5.13  In fact, changes to the takeover code introduced in May 2006 means that far from preventing discussions with employees taking place, the takeover code now explicitly requires that employees are informed along with shareholders at the time that a firm bid is made. Rule 2.6 of the takeover code says:

  "Promptly after the publication of an announcement made under Rule 2.5 [The announcement of a firm intention to make an offer]:

    (i)  the offeree company must send a copy of that announcement, or a circular summarising the terms and conditions of the offer, to its shareholders and to the [takeover] Panel; and

    (ii)  both the offeror and the offeree company must make that announcement, or a circular summarising the terms and conditions of the offer, readily available to their employee representatives, or, where there are no representatives, to the employees themselves".

  5.14  The bidder is also required to be explicit about its plans for employment if it acquires the target company. This is set out in Rule 24.1 Intentions regarding the Offeree Company, the Offeror Company and their Employees:

  "An offeror will be required to cover the following points in the offer document:

    (a)  its intentions regarding the future business of the offeree company;

    (b)  its strategic plans for the offeree company, and their likely repercussions on employment and the locations of the offeree company's places of business; ... and

    (e)  its intentions with regard to the continued employment of the employees and management of the offeree company and of its subsidiaries, including any material changes in the conditions of employment.

  Where the offeror is a company and insofar as it is affected by the offer, the offeror must also cover (a), (b) and (e) with regard to itself".

  5.15  If a bidder's intentions with regard to employment are being set out in its bid documents, and these intentions include options that would or could make 20 or more staff redundant, this should act as the trigger for consultations with employees and their representatives under requirements to consult on collective redundancies as set out above.

  5.16  Far from preventing consultation, the takeover code appears to assume that consultation with employee representatives will take place, and requires that comments from employee representatives be included when the board circulates its opinion on the offer to shareholders. Rule 30.2 on the Offeree Board Circular requires that "the board of the offeree company must append to the circular containing its opinion a separate opinion from the representatives of its employees on the effects of the offer on employment, provided that such opinion is received in good time before publication of that circular". There is not, however, a requirement for directors to inform employee representatives of their right to make a submission to shareholders. The TUC has already raised this point with the Takeover Panel and plans further interventions to lobby for this omission to be addressed.

  5.17  The takeover code further requires that the Board include its views on the employment implications in its opinion of the bid: "The board of the offeree company must circulate to the company's shareholders its opinion on the offer ... [which] must include| the effects of implementation of the offer on all the company's interests, including, specifically, employment". These documents must also be made available to employee representatives or, in the absence of employee representatives, to the employees themselves.

  5.18  Thus the takeover code, far from requiring secrecy from employees and trade unions, actually requires that the bidder company be specific in its bid about its plans regarding both condition of employment and numbers of employees; that the Board sets out its views on the employment implications of the bid in its comments to shareholders; that comments from employee representatives be included in the documents sent to shareholders; and that all the documents referred to above be made available to employees representatives or employees themselves.

  5.19  The TUC is very concerned that these aspects of the takeover code are not currently being properly implemented, and is planning to conduct some urgent enquiries among affiliates to gather more detailed information on this. When this is completed, our concerns will be communicated to the Takeover Panel.

  5.20  Just as there is a substantial gap in the reporting requirements between quoted and private companies, there is a similar gap in terms of the requirements surrounding takeovers of public and private companies. While listed companies and also unlisted plcs are covered by the takeover code, solely-owned private companies, including private equity-owned companies, are not covered. Private equity portfolio companies are often sold on from one private equity fund to another, and in these cases the information and consultation rights included in the takeover code do not apply. As set out above, other rights as set out in the Information and Consultation Directive and the Collective Redundancies Directive, are not being implemented in private equity buyout situations.

  5.21  There is no justification for offering employees in certain companies information and consultation rights in a takeover situation and not others. This is an anomaly that needs urgently to be addressed. The TUC believes that TUPE should be extended to cover takeovers by share transfers. When the Acquired Rights Directive, from which the TUPE regulations stem, was originally introduced in 1977, the option of extending its protections to cover transfers by share ownership was considered, and the TUC does not believe that there are any technical barriers that would prevent this being implemented. As well as enshrining information and consultation rights, it would also prevent employment cuts being made solely as a result of the takeover and protect workers' existing terms and conditions.

  5.22  If the Government is not minded to commit itself to this, it should at least commit itself to addressing the problems raised above in some other way. As a start, it should establish a working group to investigate the issue of employee interests, including information and consultation rights, in the context of mergers and takeovers, and draw up recommendations for reform. This working group should include representatives from unions, employers, investors and the takeover panel.


  6.1  There are three areas relating to conflicts of interest that are of concern to the TUC: potential conflicts of interest between existing shareholders and the bidder during the takeover process; conflicts of interest between limited and general partners; and, of particular concern to the TUC, conflicts of interest between private equity funds and their portfolio companies.

  6.2  There is the potential for directors of target companies to face conflicts of interest as soon as a bid from a private equity fund is proposed, as company directors are often offered highly lucrative stakes in the company if the bid succeeds. In Denmark, the Government has recently passed legislation to address this issue. A new law forbids offering incentive programmes to the management of a company in connection with a takeover bid. In addition, the buyout fund is required to announce any dividends it wishes to pay out over the next 12 months in advance, thus making it easier for existing shareholders to judge the takeover offer. The TUC believes that the UK Government should implement similar legislation in the UK and urges the Treasury Committee to investigate options for this.

  6.3  The FSA has warned of the potential for conflicts of interest between general partners and limited partners. For example, general partners are often able to over or under commit to specific company investments through "co-financing" deals. This could enable them to cherry pick the best deals for extra investment, while capping their exposure to more risky deals. Or, a fund manager may be managing investment funds at different stages of the investment cycle, both of which are invested in the same company. The interests of the two investment funds may diverge (for example, in terms of whether the private equity fund should sell to realise profit now or wait until later), while the fund manager has responsibilities to both groups. Or, if payment systems are in place that enable the fund manager to enrich its own staff and/or company directors without these payments going through the fund itself, it would be possible for the private equity fund to transfer significant value from the company to enrich its staff and company directors. If the value was transferred to the fund, the fund managers' staff would receive only a proportion of that value. The FSA argues that these are among scenarios that generate conflicts of interest between general and limited partners.[49]

  6.4  The TUC is particularly concerned about the potential for conflicts of interest between private equity fund managers and the long-term success of the companies they own. The FSA has warned that the interests of fund managers, fund investors and the company are most likely to break down where:

    —  The fund invests in many different companies, with an individual spreading their attention across the portfolio, thus limiting the time that can be spent on each one; this is a particular problem if some of the companies are in the same sector and are thus competitors.

    —  The fund has already extracted profit through a re-financing and therefore considers that finite team resources would be better spent on another company.

    —  The fund manager is taking a portfolio approach to their investments and something that is in the interests of the portfolio as a whole is not in the interest of an individual company. Engineering a takeover of one company by another could be an example of this.

    —  Loans have been provided to company managers in order to allow them to buy an equity stake in the buyout. This could lead the company managers to act in the interests of the private equity fund manager, rather than the company they are responsible for.[50]

  6.5  The FSA has also questioned the motives of the private equity fund managers and their commitment to the long-term sustainability of the company: "The entrance of new types of market participant with business models that may not favour the survival of distressed companies adds further complexities ... which may create confusion which could damage the timeliness and effectiveness of work outs following credit events and could, in an extreme scenario, undermine an otherwise viable restructuring".[51]

  6.6  Sir David Walker raised this issue in his consultation document of July 2007: "Where the equity providers have effectively lost the capital committed to a portfolio company, the general partner will be left with no direct financial interest to protect and could, if such interest were the sole criterion, feel little compunction about walking away from further engagement|But the rights of ownership should be seen to be complemented by a degree of obligation that would exclude abdication of responsibility by the general partners".[52] In his Guidelines published in October 2007, he included a recommendation on responsibility at a time of significant change: "In the event that a portfolio company encounters difficulties that leave the equity with little or no value, the private equity firm should be attentive not only to full discharge of its fiduciary obligation to the limited partners but also to facilitating the process of transition as far as it is practicable for it to do so".[53] The TUC believes that this exhortation is inadequate to address such a serious situation.

  6.7  If the interests of private equity fund manager and their portfolio companies can diverge, this has serious and detrimental implications for the portfolio company's stakeholders, including employees. It also raises major questions about whether the UK's corporate governance system is operating effectively to promote business success and protect the interests of those who contribute to that success.

  6.8  The Companies Act 2006 enshrined what the Government has called "enlightened shareholder value" as the basis of UK company law. The duties of directors as set out in the new Act require directors to serve shareholder interests, and require that in so doing they have regard, among other matters, to the interests of employees, relationships with suppliers and customers, social and environmental impacts and the likely consequences of their decisions in the long-term. The thinking behind enlightened shareholder value was that in the long-term, the interests of different company stakeholders converge, thus making it unnecessary to put responsibilities to employees and other stakeholders on an equal footing to responsibilities to shareholders.[54]

  6.9  These duties are not suited to a situation where shareholders have defined their interest as maximising a sale price for the company after two to five years. As the scenarios set out by the FSA illustrate, there is a risk that directors may be serving existing shareholders' interests at the expense of the interests of other stakeholders, future investors and the long-term success of the company. If the owners stated interest is to sell the company after a few years, having generated maximum profit along the way, this may not be compatible with the sort of business decisions needed to put the company on a sustainable long-term footing. An example of the kind of action in question is when company assets are sold to generate funds at the expense of future revenue streams. For example, the private equity owners of Debenhams sold the ownership of its stores in a refinancing deal, requiring the company to pay rent for stores it previously owned indefinitely.

  6.10  The TUC does not believe that it should be legal for private interests to buy a company and then run that company for their own benefit, at the expense of the company's long-term future. The TUC believes that it is necessary to address the issue of conflicts of interests between private equity fund managers and the companies they own, and urges to Government to look into this area as a matter of urgency.


  The TUC welcomes this opportunity to submit evidence to the Treasury Committee's resumed inquiry into private equity. We believe that despite Sir David Walker's proposals on transparency and disclosure, significant problems surrounding private equity remain that need to be addressed by policy makers. These include conflicts of interest, taxation of general partners, tax relief on debt interest payments, the impact of private equity takeovers on the long-term performance of portfolio companies, and, most important of all to the TUC, the issue of how workers in portfolio companies are affected by private equity takeovers. The TUC believes that the current regulatory regime for private equity is inappropriate and should be strengthened to ensure that private equity funds and the companies they buy operate in the public interest. In particular, the TUC believes that measures are required as a matter of urgency to protect the interests of workers in mergers and takeovers.

December 2007

35   Private equity-a TUC perspective, TUC evidence to the Treasury Committee Inquiry, May 2007. Back

36   "Private equity is casting a plutocratic shadow over British business", The Guardian, 23 February 2007. Back

37   Ministry of Taxation, Denmark, "Status på SKATs kontrolindsats vedrørende kapitalfondes overtagelse af 7 danske koncerner", March 2007. Back

38   Information obtained from the DGB. Back

39   PIRC, Proxy Voting Annual Review 2006. Back

40   FSA, Private equity: a discussion of risk and regulatory engagement, November 2006. Back

41   Kaplan, S and Schoar, A, "Private Equity Performance", National Bureau of Economic Research Working Paper 9807, June 2003. Back

42   "Pensions alert over private equity", The Telegraph, 10 May 2007. Back

43   Phalipou, L, Gottschalg, O and Zollo, M, "Performance of private equity funds: Another puzzle?", Working paper, 200. Back

44   "Private Money", Fortune Magazine, 19 February 2007. Back

45   Robert Cressy, Frederico Munari & Alessandro Malipiero, Creative Destruction? UK Evidence that buyouts cut jobs to raise returns, 30 October 2007. Back

46   Josh Lerner et al, The Global Economic Impact of Private Equity Report 2008, Globalization of Alternative Investments Working Paper Volume 1, World Economic Forum, Jan 2008. Back

47   Ammess K and Wright M, The wage and employment effects of leveraged buyouts in the UK, International Journal of Economics and Business, forthcoming, in Phil Thornton, Inside the dark box: shedding light on private equity, The Work Foundation, March 2007. Back

48   Implemented in the UK in the Trade Union and Labour Relations (Consolidation) Act 1992, Part IV, Chapter II, sections 188-198. Back

49   FSA, Private equity: a discussion of risk and regulatory engagement, November 2006. Back

50   ibid Back

51   ibid Back

52   Sir David Walker, Disclosure and Transparency in Private Equity A consultation document, July 2007. Back

53   Sir David Walker, Guidelines for Disclosure and Transparency in Private Equity, October 2007. Back

54   It should be noted that the TUC consistently argued for pluralist directors' duties, which would require directors to balance the interests of shareholder with those of employees and other stakeholders. Back

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