Data Collection Study on the Impact of Private Equity, Hedge and Sovereign Funds on Industrial Change in Europe

European Economic and Social Committee Consultative Commission on Industrial Change

Project Ref. CCMI/CFT 2/2008

Data collection study on the impact of private equity, hedge and sovereign funds on industrial change in Europe

Final Report

Authors of this report:

Eckhard Voss - Sig Vitols - Peter Wilke - Jakob Haves

Hamburg, June 2009

WILKE MAACK UND PARTNER Schaarsteinwegsbrücke 2 D-20459 Hamburg Tel : +49 40 43 27 87 43 – Fax : ++49 40 43 27 87 44 www.wilke-maack.de

Final Data Collection Report as of 24 June 2009 2

Contents

Executive Summary 4

1 Introduction and overview of this report 7 1.1 Background and key questions addressed 7 1.2 Character, methodological approach and structure of this report 8 1.2.1 Objectives and tasks of the study 8 1.2.2 Compiling, evaluation and presentation of existing data and sources 8 1.2.3 Analysis of functioning of private equity, hedge and sovereign funds and impacts on industrial change 9 1.2.4 Structure of this report 11

2 Private Equity, Hedge Funds and Sovereign Wealth Funds – their role in European financial markets 2003 - 2008 12 2.1 Overview and assessment of data sources 12 2.2 Overview of relevant financial databases 13 2.3 Role of different forms of private investment in European financial markets 2003 - 2008 15 2.3.1 Overview 15 2.3.2 Private Equity 15 2.3.3 Hedge Funds 20 2.3.4 Sovereign Wealth Funds 23

3 Functioning and Business Models of Private Equity, Hedge Funds and Sovereign Wealth Funds 28 3.1 Introduction and overview 28 3.2 Private Equity 30 3.2.1 Evolution of transaction volumes 30 3.2.2 Main industry sectors of activity 30 3.2.3 Duration of involvement 31 3.2.4 Financial instruments to complete the transactions 32 3.2.5 Ways of terminating transactions 35 3.3 Hedge Funds 36 3.3.1 Evolution of transaction volumes 36 3.3.2 Main industry sectors of activity 37 3.3.3 Duration of involvement 38 3.3.4 Financial instruments to complete the transactions 39 3.3.5 Ways of terminating transactions 39 3.3.6 Other forms of Hedge Fund investments 39 3.4 Sovereign Wealth Funds 39 3.4.1 Evolution of transaction volumes and main sectors of activity 40 3.4.2 Duration of involvement and financial instruments to complete the transactions 41 3.4.3 Ways of terminating transactions 42 3.5 Fund-specific SWOT assessments and initial conclusions regarding the impact on industrial change 42 3.5.1 Private Equity Funds 42 3.5.2 Hedge Funds 44 3.5.3 Sovereign Wealth Funds 45 Final Data Collection Report as of 24 June 2009 3

4 The impact of Private Equity, Hedge Funds and Sovereign Wealth Funds on industrial change 47 4.1 Dimensions of industrial change and the impact of alternative investments 47 4.2 Overview of existing research and analyses 49 4.3 Methodological problems and other limitations of analyzing the impact of funds on industrial change 50 4.4 Empirical evidence on the impact on industrial change at company level 52 4.4.1 Firm performance, profits and value creation 52 4.4.2 Impact on employment development 55 4.4.3 Wages and working conditions 61 4.4.4 Social dialogue and information and consultation at firm level 62 4.4.5 Management practice, corporate cultures and governance 63 4.5 Evidence from case study research 65 4.5.1 Evidence on the impact on industrial change at enterprise level 65 4.5.2 Impact on employment, working conditions and labour relations 68 4.6 Conclusions: What we know and what we don’t know 69

5 The financial crisis and Private Equity: Implications for industrial change 71 5.1 Introduction 71 5.2 The Current Situation in Private Equity 71 5.2 The crisis in Private Equity and its implications for financial stability 73 5.3 Implications for the Micro Level 76 5.4 Upcoming Problems in PE Target Companies 77

6 Conclusions 80

7 References 85

Final Data Collection Report as of 24 June 2009 4

Executive Summary

1. This report summarizes findings of a data collection study carried out between January and June 2009 in order to support the ongoing work of the EESC’s Consultative Commission on Industrial Change (CCMI) on the impact of private equity, hedge and sovereign wealth funds on industrial change in Europe. 2. Purpose: The main purpose of the research was to collect, evaluate and present a comprehensive overview on existing data and relevant sources of knowledge and empirical evidence on the impact of the three types of funds on industrial change in Europe. With regard to the latter, the focus was mainly on industrial change at the company level. 3. Tasks: Our research in particular focused on three distinctive tasks: First, to compile, evaluate and summarize existing data and sources on the three types of funds; secondly to analyse the functioning and respective business models of private equity, hedge and sovereign funds and thirdly, to summarise existing knowledge on the impact of the three types of alternative investment funds on industrial change in Europe. 4. Transparency and availability of data: it can be stated that there is a lack of transparency in PEF, HF and SWF reporting, which creates a serious problem for evaluating the impact of these funds. On the fund level decision makers are generally not required to publish data accessible to the public at large, and the quality and accuracy of information that can be gained through data bases is uneven. On the company level the reporting requirements for private (non-listed) companies vary considerably from country to country, as does the mode in which this information is made available to the public. Furthermore, companies often change name when ownership is transferred due to an investment transaction. As a result, it is virtually impossible to present a large and comprehensive dataset of private companies with more information than sector, address, date of investment, etc. from the typical online data services. 5. Growing importance of PE,SWF and HF as investors: While the relative size of HF, PE and SWF may seem modest at a global level, the relative importance of the first two types of investors is increased by 1) the use of leverage of 2-3 times own capital and by 2) the concentration of many activities within certain markets. The report gives indications and figures for the relative importance of the different funds in Europe and a list of the 10 most important actors for each of the fund types.

6. Different business models and impacts on industrial change: Private Eq- uity, Hedge Funds and Sovereign Wealth Funds in general follow different business models which also influence their behaviour and specific expectations as investors and/or owners. Differences for example exist in the type of investment made and in the time horizon, which is in some cases very short-term and focused on liquid financial assets. In contrast Sovereign Wealth Funds generally following a long-term agenda Final Data Collection Report as of 24 June 2009 5

which is following not only financial but also national economic policy goals. 7. Differences within the three types of investment funds: Beside these general differences between the funds it is also important to stress differences within certain types of funds and differences with regard to the role of these funds in different stages and situations of business development, e.g. a start-up situation, growth phases, merger and acquisitions, turnaround and crisis situations. Since all of these forms of business development either follow or result in industrial change at the enterprise level it is important to assess the role of the three types of funds also with regard to these different stages/situations of company development.

8. SWOT analyses of the three types of funds: A SWOT analyses of the different business models characterizing PE, HF and SWF reveals some significant strengths, weaknesses as well as opportunities and threats both with regard to the micro-dimension of restructuring and change at the enterprise level as well as with view on macro-economic impacts on industrial change.

9. Impact on industrial change: Regarding the impact on industrial change we are offering first a set of hypothesis how such an impact can take place. Additionally we have screened the existing research on the impact on items such as firm performance, profits and value creation; employment development; wages and working conditions; social dialogue and information and consultation at firm level; and management practice, corporate cultures and governance. 10. Summarising main findings: As a summary of the findings one can say that there is not a black or white picture on the impact assessment. One can find proof and arguments for a short term negative impact on employment at company level. But also proofs for a weak positive long term impact on the overall employment level in general.

11. Impact on labour relations and working conditions: Similar to the issue of job creation, the impact of alternative investment strategies on wages and other aspects of working conditions are highly controversial and there is a large variation between messages of business orientated surveys and studies on the one hand and more critical studies on the issue, which often are based on case study evidence. Additionally we find there is hardly any significant research on the impact of PE, HF and/or SWF investments on social dialogue and information and consultation practice at the company level.

12. Impact of the current crisis: Our analyses of the current global financial crisis on PE and its implications for industrial restructuring shows that that PE activity has in fact generated a major risk for the financial system. Given the complexity of the PE financing process this risk is distributed along different parts of the system, including originating banks, institutional investors that have purchased LBO debt from originators, Final Data Collection Report as of 24 June 2009 6

and also institutional investors who have invested directly in PE. Large banks and institutional investors are affected. 13. Micro level: On the micro level, the default probability of many portfolio companies is increasing, and credit ratings were downgraded. This will destabilize PE firms and the companies in which they are invested. We have tried to identify the magnitude of the refinancing problem over the next ten years as well as which companies will be running into refinancing problems in the next few years. 14. Macro level: On the macro level the risks for banks which have guaranteed these investments is considerable. The amount to write off loans is probably somewhere between EUR 50-80 billion, i.e. still a substantial risk to bank balance sheets and thus to financial system stability.

15. Overall conclusions and recommendations: The conclusion of our report summarizes some political recommendations arising from the research findings carried out. These recommendations in particular include sug- gestions to increase the transparency for PE, HF and SWF industry through binding reporting requirements regarding strategies of funds, level of risk, and detailed information on the financial and employment status in each portfolio company and further improvements of the regulatory frameworks. With regard to existing gaps in the European framework regulation of information and consultation in takeover situations, we are suggesting that information, consultation and participation rights are re-examined in order to ensure that workers are informed about the economic status of their company and have real bargaining rights before PE deals are consummated, during the restructuring process, and before exit. Finally, it is suggested that the establishment of a European rating agency should be discussed which provides objective ratings on the financial soundness and default probabilities of issuer companies. Ratings should be mandatory for all issues above a certain size.

Final Data Collection Report as of 24 June 2009 7

1 Introduction and overview of this report

1.1 Background and key questions addressed Hedge funds (HFs), private equity funds (PEFs) and sovereign wealth funds (SWFs) have existed for quite some time.1 Their enormous growth in recent years is closely connected with the fundamental changes in financial markets occurring in the context of globalisation. As the current financial crisis illustrates, these funds and their impact on financial markets and business have important implications for the global economy, the structure and behaviour of financial markets as well as corporate practice within them. From the European point of view there are crucial questions resulting from the growing influence of private equity, hedge funds and, to a growing extent, sovereign wealth funds as well: What impact do these funds have on industrial change and the functioning of the “real economy” throughout Europe, e.g. in terms of employment development, working conditions and industrial relations? Which implications and effects do these capital funds and their increasing role have in particular on the specific European strategy of combing economic and social goals, i.e. the Lisbon objectives of making Europe “The most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth, more and better jobs and better social cohesion”? Does the current organization of financial markets in Europe provide op- timal conditions for achieving the Lisbon goals? Even before the current financial crisis emerged different European institutions and key actors such as the European Commission2, the European Par- liament as well as social partner organisations and business organisations have raised and addressed these questions, leading to an ongoing debate on the nature, functioning and effects of capital funds. At the same time, there is quite a controversial debate on both macro- and micro-level effects of private and state-owned capital funds on industrial change and restructuring in Europe today. While surveys and studies carried out by or on behalf of capital fund organisations themselves stress the overall positive effects of these funds on employment creation, innovation and other aspects of business development in Europe3, other surveys highlight the negative effects both at the level of micro-economic restructuring (i.e. reducing wages, R&D investments and the long term innovation capacity in

1 In oder to simplify terminology these three types of funds will be referred to as "capital funds" in this report. 2 EU Commission (2009): “Open Hearing on Hedge Funds and Private Equity”, February 26th & 27th. http://ec.europa.eu/internal_market/investment/docs/conference/summary_en.pdf. 3 See for example: Achleitner, Ann-Kristin and Klöckner, Oliver (2005): ”Employment Contribution of Private Equity and Venture Capital in Europe”, Centre for Entrepreneurial and Financial Studies (CEFS) on behalf of the European Private Equity and Venture Capital Association (EVCA). Final Data Collection Report as of 24 June 2009 8 favour of short term profits) as well as on the sustainability of financial markets in Europe.4

1.2 Character, methodological approach and structure of this report

1.2.1 Objectives and tasks of the study This report has been carried out as an independent expert report in order to support the work of a study group of the EESC’s Consultative Commission on Industrial Change (CCMI) on the impact of private equity, hedge and sovereign wealth funds on industrial change in Europe. In light of uncertainties about the impact of private equity funds, hedge funds and sovereign wealth funds on industrial change in Europe it would seem to be important that the deliberative process within the European Eco- nomic and Social Committee and the drafting of an EESC opinion be built upon a solid base of data and other empirical evidence. The main purpose of the research documented in this report was to collect, evaluate and present a comprehensive overview on existing data and relevant sources of knowledge and empirical evidence on the impact of the three types of funds on industrial change in Europe. With regard to the latter, the focus was mainly on industrial change at the company level. Arising from this our research focused on the following three sets of tasks: (1) Compiling, evaluation and presentation of existing data and sources

(2) Analysis of functioning of private equity, hedge and sovereign funds and their impact on industrial change (3) Summarizing existing knowledge on the impact of the three types of alternative investment funds on industrial change in Europe

1.2.2 Compiling, evaluation and presentation of existing data and sources Due to the uneven degree of transparency regarding the three types of funds, the comprehensiveness of any data collection will vary by type of fund:

There are several comprehensive commercial databases on Private Equity Funds offering information on individual PE investments, including identity of investing PEF, timing of investment, characteristics of the target company (and, in most cases for larger investments, value and mode of financing of the deal). Due to the secrecy of most Hedge Funds regarding investment strategy and portfolio, the database must by necessity be restricted to significant shareholdings in listed companies. Since the 1990s investors in listed companies in the European Union have been required to disclose shareholdings of over five percent. Many countries have set this disclosure threshold much lower. Sig- nificant shareholdings by HF thus in principle must be registered with the

4 See for example: Socialist Group in the European Parliament/PSE (2007): “Hedge Funds and Pri- vate Equity – A Critical Analysis”, reported by Ieke van den Burg and Poul Nyrup Rasmusen. Final Data Collection Report as of 24 June 2009 9 target company and disclosed to the public. Due to this requirement, it is possible to put together a comprehensive database of significant HF investments in industrial companies, either through drawing on the databases of individual regulatory authorities at national level or, more conveniently, through the Thomson ONE Banker Ownership Module (provided by Reuters Thomson). This data allows for determining when HF have initiated and exited significant investments in listed companies. Sovereign Wealth Funds vary widely regarding transparency, with the Nor- wegian government fund generally regarded to have the highest level of transparency. SWFs are (as are all investors – see discussion in PEFs above) required to disclose significant shareholdings in European listed companies. Above and beyond this, the database includes investments made by SWFs with high levels of transparency (e.g. through lists of investments in their annual reports or on their websites). Based on existing data and literature we have elaborated a grid in order to classify and gather the different sources which are presented and assessed with regard to accessibility and reliability in this report. Furthermore and on the basis of this grid data sources and secondary data have been stored in an electronic format: For each database source a profile sheet has been prepared while secondary data and other information relevant to our survey have been stored in electronic form (excel worksheet).

1.2.3 Analysis of functioning of private equity, hedge and sovereign funds and impacts on industrial change The quantity of literature on the three types of funds to be studied varies widely. The literature on PEFs is most extensive, with the oldest studies already some decades old. Although the earlier literature focused on the US, more and more studies have been done in Europe. These studies have focused on a variety of outcomes, including returns for investors in PEFs, and the employment, sales and profitability outcomes of PEF investments in portfolio companies. The relevant literature on HF is less extensive, and due to the lack of transparency regarding most HF investments, focuses mainly on returns to investors. Some recent econometric work, however, has looked at significant shareholdings by HF in listed companies. Scientific interest in SWFs, however, has been quite recent. The literature here is quite thin, particularly on econometric studies on the impact of SWF investments. In general, the econometric studies have focused on trying to asses the overall or average affect of specific types of investors on companies and various outcomes (e.g. employment levels). An issue that has been largely unexplored here has been heterogeneity between different funds within each fund group, i.e. some types of PEF may have very different investment strategies than other PEFs, with correspondingly different types of outcomes. Fur- thermore, the impact of different national regulatory regimes (e.g. worker information and participation rights) on the way these funds restructure companies has been largely unexplored. Final Data Collection Report as of 24 June 2009 10

Given this background, our analysis had to separate the issue of functioning of capital funds from the impact analysis: While with regard to the former, empirical data and figures are available, the latter mainly has to rely on qualitative evidence and other sources. With regard to the functioning of the three types of funds this study analyses in particular the following aspects for the period 2003 – 2008: First, the relative importance and role of the three funds in European financial markets are assessed based on our evaluation of existing data and other sources. Secondly, a deeper analysis of the functioning and impact of private equity, hedge funds and sovereign wealth funds covering the period 2003 – 2008 has been carried out on the basis of the following indicators and aspects: 1. Number of volume of transactions in absolute terms 2. Main sectors of activity of the acquired companies 3. Duration of involvement 4. Financing instruments to complete the transaction (equities, LBO, others) 5. Ways of termination of the transaction

Given the limited empirical data available our analyses faces several methodological problems. Our approaches to deal with the different conditions with respect to the three types of capital funds are presented in the following overview. Methodological approach to analyse the functioning of funds Indicators Private Equity Funds Hedge Funds Sovereign Wealth Funds 0) Relative importance of Calculation of relative impor- Calculation of importance Calculation of importance private equity, hedge tance takes into account takes into account use of takes into account not only and sovereign transac- multiplication through use of leverage plus shorter aver- asset size but also concen- tions within the financial leverage (typically 2-3 times age duration of investment tration in M&A activity and markets equity investment) plus also concentration in sectors concentration in certain like energy and financial markets (primarily M&A) services 1) Number and volume of Summary data from EVCA We calculate a “minimum” We calculate a figure based transactions in absolute (European Private Equity figure on significant equity on all the deals we find in terms and Venture Capital Asso- participation in listed com- Zephyr, SDC Platinum and ciation) panies for the past two Reuters Thomson owner- years based on the Reuters ship data Thomson ownership data. 2) Main sectors of activity EVCA summary data (plus Own analysis for last two Own analysis based on of the acquired compa- analysis of raw data on years based on significant individual deal data from the nies individual PE deals) holdings in listed companies above data sources (Reuters Thomson) 3) Duration of involvement Estimate from Davos 2008 Own analysis based on Own analysis based on the study on the characteristics calculation of portfolio turn- individual deal data from the of private equity over based on quarterly above sources data for the last 2 years. Final Data Collection Report as of 24 June 2009 11

4) Financing instruments Standard and Poor’s LCD Hedge funds directly pur- SWFs generally purchase to complete the trans- summary data chase the equities, however, equities directly – however, action (equities, LBO, they generally leverage their they often purchase a minor- others) own capital by a certain ity stake multiple

5) Ways of termination of EVCA summary data HF typically take minority Own analysis based on the transaction shareholdings in listed com- individual deal data listed panies, and exit through above sale of these shares on secondary markets

1.2.4 Structure of this report Chapter 2 presents an overview of our data collecting work and the assessment of different data sources of the three type of funds (2.1 and 2.2). Also included in this part of the report are major findings from our work on the relative importance and role of the three funds in European financial markets based primarily on our evaluation of existing data and other sources (2.3). More details on the strategies and functioning of the three types of funds along the five indicators are presented in chapter 3, focusing on the largest investors in each fund type. At the end of this chapter our study presents a summary of findings with regard to the different business models connected to the three types of funds as well as a SWOT assessment focussing on likely impacts on industrial change. This assessment should also be regarded to a detailed evaluation in chapter 4 of existing knowledge and empirical evidence on the impact of the three investment fund types on industrial change. According to our major research tasks we focus mainly on the micro level, i.e. industrial change at the company level presenting findings of relevant surveys in particular with regard to firm performance and value creation, employment development, wages and working conditions. Furthermore, this part of our study also discusses other aspects such as the impact of short-term versus long-term investment strategies and the impact of increased risk orientation on company development. Finally, in order to address impacts beyond company level industrial change (particularly in the context of the current economic situation), chapter 5 provides the results of an own analysis, focusing on the developing crisis in the private equity industry.

Final Data Collection Report as of 24 June 2009 12

2 Private Equity, Hedge Funds and Sovereign Wealth Funds – their role in European financial markets 2003 - 2008

2.1 Overview and assessment of data sources As a general statement it can be said that there is a lack of transparency in PEF, HF and SWF reporting, which creates a serious problem for evaluating the impact of these funds. On the fund level decision makers are generally not required to publish data accessible to the public at large, and the quality and accuracy of information that can be gained through (as a rule quite expensive) data bases is uneven (see below for a discussion of this). On the company level (i.e. level of the firms that funds invest in) the reporting requirements for private (non-listed) companies vary considerably from country to country, as does the mode in which this information is made available to the public. Furthermore, companies often change name when ownership is transferred due to an investment transaction. As a result, it is virtually impossible (the only partial exceptions here are the U.S., and to a lesser extent the UK) to download a large and comprehensive dataset of private companies with more information than sector, address, date of investment, etc. from the typical online data services – quite unlike the case for other kinds of studies, such as of listed companies, for which detailed information is available due to extensive publicity requirements. Some of the most important methodological problems related to the available sources and findings are as follows:

Sampling issues: The issue that is currently most discussed is the effect of buyouts of companies which are listed on a stock exchange (public companies). This is a different category of company from portfolio investment in small start-up companies. It is well known, and not contentious, that start- up companies which survive will show significant growth. A number of surveys however include data on both buyouts and venture capital investments, but then use the data to draw conclusions about buyouts. Such data may however reflect the positive impact of venture capital, and within the total, the impact of buyouts may be negative. Data issues: Many industry surveys rely on data provided by respondents in the portfolio investment-owned companies themselves, which is not checked or verified, or use respondents’ own judgments and opinions as raw data. This kind of data is less robust than verifiable public data. Interpretation issues: Any study of the effects of a specific phenomenon, such as portfolio investments, needs to establish what difference that factor makes. Data on the employment changes in portfolio investment companies therefore needs to be compared with data on other similar companies which have not changed ownership. Such comparisons are sometimes made with trends in the whole economy, but should be made between portfolio investments and non- portfolio investment companies in the same sector – other- Final Data Collection Report as of 24 June 2009 13 wise the comparison may simply reflect the fact that portfolio investment companies are in faster-growing sectors, for example.

2.2 Overview of relevant financial databases

Source Title Character Accessibility Completeness/Reliability

1 EVCA EVCA Annual reports Printed reports can Comprehensive overview of overall PE Yearbooks including statistics be ordered. Sum- investment, fundraising and exit activ- on number and maries available ity, with breakdowns by country, sector, value of PE in- online from the and type of transaction. vestments, by German private country and sector equity and venture capital association. 2 Standard Leveraged Summary reports Summary reports Good overview of LBO activity in and Poor’s Commentary on number of buy- available by re- Europe. Detailed data on individual and Data outs and financing quest. Access to investments, particularly where Stan- (LCD) structure, by year. online database dard and Poor’s issues a credit rating Online database restricted to inves- (i.e. a high percent of the larger in- with detailed data tors due to con- vestments). on individual cerns about confi- transactions. dentiality.

3 Thomson VentureXpert Online Data Base By subscription for Considered the most comprehensive Reuters summary data and commercial data base on private eq- a selection of vari- uity. Has detailed information on portfo- ables for individual lio companies, including date of initial investments and investment, follow-up investment funds. More de- rounds, sector of activity, identity of tailed data on indi- investor, etc. However has gaps (es- vidual funds must pecially for smaller firms) and has lim- be negotiated with ited data regarding exits and financing the provider. structure. 4 Thomson Thomson Online Data Base By subscription Comprehensive online database for Reuters ONE Banker significant shareholdings in listed com- Ownership panies (including by HF, SWF and PE). Module Comprehensive data goes back two years. Data going back further (as far back as 1997) is available through an additional module, but at additional cost. 5 SWFs Annual re- Report on invest- Online or by re- Transparency of SWFs varies greatly ports ment activities quest

6 Bureau Zephyr M&A activity in- By subscription Most individual transactions are listed, van Dijk formation (sum- but there are many data gaps, particu- mary reports and larly regarding financing. individual transactions, including PE and SWF).

7 Thomson SDC Plati- Data on M&A By subscription Data on many SWF and PE invest- Reuters num transactions and ments. Follow-up data (e.g. on exits) new securities not linked. issues 8 Online Online Investment activity Quite open, but Varies according to size and location of financial searches by SWFs and ma- subscription ac- investment press jor hedge funds cess to some media Final Data Collection Report as of 24 June 2009 14

Source Title Character Accessibility Completeness/Reliability

9 PEREP Platform for Detailed data on Through negotia- Comprehensive summary of activity Analytics Private Equity individual PE tion with the Euro- for recent data data in investments. pean Venture Cap- Europe Used to gener- ital Association. ate summary Data on individual reports for deals not disclosed EVCA 10 SWF Fund Rank- Overview of size Online Comprehensive list of larger SWFs Institute ing of SWF 11 SWF Linaburg- Rating of De- Online Comprehensive rating of larger Institute Maduell gree of Trans- SWFs Transparency parency Index 12 Dealogic Dealogic Detailed data on By subscription Fairly comprehensive, particularly on many M&A larger deals transactions, including PE 13 Standard CapitalIQ Detailed data on By subscription Fairly comprehensive, particularly on and Poor’s many M&A larger deals transactions, including PE

14 National Large share- List of share- Varies greatly by Comprehensive for direct equity financial holding regis- holdings above country, e.g. cur- holdings. Generally does not cover regulatory ters the minimum rent German and short equity positions, indirect voting authorities threshold de- historical Italian rights (empty voting) or equity op- fined by national data are online tions. law. versus UK data which is only available by subscription to a financial news service. 15 Prequin Prequin HF Data on finan- By subscription Fairly comprehensive for the larger and PE data cial returns and PE and HF bases basic data on HF and PE

16 Centre for CMBOR Database on Individual data is Good coverage of PE deals in UK, Management buyout data- European buy- confidential, how- partial coverage for rest of Europe Buy-outs base outs, including ever summary research, PE sponsored reports are com- deals piled by CMBOR Nottingham and custom analy- University ses can be negoti- Business ated. School Source: Own compilation.

Final Data Collection Report as of 24 June 2009 15

2.3 Role of different forms of private investment in European financial markets 2003 - 2008

2.3.1 Overview While the relative size of HF, PE and SWF may seem modest at a global level, the relative importance of the first two types of investors is increased by 1) the use of leverage of 2-3 times own capital and by 2) the concentration of many activities within certain markets. The following table shows the relative importance of different investor types, at a global level. Global assets under management Rank Fund type billions USD Figures as of — Private wealth $ 40,000 2007 1 Pension funds $ 28,228 2007 2 Mutual funds $ 26,200 2007 3 Insurance companies $ 18,836 2007 4 Real estate $ 10,000 2006 5 Foreign exchange reserves $ 7,341 February 2008 6 Sovereign wealth funds $ 3,300 2007 7 Hedge funds $ 2,300 2007 8 Private equity funds $ 2,000 2007 9 REITs $ 764 2007 Note: Around one third of private wealth is incorporated in conventional investment management (Pension funds, Mutual funds and Insurance assets). Source: International Financial Services London.

2.3.2 Private Equity PricewaterhouseCoopers data suggests that Europe accounts for just somewhat less than one third of global PE activity. Overall world PE investment for 2007 was estimated at USD 297 billion, with a breakdown by country indicating that Europe accounted for about USD 85 billion (PwC Private Equity Re- port 2008: 41-42). Although global data from PricewaterhouseCoopers for 2008 was not available at the time of writing of this report, data from the national and European levels indicates that fundraising and investment activity decreased dramatically in 2008, however. Global Trends in PE Investment and Fundraising Activity (US$bn)

Source: PricewaterhouseCoopers, Private Equity Report 2008: 41.

Final Data Collection Report as of 24 June 2009 16

Similarly to the case of HF, PE is concentrated in certain types of activities, such as mergers and acquisitions (M&A). PE has accounted for up to 28 percent of M&A quarterly deal volume in Europe (4Q03). Over the years we are examining, PE has accounted for about one sixth of M&A activity (see table on the following page). PE accounts for an even greater proportion of buyout activity. Stroemberg’s study for the Davos 2008 PE (2008: 16) report shows that, historically, PE has financed 80 percent of buyout deals by number and 92 percent by financial value. EU M&A Activity (Overall and PE-Driven), 2003-2008 Overall EU M&A Europe PE M&A Financial Value Value Year ($mil) Deals ($mil) Deals % of Total 2003 504,009.1 10,076 83,707.9 757 16.61 2004 839,838.2 12,675 149,640.9 1132 17.82 2005 992,496.7 10,715 171,949.5 1206 17.32 2006 1,320,256.7 12,603 280,361.4 1725 21.24 2007 1,592,773.9 14,647 247,004.1 2081 15.51 2008 1,140,204.6 13,541 96,774.9 1551 8.49 Source: Thomson Reuters

According to the statistics of the European Private Equity and Venture Capital Association (EVCA), investments by European PE and venture capital firms amounted to €73.8bn in 2007, and approximately 5,200 European companies received private equity investments. Compared with 2006 European private equity investment grew slightly (reaching €71.2 billion in 2006), but grew much more strongly compared to 2005 (€47.1 billion). Around 75% of the total funds raised were earmarked for buyout investment. The share of venture capital in fundraising was only €17.5 billion, or 15.5% of total funds raised.5 European leveraged buy-outs in 2006 amounted to 160 billion Euros, an increase of 42% on 2005. With the usual leverage ratio of 1:3 or 4, this corresponds to a buy-out capacity of 640 billion Euros in 2006.6 Preliminary data for 2008 from EVCA suggest that investment activity decreased by about 27 % relative to 2007. The US funds are still the major investors in the worldwide PE business. US funds like Texas Pacific Group, Blackstone and KKR, together have a capacity equalling more than 30% of worldwide private equity.7 Thus these funds are important actors in Europe. Although a complete list of the most important funds concerning investment volume or total investment activity with a focus on Europe is not available, some statistics which allow a rather good estimation of the most important funds in Europe. According to the Centre for Man- agement buy-outs research at Nottingham University Business School the table below show the biggest PE-deals in continental Europe and Great Brit- ain in the years 1999 to 2008.

5 Machado, C.D. and Raade, K. (2008): “Recent Developments in the European Private Equity Mar- ket”, in: European Commission: Economic Papers No. 319 (April), p. 3. 6 PSE (2007): p. 14. 7 Ibd. p. 15. Final Data Collection Report as of 24 June 2009 17

Largest PE-Deals by Year in Continental Europa 1999 – 2006

Year Company Name Country Value/€m PE company 1999 Friedrich Grohe Germany 1,372 BC Partners 2000 North Rhine Westphalia Cable Germany 2,966 Callahan Invest Limited Goldman Sachs Group, Providence 2001 Eircom Ireland 4,810 Equity Partners, Towerbrook Capital and Warburg Pincus 2002 Legrand France 5,130 KKR BC Partners, CVC, Permira, Investitori 2003 Seat Pagine Gialle Italy 3,030 Associati 2004 Celanese Germany 3,100 Blackstone Consortium under the leadership of 2005 Wind Telecommunications Italy 12,100 Naguib Sawiris Blackstone, Permira, KKR, Apax, 2006 TDC Denmark 13,000 Providence Source: Centre for Management buy-outs research, Nottingham University Business School.

Largest PE-Deals by Year in Great Britain 1999 - 2007 Year Company Name Value/£m PE company 1999 Avecia 1,400 Cinven 2000 MEPC/Leconport 3,500 Hermes Private Equity 2001 Yell Group 3,100 Apax, Lion Capital 2002 Unique Pub &Voyager Pub 2,000 Terra, Cinven 2003 Spirit Amber 2,500 CVC, Merrill Lynch 2004 The Automobile Associations/AA 1,800 CVC, Permira Bain Capital, Thomas H. Partners, 2005 Warner Chilcott plc 1,600 JP Morgan 2006 United Biscuits 1,600 Blackstone, PAI Partners 2007 Alliance Boots 11,100 KKR Source: Centre for Management buy-outs research, Nottingham University Business School.

In addition to the biggest US players like KKR and Blackstone, most of the European investments are carried out by European PE companies -- in most cases from Great Britain, with the exception of the French PAI Partners. Nev- ertheless companies like Permira, Apax, CVC, Terra and Cinven belong to the 50 biggest PE companies worldwide.8 The following list shows the biggest players in merger & acquisition deals in Europe.9

8 Measured by raised capital between 2002 and 2007 9 PSE (2007): p. 71. Final Data Collection Report as of 24 June 2009 18

Biggest M&A deals in Europe (December 2006)

Number mergers & acqui- Ranking world- Fund Volume in $bn. Origin sitions deals wide (2007)10 Kohlberg Kravis Roberts 27.5 5 US 2 (KKR) 3i 25.9 25 GB 13 AplInvest Partners 20.8 3 NL 38 Apax Partners 19.7 11 GB 7 Goldman Sachs Int. 17.3 3 US 3 Carlyle 14.9 8 US 1 Cinven 12.4 6 GB 11 Hellmann & Friedman 12.2 3 US 16 Contracted Services 11.3 1 ? ? Thomas H. Lee Partners 11.3 1 US 30 Source: Centre for Management buy-outs research, Nottingham University Business School.

The US investment company KKR again is one of the mayor players. The biggest PE firm worldwide (the Carlyle Group) must also be added to a list of the most important PE companies, together with the British 3i. Out of this a list of the eleven most relevant PE actors in Europe results (see table below). Due to missing data concerning the total investment activities and the volume of such transaction in Europe, the following list should be understood as an underestimate of total activity. 11 most relevant PE actors in Europe

Fund Headquarter Foundation Capital Rank PEI 50 CVC Capital Partners London 1981 $36.84 bn11 512 Profile and investment At the moment CVC funds own 52 companies worldwide employing approxi- characteristics mately 447,000 people. CVC investments are concentrated mostly in Western Europe and to a lesser degree in Asia. Only a few investments are undertaken in the US. The most significant investments include Evonik Industries, the Flint Group, the Elster Group (all Germany), Cortefil (Spain), Saga/AA, Formula One (both Great Britain), SEAT Pagina Gialle (Italy) and Kappa Packaging (Netherlands).

BC Partners London 1986 $9.26 billion 33 Profile and investment Since 1986 BC Partners have invested in 68 companies with a total value of $64 characteristics billion. At the moment BCP have investments in 16 companies, mainly in Western Europe. Significant investments are Unitymedia, Brenntag (both Germany), Fit- ness First (Great Britain), SEAT Pagina Gialle (Italy), Picard (France), Amadeus (Spain). Significant exits in the past were Grohe, Techem (both Germany), Gal- bani (Italy), KTM (Austria), Sanitec (Finland) and General Healthcare Group (Great Britain).

10 http://www.peimedia.com/resources/Conference/downloads/PEI50_Brochure_final.pdf. 11 Capital raised over five years from 1 January 2003 to 15 April 2008 12 http://www.peimedia.com/resources/PEI50/PEI-50_executivesummary.pdf. Final Data Collection Report as of 24 June 2009 19

Fund Headquarter Foundation Capital Rank PEI 50 Kohlberg Kravis Ro- New York 1976 $39.67 billion 4 berts (KKR) Profile and investment At the moment KKR have investments in 47 companies worldwide. 15 companies characteristics are based in Europe. Significant investments in Europe are Alliance Boots (Great Britain), Pages Jaunes Group, Legrand Holdings (both France), KION Group, ATU, ProSiebenSat1 Media (all Germany) and TDC (Denmark).

Permira London 1985 $25.43 billion 8 Profile and investment Permira has a strong focus on the European market. Following the 2007 annual characteristics report Permira have investments in 23 companies with a total firm value of €70 billion and approximately 220.000 employees. 20 of these companies are based in Europe with a focus on Great Britain. Significant investments are DinoSol, Cortefiel (both Spain), Saga/AA, Birds Eye Iglo, Gala Coral Group (all Great Brit- ain), Debitel, Cognis, ProSiebenSat1 (all Germany), Valentino Hugo Boss, SEAT Pagina Gialle (both Italy), Maxeda (Netherlands), TDC (Denmark).

Blackstone New York 1985 $23.3 billion 10 Profile and investment At the moment Blackstone have investments in 55 different companies worldwide. characteristics In the beginning Blackstone concentrate their investment activities on the US but meanwhile they also undertake significant investment in Europe. Significant investments in Europe are United Biscuit, Merlin Entertainment, Center Parks (all Great Britain), TDC (Denmark), Deutsche Telekom (Germany), Orangina (French), Nielsen (Netherlands).

Providence Equity Providence 1989 $16.36 billion 16 Partners (Rhode Island) Profile and investment Providence focus on media, entertainment, communication investments. Since characteristics 1989 the firm has invested in more than 100 companies worldwide. Providence is mainly active in the US but also undertake significant investments in Europe. Due to their specification investments of Providence in Europe are limited to companies in the telecommunication and television sector, like Canal Digitaal (Nether- lands), Grupo Corporativo Ono (Spain), Kabel Deutschland (Germany), Volia Cable (Ukraine), TDC (Denmark), MobileServ (Great Britain), Com Hem (Swe- den). Significant exits in the past are ProSiebenSat1 (Germany) or Eircom (Ire- land).

Terra Firma Capital London 1994 $17 billion 14 Partners Profile and investment Since 1994 Terra Firma has invested approximately €11 billion mainly in Europe. characteristics At the moment Terra has investments in eight companies which are all based in Europe, mainly in Great Britain and Germany. Prominent investments are Anning- ton, EMI, Odeon/UCI (all Great Britain), Tank & Rast and Deutsche Annington (both Germany). In the past Terra Firma undertake investments in the British Unique Pub Company and the hotel group Le Meridian.

3i Group London 1984 $17 billion 12 Profile and investment The 3i group arose from a corporation of several British banks with the aim to characteristics undertake larger investments in companies. 1984 the banks sold off their stakes and 3i became a public limited company, which today is listed on the London Stock Exchange. Currently 3i has investments in more than 100 companies globally but with a clear focus on Western Europe, especially Great Britain (45 investments). The second largest target county is Spain (15 investments) followed by Germany (14 investments). In most cases 3i invest in SMEs with a enterprise value up to €1 billion. Their portfolio contains a relatively large number of smaller investments rather than very large companies. Final Data Collection Report as of 24 June 2009 20

Fund Headquarter Foundation Capital Rank PEI 50 Cinven London 1977 $11.93 billion 26 Profile and investment Cinven originally based on three British pension funds which are still important characteristics partners of Cinven. Cinven concentrate on the European private equity market and at the moment are invested in 19 European companies. Prominent investments are Amadeus (Spain), Springer (Germany), Dutch Cable/Ziggo (Nether- lands) and Gala Coral (Great Britain). In the past Cinven undertook major investments in the Dutch Kappa Packaging, Unique Pub Company and Avecia.

Carlyle Group Washington 1987 $52 billion 1 Profile and investment The Carlyle Group holds 30 PE funds which invest globally in companies with characteristics generate $109 billion in revenue and employed more than 350.000 people. In the buyout sector Carlyle has three special funds with a volume of $8.2 billion which invest in Europe. Famous investments are the British Hertz Corporation or the German Storck GmbH. Carlyle also has a huge real estate section which also invests in Europe. In comparison to European PE companies the investment activity in Europe is relatively small; their main focus still lays on the US. Due to their huge absolute investment volume and their diversified investment portfolio the group nevertheless is an important player in the European PE business.

Apax Partners London 1969 $25.23 billion 9 Profile and investment Apax Partners as it exist today is a merger of the 1969 founded company Patricof characteristics & Co. and the 1972 founded Venture Capital firm MMG. Apax Partners invest in five business sectors; Tech & Telecom, Retail & Consumer, Media, Healthcare, Financial & Business Services. Famous investments in the past were Versatel, Sulo, Kabel Deutschland (Germany), Yell Group, New Look, Inmarsat, Somerfield (UK), TDC (Denmark), NXP/Semiconductor Division of Philips Electronics (Neth- erlands). Source: Wilke, Maack and Partner based on information of the companies websites.

2.3.3 Hedge Funds The OECD estimated the degree of leverage used by hedge funds in 2006 to be over 3, implying the use of loans of ca. USD 5.5 trillion, or a total investment capacity of ca. USD 7 trillion.13 The nature of HF activity also leads to this type of investor accounting for a very high market share in certain types of trading activities. Although similar figures are not available for Europe, HF share of trading activity in equity and other markets is likely to be similarly high here.

Assets under management (AUM) by HF grew rapidly until mid-2008. It is estimated that hedge funds in 2006 managed some $ 1.3 trillion with around 6,400 single hedge funds worldwide.14 According to estimates in 2007 hedge funds managed some $ 1.7 trillion with around 6,900 single funds worldwide.15 A more recent estimate suggests that HF AUM grew to a peak of about $2.7 trillion in the middle of 2008, before declining sharply to $1.8 trillion due to declines in asset values and redemptions.16 Similar to PE the US is still the dominant region for HF activities. HF based in the US counting for more than 68% of the total capital under management. Nevertheless HF ac-

13 Blundell-Wignall, Adrian (2007): „An Overview of Hedge Funds and Structured Products: Issues in Leverage and Risk“, OECD. 14 Figures are based on the HF database, managed by HF Research INC. 15 PSE (2007): p. 14. 16 Hedge Fund Intelligence press release, 5 March 2009, "Global Hedge Fund Assets Drop More than 30% in 2008 to $1.8 trillion." Final Data Collection Report as of 24 June 2009 21 tivities in Europe are becoming more important and accounted for 25% of the global HF industry in 2007.17 Following the “Hedge Fund Asset Flow & Trends Report 2006 – 2007”, “Europe continued to be the fastest growing major investment region for most hedge funds. Total assets in funds which invest primarily in European markets increased at a rate of 46% in 2006 to $276.5 billion - 64% of the $87 billion increase was from new allocations”. The following table on the geographical distributions of HF shows that approximately one third of HF assets are accounted for by HF based in Europe (total of UK, EU and Switzerland, from above table, of ca. USD 480 billion). Geographical Distribution of HF, by Assets Under Management (mid-2006) Country Mid 2006 Estimates, $bn USA 870 UK 320 EU 118 Australia 47 Non-Japan Asia 34 Switzerland 23 Cana 11 Japan 7 Total 1,430.55 Source: IOSCO, and OECD questionnaire on Hedge Funds, taken from Blundell-Wignall 2007: 42. Nevertheless concrete statements about investments in Europe are difficult because there is no unified and comprehensive database about such actions. However the US requires investors which exceed a certain threshold to make this information publicity available through filing a form with the US security exchange regulator (SEC). When a person or group of persons acquires beneficial ownership of more than 5% of a class of a company's equity security registered under Section 12 of the Securities Exchange Act, they must file a Schedule 13D with the SEC. In Europe, EU member states have a minimum disclosure requirement (as required by EU directive) – however, every member state has its own regulation and share register, and 23 different languages make an analysis more difficult. Due to this it is not surprising that most studies dealing with the influence of HF on industrial change have focused on the US, based on information that is publicly available and in a common language.

17 Ibd. Final Data Collection Report as of 24 June 2009 22

Shares of Hedge Fund Trading in US Markets % Cash equities 30 Credit Derivatives (plain vanilla) 60 Credit Derivatives (structured) 33 Emerging Market Bonds 45 Distressed debt 47 Leveraged loan trading 33 High Yield bond trading 25 Source: Greenwich Associates, cited in Blundell-Wignall (2007: 42).

The following table identifies the largest 10 HF by size (assets under management, or AUM). One interesting observation is that, in some cases, the identifiable equity holdings are only a small fraction of the total AUM. This can be attributed to a number of factors, such as concentration on other markets (bonds, derivatives, etc.), concentration on very small shareholdings in countries where the disclosure requirements are not very strong, and concentration on short-term strategies including day trading and the exploitation of very short term pricing anomalies. A second interesting observation is the massive reduction in identifiable equity holdings by some HF, in a couple of cases reaching almost 75 percent of the portfolio value. This decrease in value is in all likelihood attributable partly to the de-levering phenomenon (i.e. forced liquidation of assets due to reduction in bank credit availability) but also partly due to the shift from long to short equity positions (the latter of which is undisclosed except under very limited circumstances, e.g. new disclosure rules in the UK). Top 10 HF by Assets under Management and their equity holdings Assets Identifiable Equity Fund Name June 2008 Holdings (billion USD) Change from Current 2nd Half 2008 Highbridge / JP Morgan Asset Management 18 48.1* / 5.7** 4.0 -4.2 Bridgewater Associates 43.5 1.3 -1.9 D.E. Shaw Group 37.1 18.0 -7.8 Paulson & Co 34.9 6.5 -0.6 Och-Ziff Capital Management 33.3 2.5 -6.5 Farallon Capital Management 33.0 1.9 -6.2 Renaissance Technologies 29.0 27.6 -8.4 Goldman Sachs Management 26.9 NI NI Harbinger 24.0 2.3 -7.1 Barclays Global Investors 19.0 NI NI

The next table shows the top 10 HF with headquarters in Europe (in fact all ten are located in London). Unless otherwise noted, figures for 2009 refer to 1 Janu- ary 2009.

18 Highbridge was purchased by J.P. Morgan Asset Management in 2005. Final Data Collection Report as of 24 June 2009 23

Top 10 HF by Firm Capital with HQ in Europe, 2008

Source: Institutional Investor (www.iimagazine.com)

2.3.4 Sovereign Wealth Funds The distinguishing feature of SWFs from other investment funds is that they are state-funded. While some are more than fifty years old, over the past decade they have rapidly grown in importance to become an important source of investment and market liquidity at a time of difficult access to capital. Today, more than thirty countries have SWFs, with twenty new SWFs created since 2000. Typically, SWFs portfolios include a wide range of financial assets, including fixed-income securities but also equities, real estate and alternative investments. The assets managed by SWFs today are estimated at $ 2 – 3 trillion, equivalent to about half of global official reserves, or the combined capital of all hedge funds and private equity firms. Accord- ing to the IMF assets managed by SWF could reach $ 6 – 10 trillion by 2013. Other commentators also project rapid growth over the next five to ten years. For example, Morgan Stanley projects that SWFs’ assets could exceed official reserves by 2011, and Standard Chartered projects SWFs’ assets to reach US$13.4 trillion over the next decade.19 In the past few years more and more SWFs act as global equity investors. Most of these investors were established in countries that are rich in natural resources like oil, for example countries from the Arab Gulf region, Ex-Soviet Union countries or Norway. A second category of SWF relates to the accumu-

19 Morgan Stanley (2007): “How Big Could Sovereign Wealth Funds be by 2015” and Gerard, Lyon (2007): “State Capitalism: The Rise of Sovereign Wealth Funds”, in: Journal of Management Re- search Vol. 7 (3). Final Data Collection Report as of 24 June 2009 24 lation of foreign currency as a result of substantial net exports, especially in the cases of China, Singapore and other East Asian exporters. Prominent examples of SWF investments are the acquisition of the British P&O by the Saudi-Arabian Dubai Ports or the recent investment of the Dubai Ipic Fund in the German enterprise Daimler Benz. Despite frequently voiced concerns that sovereign wealth fund investments serve political objectives and conflict with national interests, little is known about the investment allocation of sovereign wealth funds. This is because most SWFs do not disclose details about their investments. This lack of transparency is one reason that SWFs have generated such controversy in recent years regarding their operations and investments. Few SWFs outside the industrialized democracies provide lists of their portfolio companies to the public. One commonly-used instrument for rating the disclosure policies of SWFs is the Linaburg-Maduell Transparency Index. Accord- ing to this index SWFs can receive scores of between 0 and 10 (lowest to highest disclosure practices). Low scores can be received through the fulfil- ment of relatively simple criteria, such as management of own web site or provision of basic contact information. Scoring Criteria for the LM Transparency Index Point Principles of the Linaburg-Maduell Transparency Index +1 Fund provides history including reason for creation, origins of wealth, and government ownership structure +1 Fund provides up-to-date independently audited annual reports +1 Fund provides ownership percentage of company holdings, and geographic locations of holdings +1 Fund provides total portfolio market value, returns, and management compensation +1 Fund provides guidelines in reference to ethical standards, investment policies, and enforcer of guidelines +1 Fund provides clear strategies and objectives +1 If applicable, the fund clearly identifies subsidiaries and contact information +1 If applicable, the fund identifies external managers +1 Fund manages its own web site +1 Fund provides main office location address and contact information such as telephone and fax Source: SWF Institute, www.swfinstitute.org.

The largest three SWFs currently have scores of only between two and three on the LM Transparency Index. Most SWF equity investments can therefore be identified mainly only by triggering of minimum disclosure limits for ownership of listed companies (between 3-5 percent of shares in many industrialized democracies), through acquisition of major stakes in private companies, or through press reports. Furthermore, SWFs are increasing much of their exposure to European equities indirectly, through investments in HF and PE. Ernst & Young estimate that SWFs account for 10% of all PE investment in recent years, and that this share is expected to grow (Ernst & Young: InterChange Vol. 23, March 2009, p. 11). Prequin reports that the average current SWF allocation to HF is 7 percent, and that the average target allocation is 9% (Prequin 2009, p.3). Final Data Collection Report as of 24 June 2009 25

SWF impact on industrial change in Europe is thus increasingly being indirectly channeled through these other paths. Comparable to PE and HF a list of the most relevant SWF actors and their investment activities in Europe is not available. Nevertheless some data is accessible which allow an approximation. Trueman provide a list of the finan- cially strongest SWF worldwide.20 Leading funds are managed by UAE, Nor- way, Singapore and Kuwait. Fotak et al use a combination of the Zephyr and SDC database to identify the target countries of these SWF investments. The “Zephyr Sample” is drawn from the Zephyr Mergers and Acquisitions database, provided by Burea van Dijk Electronic Publishing, and covers global mergers and acquisitions (including acquisitions of minority equity stakes) from 1997 through July 18, 2008. The “SDC Sample” is drawn from the Se- curities Data Corporation Global New Issues database, covering the period 1970 through June 15, 2008, and Fortak et al sample principally involves share offerings by target firms directly to funds. Following Fortak et al the most active SWFs in direct equity investments are funds from the UAE (43 investments in Europe), Singapore (22 investments), Kuwait (15 investments), Libya (13 investments), Canada (8 investments) and Qatar (5 investments). A breakdown of total investment activity in Europe is not covered. Nevertheless this overview gives an estimation of the most relevant SWF direct investors in equity worldwide (thus narrowing down the list of candidates for Europe). Due to the fact that some countries manage multiple SWFs and Fotak et al only list the managing countries but not the single funds, a concrete identifi- cation of the investing fund is difficult. For example the Singapore and the VAE manage two respectively three different funds.21 Which of these funds finally undertake the investment can not be said with absolute certainty. More simple is the situation in the case of countries which only manage one SWF. Additionally we add the second largest SWF worldwide and only Euro- pean SWF, the Norwegian Government Pension Fund-Global. Taking these considerations into account we identify the following ten SWFs as most relevant for investment in Europe. The 10 most relevant SWF investors in Europe

Fund Origin Foundation Capital Abu Dhabi Investment Abu Dhabi/United 1976 $627bn Authority Arab Emirates Profile and investment According to estimates the ADIA is the largest SWF worldwide. The main fund- characteristics ing source is surpluses out of the oil production of the Abu Dhabi National Oil Company. Its PE activities are mainly carried out by the Abu Dhabi Investment Company.

20 Trueman, Edwin (2007): “A scoreboard for Sovereign Wealth Funds”, Peterson Institute Washing- ton, p. 10. 21 Ibd. Final Data Collection Report as of 24 June 2009 26

Fund Origin Foundation Capital Mubadala Develop- Abu Dhabi/United 2002 $10bn ment Company Arab Emirates Profile and investment The Mubadala Investment Company is totally owned by the Abu Dhabi Emirate. characteristics As is the case for other SWFs based in the gulf region, the main funding source of Mubadala is oil. According to the SWF-Institute Mubadala has a tendency to invest in high technology and aerospace firms. Additionally the firm has invested in oil fields, real estate and hospitals. Prominent European investments are Fer- rari and Piaggio Aero Industries (both Italy).

Istithmar World Dubai/United Arab 2003 $4bn Emirates Profile and investment Istithmar World is the investment arm of the government owned Dubai World. characteristics According to Dubai World the equity portfolio of Istithmar (Istithmar World Capi- tal) has invested in 35 companies with total capital deployed in excess of $3.5 billion worldwide. European investments mentioned include the Pension Insur- ance Corporation Holdings and the Spa company ESPA .

Kuwait Investment Kuweit 1953 $202.8bn Authority Profile and investment Based on oil revenues the KIA invests in local, Arab and international markets. characteristics Prominent investments in Europe are minority stakes in the German Daimler AG, the GEA Group (also Germany) and British Pertroleum (BP).

Qatar Investment Qatar 2003 $62bn Authority Profile and investment In order to be less reliant from their oil and gas revenues in the future the QIA characteristics have several investment vehicles which are active globally. Beside equity investments QIA also carry out real estate investments via their investment company Qatari Dia. Significant European investments are the equity stakes in the London Stock Exchange, Barclays and the supermarket group Sainsburys (all in Great Britain). Alberta Heritage Canada 1976 $14.9bn Savings Trust Fund Profile and investment The fund was created with several goals in mind. It should be an investment for characteristics future generations, should strengthen and diversify the Canadian economy, im- prove quality of life and, finally, the fund should provide insurance for rainy days. According to the SWF Institute the fund was originally designed for economic development, but now primarily it is a long-term savings and investment fund. The Trust Fund invests worldwide through their investment vehicle the Alberta Investment Management Corporation. In addition to direct equity investments with a focus on the Canada and the US, the investment fund also use PE companies as partners. Through companies like Cinven, CVC or Apax the Alberta Heritage Fund is also active in Europe.

Libyan Investment Libyia 2006 $65bn Authority Profile and investment The main investment vehicle is the Libyan Arab Foreign Investment Company, characteristics which was founded in 1981. The firm focuses on industrial, commerce, agriculture, tourism, and real state sectors and invests globally. In Europe the company has a clear focus on Italy. Significant investments are the football club Juventus Turin, UniCredit and Telecom Italy (all Italy). Outside of Italy the fund was active in a buyout of the Luxemburg subsidiary of the Kaupthing Bank and investing in the Belgian-Netherlands bank Fortis. Final Data Collection Report as of 24 June 2009 27

Fund Origin Foundation Capital Government of Sin- Singapore 1981 $247.5bn gapore Inv. Corpora- tion Profile and investment The main funding source of the Government of Singapore Investment Corpora- characteristics tion (GIC) is the large currency reserves which Singapore saved during the 1970s. As other SWFs the GIC has a diversified investment portfolio including private equity as well as real estate activities. GIC has a strong focus on the Asian and US market but also has some significant investments in Europe. One significant investment was the infusion of capital in the Swiss bank UBS during the subprime crisis. The first annual report of GIC (published in 2008) mentioned 35 investments in Europe, however it did not provide a list of the target companies. Furthermore GIC didn’t distinguish between PE and real estate. According to GIC it has stakes in the British Airports Authority as well as the Associated British Ports Holdings.

Temasek Holdings Singapore 1974 $85bn Profile and investment The second SWF of Singapore also is also funded by huge currency reserves but characteristics traditionally focused on local Singapore business, with a recent diversification of holdings to surrounding Asian countries. To a lesser degree they have investments in the US, Australia and Europe. Temasek mainly invests in financial services, telecommunications and in the transport and logistic branch. In Europe investments in the British banks Barclay and Standard Chartered are public.

Government Pension Norway 1990 $326bn Fund-Global Profile and investment The Government Pension Fund Global invests the profits from Norwegian petro- characteristics leum income. The fund is the largest SWF in Europe and the second largest SWF in the world. Of note is that the Norwegian fund is the most transparent SWF concerning their investments and holdings. Furthermore, potential target companies must fulfil ethical guidelines concerning business behaviour. To monitor the invested companies the fund has a special council to check compliance with these guidelines. In the past several prominent European companies were removed from the investment portfolio due to noncompliance, e.g. the French-German EADS, the Italian Finmeccanica, the French Thales SA (all because of producing controversial military components) or the British companies Rio Tinto and Ve- danta Resources (because of environmental damage). Most of the excluded companies are based in the US. According to the annual report 2008 the fund is shareholder in almost 7900 companies around the world. The largest European holdings in 2008 include Royal Dutch Shell, BP, HSBC Holdings, Vodafone Group (UK), Nestle, Novartis, Roche (Switzerland), E.ON AG (Germany) and Total (France).

Final Data Collection Report as of 24 June 2009 28

3 Functioning and Business Models of Private Equity, Hedge Funds and Sovereign Wealth Funds

3.1 Introduction and overview After having presented basic data on the relative role of the three types of capital funds in Europe today, the basic aim of this chapter is to present information and available data on the functioning of the three types in more detail before concentrating the analyses on the issue of the impacts on industrial change in the following chapter of this report. Before describing major aspects with regard to the functioning of the three types of investments funds it is important to summarize certain characteristics and differences in the respective business models: Here, it is important to stress that Private Equity, Hedge Funds and Sover- eign Wealth Funds in general are following different business models which also influence their behavior and specific expectations as investors and/or owners. As the following overview illustrates, there are important differences with regard to the aspects such as main investment focus and the investment horizon/duration. While for example Hedge Funds are similar to Private Equity Funds in the way they obtain finance and using the leverage instrument, both types of funds differ significantly in the type of investment made and in the investment time horizon. In the case of Hedge Funds the time horizon tends to be much shorter-term and focused to a greater extent on liquid financial assets. In contrast to both these types of funds Sovereign Wealth Funds generally follow a long-term agenda which pursues not only financial but also national economic policy goals. With regard to Sovereign Wealth Funds it is also important to note that these institutions not only invest in company stakes but also invest money in other funds, including Pri- vate Equity and Hedge Funds. Beside these general differences between the funds it is also important to stress differences within certain types of funds and differences with regard to the role of these funds in different stages and situations of business development, e.g. a start-up situation, growth phases, merger and acquisitions, turnaround and crisis situations. Since these forms of business development all either follow or result in industrial change at the enterprise level it is important to assess the role of the three types of funds also with regard to these different stages/situations of company development. Finally, it is important to differentiate between two different styles of investment behavior – passive and activist – which also is not necessarily connected to the different types of funds. Though most Sovereign Wealth Funds are regarded as rather “passive” investors with little direct involvement in management decisions, while Private Equity and Hedge Funds are much more activist investment styles, there are significant varieties within as well as between both types of funds in reality. Final Data Collection Report as of 24 June 2009 29

The following table summarizes major basic aspects of the different business models of the three types of funds. Basic characteristics of PE, HF and SWF business models Aspect Private Equity Hedge Funds Sovereign Wealth Funds Investment focus Primarily private and Broad variety of asset Broad variety of asset public equity classes, like options, classes, including in- futures, commodities, vestments in private and currencies, and also public companies investment in private equity Ownership orientation In most cases majority In most cases minority Both majority and minor- shareholder orientation shareholder orientation ity shareholder orientations Investment horizon Investment periods of 5 Average initial lock up Long term investment years and more (though period of 10 months or exit may sometimes be less sooner) Selection strategies Undervalued companies Undervalued companies Large variety – in con- for investments with inefficient manage- with a story of take-over trast to PE and HF not ment; possibility to pur- targets and the potential only financial strategies chase stakes from large for profits through break- but also national (eco- share holders (families, ing up the company and nomic) policy orientations state); free cash flow; disposing assets are important in this con- break up and sell possi- text bilities Different stages of Early, medium as well as Large variety – HF are Focus on medium stage company develop- late stage investments also the largest buyers of investments ment distressed securities Exit strategies Important and part of the Possibility of short term Not defined investment strategy exit important/ dominant Reward system for High performance based High performance based Not known fund manager compensation compensation Determination of per- Final valuation at exit, Periodically, based on Periodically and long formance based on the final cash the net asset value of the term, based on dividend flow from the investment investment via marking payment and long term portfolio to market and on divi- market value dend paid Investment behaviour Activist investor in most Generally rather indirect “Patient” capital – in / influence on man- cases influence but also cases general passive type of agement decisions of activist investors investor Strategies for the In most cases clear Clear strategic orienta- Strong interest in long company invested strategy, e.g. growth, tion only in cases of ac- term competitive and turn-around, restructuring tivist investors financial base of the company Using of leverage Yes, often used Yes, possible Less important instruments Return objectives Strong Strong Only weak Source: own, based on Achleitner, Betzer, Gider, Investment rationales of Hedge Funds and Private Equity Funds in the German Stock Market, December 2008, p.33.

Due to the fact that the different business models of the funds and the different investment styles also will determine and influence the behaviour of the funds as investors and owners it is very difficult to draw “simple” general Final Data Collection Report as of 24 June 2009 30 conclusions with regard to the impact of the three types of funds on industrial change and restructuring.

3.2 Private Equity

3.2.1 Evolution of transaction volumes The most comprehensive overview of PE activity in Europe is provided by the European Private Equity and Venture Capital Association (EVCA) – although this database also has its limitations. The data has been gathered primarily through the national affiliates of EVCA, which in turn relies on voluntary disclosure from member PE firms. Due to the increasing public controversy surrounding the operation and impact of PE, EVCA has set up an institute (PEREP_Anlaytics) with an academic advisory board in order to compile and analyze the data. EVCA estimates that about 60 percent of PE funds in Europe provide them with data, but since larger funds are more likely to re- spond, one can assume that the percentage of deals covered is much larger. A second point to note is that, up until 2007, the data covered investments by PE firms based in Europe. Since there is some activity by non-European PE funds investing in Europe, and some investing activity by European PE funds outside of Europe, these figures do not exactly add up to PE investment in companies based in Europe. The following table illustrates the rapid growth of investments by PE in Europe until 2007 and recently in 2008 a sharp decline in the volumes invested and the number of investments. PE Investment Activity Overview, 2003-2008 Investment Activity No. of No of Volume (EUR bill) Companies investments 2003 29.1 7,446 10,375 2004 36.9 6,985 10,236 2005 47.0 7,207 10,915 2006 71.2 7,536 10,760 2007 73.8 5,684 8,411 2008 52.4 4,593 n/a Source: EVCA. Note: 2008 data is preliminary. Number of investments is greater than number of companies, since some companies have multiple rounds (and also may have multiple investors).

3.2.2 Main industry sectors of activity The following tables provide some data on the distribution of PE investment activity, by sector. Detailed data for 2008 was not yet available as of this date. Due to a change in sectoral classification systems, the data for 2003-5 and 2006-7 are presented in different formats. The data show that PE activity is spread over a wide range of sectors. It is interesting that the greatest investments are not in a single industry branch but in communications and in consumer related business like retail. Addi- tional computer related industry and medical/health related companies at- tracted a large amount of investments. Companies in high tech sectors like Final Data Collection Report as of 24 June 2009 31 life sciences, communications and computers received at least EUR 1 billion in each of the years between 2003-2007. However, less R&D-intensive sectors such as business service-oriented sectors such as retail and business services also received substantial investment, particularly in the latter years. Distribution of PE Investment Activity, 2003-2005 2003 2004 2005 Amount Amount Amount # compa- (mill # compa- mill # compa- Sector (mill EUR) nies EUR) nies EUR) nies Communications 4924.4 1192 4924.4 806 7247.1 718 Computer Related 1732.6 1323 2350.6 1273 2438.5 1252 Other Electronics Related 553 318 457.5 322 620.1 339 Biotechnology 681.6 740 686.6 507 868.3 620 Medical/Health Related 1755.1 675 2801.2 749 3498.2 767 Energy 351.2 90 677.8 109 961.5 166 Consumer Related 5649.3 736 8546.6 801 12951 924 Industrial Products and Services 1989.6 503 1949.7 486 4163.9 543 Chemicals and Materials 663.1 227 1003.5 209 911.7 185 Industrial Automation 474.4 128 219.4 128 1171.6 93 Other Manufacturing 2238.9 364 2623.9 347 2885.5 285 Transportation 1550.3 123 892.9 113 1012.7 120 Financial Services 683.5 178 1524.1 140 1620 123 Other Services 2845.9 471 5070.7 456 2563.4 472 Agriculture 56.2 38 140.4 35 161 53 Construction 982.4 162 816.9 199 1446.2 161 Other 1964.7 573 2233.6 309 2479.8 386 Total investment 29095.9 7446 36919.8 6985 47000.4 7207 Source: EVCA.

Distribution of PE Investment Activity, 2006-2007

2006 2007 Amount (mill # compa- Amount (mill # compa- Sector EUR) nies EUR) nies Agriculture 78.5 63 448 37 Chemicals & Materials 2055.7 171 2706.7 127 Life sciences 7638.5 1368 7403.1 971 Computer & consumer electronics 6297 1624 3792.3 959 Communications 9848.8 634 9007.1 585 Consumer goods & retail 10958.6 790 9485 445 Consumer services, other 8432 361 Business & industrial products 11494.2 1119 10298.4 662 Business & industrial services 10920.3 664 8382.7 447 Transportation 2047.6 117 3432.4 116 Construction 1554.3 183 2527.1 97 Energy & equipment 1655.6 199 3350.6 281 Financial services 2376.7 206 3511.4 129 Real estate 125.4 11 Unknown 4238.6 398 884.4 456 Total investment 71164.5 7536 73787.6 5684 Source: EVCA.

3.2.3 Duration of involvement Due to the length of many PE investments, the task of calculating the average duration of involvement of a PE fund in a target firm is more complex. One of the studies included in the first set of working papers for the Davos Final Data Collection Report as of 24 June 2009 32

Globalization of Alternative Investments project22 attempted to calculate the holding period for individual LBO transactions going back to 1970. One com- plicating factor is that only a relatively small proportion of investments in our target time period (2003-2008) have actually been exited. Another is that some investments that have been failures are still being held on the books even there is no chance to exit them (“living deads”). This study calculates a number of measures to attempt to capture the duration of involvement – in addition to mean and median time to exit (among investments that are actually exited), the proportion of investments that are actually exited within specific time lengths after the initial investment are also calculated. This study calculates a median duration of investment of approximately 50 months for investments that were made in the 1990s and subsequently exited (one can presume that almost all LBOs that were initiated in the 1990s and not yet exited are probably failures). For LBO investments undertaken between 1995-2002, approximately 40 percent were exited within 60 months of the initial investment. As of late 2007, the author of the study claims that the experience with LBOs initiated between 2003-2007 (i.e. within our time frame of interest) has not been out of line with these historical precedents. These findings are in line with the general business model of PE investors, which is to start a restructuring process in the company they bought with the aim of improving profitability. By improving profitability a higher price can be achieved when the company is sold again.

3.2.4 Financial instruments to complete the transactions When examining the financing structure of PE investments, it is important to distinguish between buyout and VC. Due to the riskiness of investment in start-up companies, VC investments (particularly seed and early stage) are generally 100 percent equity financed. (In some countries this finance may have been supplemented by state programs that either provided supplemen- tal loans or loan guarantees, particularly during the technology bubble phase). Later stage investments, which are considered somewhat less risky, may have some private debt financing which is not guaranteed by the state. So-called mezzanine financing is a form of financing which has a mixture of characteristics of equity and debt – on the one hand interest payments (or payments in kind, PIK) according to a contractual schedule are expected, on the other hand some kind of participation in the potential increase in value in the equity of the target firm (e.g. warrants) is frequently included. The higher risk of investing in these firms is compensated for through interest rates considerably higher than the market rate and/or the equity participation mechanisms. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. Since mezzanine financing is usually provided to the borrower very quickly with little due dili- gence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.

22 Stroemberg, Per (2007): “The New Demography of Private Equity”, Swedish Institute for Financial Research.

Final Data Collection Report as of 24 June 2009 33

LBOs are typically financed through a combination of direct equity investment by the PE fund (either alone or together with a small number of other PE funds) and debt finance (direct loans, syndicated loans, or securitized finance) provided by external investors (banks, hedge funds, pension funds, etc.). Management may or may not take an equity stake in the company. The use of debt finance in LBOs has been a subject of major controversy, and there are a number of studies on financing structure as well as summary statistics available from commercial data providers such as Standard and Poors’ LCD. Over the period of examination for this study (2003-2008) the average equity contribution has been roughly one third of the deal financing, with the proportion of equity financing (and especially the non-PE equity contribution) decreasing up until the beginning of the financial crisis. In 2008, the increasing risk aversion of financial investors led to a substantial increase in the equity contribution as illustrated in the following figure. Average equity contribution to LBOs

Note: Includes only transactions for which Sources/Uses were made available. Equity includes shareholder loans, common equity and preferred stock down streamed to the operating company as common equity as well as vendor note proceeds. Source: Own, based on Standard & Poors: Europe Senior LBO, 4Q8.

A second concern regarding the financing of LBO deals has been the increasing purchase prices paid for the target firms, meaning that a greater proportion of earnings are committed to interest payments. Over the period we are examining the purchase price has increased from a multiple relative to earnings (EBITDA) of less than 7 to almost 10 (see figure). Final Data Collection Report as of 24 June 2009 34

Average LBO Purchase Price as Multiple of Pro Forma Trailing EBITDA

A large portion of the debt financing was provided through high yield bonds (particularly for the larger deals) as well as syndicated loans (for the mid- size deals). With the start of the financial crisis, the perceived risk of this debt financing has greatly increased, and the market value of this credit has plunged (see figure). Mark to Market Pricing of Leveraged Loans

Source: LSTA (Loan Syndication and Trading Association) Source: Standard & Poors. Final Data Collection Report as of 24 June 2009 35

Typical for a PE investment is the usage of a leverage instrument (credit fa- cility) by the PE investor or fund in financing the deal. Once the deal is closed the PE investor will start a whole series of financial operations in the target company to get as soon as possible parts of the invested money back. Such instruments are the transfer of the loans and credits used for buying to the target company. Or operations which free money at the target company. Of- ten used instruments are selling less profitable parts of the target company or sale and lease back of buildings and long term investment goods.

3.2.5 Ways of terminating transactions EVCA publishes annual summary data on PE exits by year (both volume of sales and number of companies exited), broken down by method of exit. As of the writing of this draft data for 2008 was not yet available. The table shows that the volume of exit activity increased rapidly after 2003, but peaked in 2006 and had already dropped by about EUR 6 billion in 2007. Every mode of exit except write-offs increased in volume between 2003 and 2006. In 2007 the drop in divestment activity was particularly strong in the categories of public offerings, sales to financial institutions and sales to management (buy-backs). Divestment through sales to another PE house continued to increase strongly and divestment by trade sales increased slightly between 2006 and 2007 (see table). PE Divestments in Europe, 2003-2007

2003 2004 2005 2006 2007

Volume # of Volume # of Volume # of Volume # of Volume # of cos cos cos cos cos Divestment by 2,762 650 4,627 686 6,721 901 7,518 809 7,620 699 Trade Sale Divestment by 1,600 281 2,305 338 2,650 490 5,348 439 2,586 239 Public Offering Divestment by 756 37 1,368 59 1,331 184 2,978 108 1,117 82 Floatation (IPO) Sale of Quoted 8447 244 937.1 279 1,319 306 2,3716 331 1,469 157 Equity Divestment by 1,58 774 1,901 703 1,406 628 1,256 494 500 229 Write-Off Repayment of 2,150 1112 4,166 935 6,962 954 5,655 787 4,322 717 Preference Shares/Loans Sale to Another 2,740 144 2,555 223 5,474 298 5,495 336 8,217 302 Private Equity House Sale to Financial 819 94 577 82 1,207 92 1,784 153 901 93 Institution Sale to Manage- 742 420 942 707 1,589 647 2,025 857 939 240 ment (Buy-back) Divestment by 1,163 696 2,478 528 3,787 837 4,026 573 1,975 416 Other Means Total Divestment 13,554 4,019 19,550 4195 29,796 4824 33,107 4448 27,059 2726 Source: EVCA Yearbooks. Final Data Collection Report as of 24 June 2009 36

3.3 Hedge Funds

3.3.1 Evolution of transaction volumes Due to the lack of transparency of HF activities in Europe it is only possible to get a very limited overview of HF activity. The major source of information on equity holdings is the requirement to disclose major shareholdings to national authorities, which by EU regulation is a minimum of 5 percent of shares. Some countries have gone beyond this and have a minimum threshold of 3 percent. In addition to these there are some further sources of information which allow us to supplement the large shareholdings to some extent (e.g. some HF have more disclosure of positions, and some companies, particularly listed Nordic companies, list less significant shareholdings on their websites). The main data source we are using here is the equity ownership module included in Thomson Banker One (provided by Thomson Reuters), which attempts to gather as much information on ownership as possible on listed companies. In many cases (particularly large companies with dispersed ownership), Banker One is only able to identify 25-30% of shareholders. This database includes reports on ownership data for listed European companies on a quarterly basis, including name and type of investor, name and main sector of the target company, number and value of shareholdings, and changes in shareholdings. The information included here starts with a report from 2Q 2007, which includes changes from 1Q 2007 (but appears to be not quite complete for 1Q 2007, since Thomson Reuters only recently began historical data through this product). This data shows a maximum figure of HF investments of just short of USD 7 billion (end of 3Q 2007), which is certainly only a fraction of the total long equity holdings by HF in listed European companies (see Exhibit 3). The number of positions (investments by individual HF in individual listed companies) varies between roughly 1400 and 2800. Summary Analysis of Hedge Fund Ownership Data Value Shares held Shares exchanged HF Positions ($mill) (million) (in mill) Net Net Turnover Time Period Begin Q End Q End Q Begin Q End Q sales purchases rate 1 Q - 2 Q 2007 1394 1944 6,793.4 384.3 414.6 134.4 446.6 33.6% 2 Q - 3Q 2007 1472 2046 6,897.6 414.6 712.1 145.3 442.8 25.8% 3 Q - 4 Q 2007 2277 2270 6,606.0 695.0 643.9 335.7 284.6 42.5% 4 Q 07 - 1 Q 08 2343 2280 6,729.1 708.6 636.2 357.8 285.5 42.5% 1 Q - 2Q 2008 2703 2239 6,227.9 696.9 632.1 333.4 268.7 40.4% 2 Q - 3Q 2008 2784 2186 6,019.3 888.9 865.5 359.0 346.9 39.5% 3 Q - 4Q 2008 2789 2065 5,431.1 741.9 631.4 384.1 273.6 39.8% Source: Own analysis from Thomson Banker One Ownership Data.

Here we see relatively stable volumes in 2007 and 2008 until the last quartil of 2008. Obviously the financial crisis changed the market opportunities for hedge fund investment. Because we know that many hedge funds are rather opportunistic in their investment style in PE (a kind of hit and run policy without long term investments) this finding is not surprising. Final Data Collection Report as of 24 June 2009 37

3.3.2 Main industry sectors of activity Although Thomson ONE reports only a fraction of HF equity holdings in Europe, it does provide a detailed breakdown of the primary sector of the target company. Assuming that the investment activity captured here is representative of the sectoral activity of HF overall, we can see that activity is concentrated in the financial services area, followed by technology/telco and energy companies (see table). Compared with the PE investments the great influence of investment in banks is obvious. HF Equity Investment Breakdown by Sector - Dec 2008

Number of Total Value of Number of Total Value of Micro Industry HF Invest- Investments Micro Industry HF Invest- Investments ments ($mill.) ments ($mill.) Aerospace/Defense 9 7.72 Investment Management 22 58.57 Agricultural Products 12 15.87 Investment Trust 2 .32 Leisure Time (Prod- Airlines 8 13.3 12 24.96 ucts/Services) Auto Parts & Equipment 9 11.29 Lodging-Hotels 10 6.75 Automobiles 44 94.88 Machinery 75 109.48 Manufacturing (Diversi- Banks (Major Regional) 115 628.04 21 40.04 fied) Manufacturing (Special- Banks (Money Center) 42 106.33 50 140.37 ized) Banks (Regional) 13 43.69 Metal Fabricators 2 6.04 Beverages (Alcoholic) 16 164.97 Metals Mining (other) 19 71.01 Beverages (Non- Miscellaneous Transpor- 4 10.92 3 2.61 Alcoholic) tation Biotechnology 18 29.14 Multi-Industry 35 55.65 Broadcasting 19 48.57 Mutual Funds 63 149.16 (TV,Radio,Cable) Natural Gas-Distr-Pipe Building Materials 34 58.38 7 13.28 Line Cellular/Wireless Tele- 29 121.59 Non-Metals Mining 4 3.77 comms Oil & Gas (Domestic Chemicals 66 88.03 6 8.37 Integrated) Communications Equip- Oil & Gas (Exploration & 45 101.05 28 122.38 ment Production) Oil & Gas (International Computer Hardware 2 10.15 60 240.29 Integrated) Oil & Gas (Refining & Computer Services 26 65.55 26 58.17 Mktg) Computer Software 24 85.07 Oil & Gas (Services) 26 27.76 Computers (Networking) 4 1.21 Paper & Forest Products 22 31.51 Computers (Peripherals) 4 9.61 Personal Care 17 29.62 Consumer (Jew- 8 72.62 Photography/Imaging 1 2.93 elry/Novelties) Power Producers (Inde- Consumer Electronics 12 12.61 6 1.99 pend) Containers/Packaging 2 3.83 Publishing 20 11.61 (Paper) Distributors (Durables) 12 18.26 Publishing-Newspapers 11 12.27 Distributors (Food & 4 11.78 REIT-Mixed Properties 1 .11 Health) Diversified Metals 17 53.34 REIT-Net Lease 1 .28 Electric Companies 55 152.6 Real Estate 44 111.66 Final Data Collection Report as of 24 June 2009 38

Number of Total Value of Number of Total Value of Micro Industry HF Invest- Investments Micro Industry HF Invest- Investments ments ($mill.) ments ($mill.) Electrical Equipment & 14 38.08 Restaurants 2 6.06 Components Retail (Building Sup- Electronics 20 50.21 1 2.87 plies) Retail (Com- Electronics (Defense) 3 13.22 1 1.78 puters/Electrons) Engineering & Construc- 39 139.55 Retail (Footwear) 2 .52 tion Retail (Home Shop- Financial (Diversified) 56 184.64 1 1.2 ping/Catalog) Foods 40 154.38 Retail Specialty-Apparel 33 216.95 Gaming, Lottery & Pari- Retail Stores-Dept 9 46.04 11 56.61 mutuel Stores Gold/Precious Metals Retail Stores-Food 8 53.36 16 48.91 Mining Chains Retail Stores-Gen Mer Hardware & Tools 7 17.3 4 5.38 Chain Health Care (Diversified) 3 4.22 Retail-Specialty 3 .91 Health Care Savings & Loan Com- 78 141.16 1 .41 (Drugs/Pharms) panies Health Care (Long Term 1 .11 Semiconductors 3 3.28 Care) Health Care (Managed Services (Advertis- 1 .26 15 23.1 Care) ing/Mktg) Health Care (Med Services (Commercial 20 17.37 46 175.3 Prods/Sups Consum) Health Care (Special 3 .36 Services (Employment) 8 18.5 Services) Services (Fa- Holding Companies 19 31.97 7 12.1 cils/Enviromntl) Homebuilding 1 .57 Services (Rentals) 13 15.43 Household Furnishings & 6 12.34 Shipping 27 50.09 App Household Products Specialty Communica- 7 12.05 4 1.83 (Non-Durables) tions Housewares 1 .73 Steel 27 51.79 Telephone-Long Dis- Insurance (Life/Health) 26 29.34 1 3 tance Insurance (Multi-Line) 17 57.51 Textiles 1 2.59 Insurance (Property- 2 5.88 Tobacco 7 6.51 Casualty) Insurance Brokers 4 2.28 Truckers 4 2.61 Integrated Telecom 83 223.06 Trucks & Parts 14 30.29 Internet 12 11.07 Waste Management 4 3.63 Investment Bank- 20 44.48 Water Utilities 1 .86 ing/Brokerage Source: Thomson ONE.

3.3.3 Duration of involvement Using the quarterly data report from Thomson on HF ownership stakes, it is possible to make an estimate of the average holding period or duration of involvement of HF in listed companies. Using a formula based on portfolio analysis, net sales and net purchase over the past quarter are calculated separately, and the lower of either total net sales or total net purchases for Final Data Collection Report as of 24 June 2009 39 reported positions is used as a numerator. The average of total outstanding shares over the two quarters is used as a denominator. The analysis is based on the number of shares outstanding or turned over (i.e. not weighted by value). The table above (Summary Analysis of Hedge Fund Ownership Data) also includes summary figures for turnover, which shows a turnover of around 40 percent per quarter. This is a turnover rate of approximately 160 percent on an annualized basis, which indicates an average holding period of HF investments of less than one year. Given that turnover may be even higher for small HF not covered by this data (e.g. daytrading HF), the duration of holdings of listed equity may be even lower for HF overall.

3.3.4 Financial instruments to complete the transactions HF generally make direct cash purchases of listed equity. However, the discussion in the introduction indicates that these purchases are ultimately financed mainly through debt due to the leveraging structure of HF as a whole.

3.3.5 Ways of terminating transactions Given that HF equity investments are overwhelmingly in liquid assets (in the case of equity, in shares of listed corporations), and holding periods of relatively short duration, transactions are mainly terminated the way they were initiated, i.e. sales on open equity markets or negotiated sales to other institutional investors.

3.3.6 Other forms of Hedge Fund investments HF can not only directly invest in companies by buying shares. In some cases they are also investors who will buy debts of companies from banks and other investors. In these cases they will take a role of active investors and interfere in the restructuring process of a company. Partly they will also join other PE investors very opportunistic to make some short term profits in the aftermath of a company restructuring process.

3.4 Sovereign Wealth Funds The approach here is to in part replicate the methodology used by Fotak et al “The Financial Impact of Sovereign Wealth Fund Investments in Listed Com- panies” (2008). This approach compiles a comprehensive list of SWFs, and then searches for equity transactions by each SWF in two databases: Zephyr’s database on M&A transactions, and SDC Platinum’s database on Global New issues. Our analysis, however, will focus on European investments by SWF, and will also supplement with a search in Thomson One ownership module. It is important to note that SWFs also have indirect impact on European industry through their large stakes in PE and HF – Prequin reports that these holdings are substantial. Final Data Collection Report as of 24 June 2009 40

3.4.1 Evolution of transaction volumes and main sectors of activity Fotak et al report a total of 430 transactions in Zephyr and 232 in SDC Plati- num, with 42 observations being common to both samples, between 1970 and June 15, 2008. Zephyr reports an average target value of ca. EUR 4 billion, and SDC estimates an average deal size of EUR 600 million. Given that there is a strong home country bias in SWF direct equity investments, and that our period of interest is much shorter than the time period used by Fotak et al, it appears that investments, the figure we will be calculating will be considerably lower. It thus appears that SWF direct impacts on European industrial change are modest, compared to the impact of HF and PE. With regard to major industry sectors of investment, Fotak et al report a concentration of SWF investments in financial services and in energy companies. Our own analysis of major shareholdings in the top 600 European listed companies indicates that SWF now are the largest shareholder in 8 of these companies (see below). Top 600 European Listed Companies in which a SWF is the largest Shareholder Company Investor Name % O/S OMV AG International Petroleum Investment Company (IPIC) 50.66 Sainsbury J Plc Qatar Investment Authority 27.27 London Stock Exchange Qatar Investment Authority 15.26 Group Marfin Investment Group Dubai Investment Group 10.07 Holdings SA Credit Suisse Group Qatar Investment Authority 8.45 Gea Group AG Kuwait Investment Office 8.21 Daimler AG Kuwait Investment Office 7.59 British Land Co Plc Government of Singapore Investment Corp. (UK) 7.11 Source: Own analysis from Thomson Banker ONE data.

Beyond that, the strategies of the Top 10 SWFs vary considerably with regard to equity stakes in European companies. Whereas the norm appears to be substantial non-controlling stakes of around 3-10 percent, in some cases this is considerably higher. Some SWFs however have no identified substantial stake in a European company. The Norwegian Government Pension Fund (Global) appears to act like a typical pension fund by spreading its investments quite broadly over a large number of companies, taking only small stakes in those companies. Final Data Collection Report as of 24 June 2009 41

Top 10 SWFs and their Major European Holdings Assets Country Fund Name Major European Equity Holdings $billion UAE - Abu Abu Dhabi Investment Au- 627 Piaggio Aero (35%), Ferrari (5%) Dhabi thority Saudi Arabia SAMA Foreign Holdings 431 Banca Intesa (undisclosed minority stake in 2004) China SAFE Investment Company 347 Norway Gov't Pension Fund Global 326 holds less than 5 percent in numerous listed companies Singapore Government of Singapore 248 British Land Co Plc (7.1 %), Liberty Investment Corporation International Plc (4.97%), Great Port- land Estates (4.8%), Brixton (10%) Russia National Welfare Fund 220 Kuwait Kuwait Investment Authority 203 Daimler AG (7.6%), Gea Group AG (8.2%), European Islamic Investment Bank Plc (3.7%), Victoria-Jungfrau Col- lection (55%) China China Investment Corpora- 190 N.N. tion China - Hong Kong Monetary Au- 173 N.N. Hong Kong thority Investment Portfolio Singapore Temasek Holdings 85 Standard Chartered (14.1%), Intercell AG (8.4%) Source: Own analysis.

3.4.2 Duration of involvement and financial instruments to complete the transactions The financial instruments used by SWFs to complete transactions are overwhelmingly cash purchases – SWFs have large cash reserves financed mainly through revenue from commodities. Prequin reports that the use of leverage by SWFs is limited to indirect leverage, i.e. through investments in HF and PEF, which in turn use leverage for their equity investments.

The table below shows that the investment styles of major SWFs with regard to listed European companies vary widely. The number of investments ranges from almost 1600 (Norges Bank) to only one or two investments (the case for four SWFs). Some SWFs prefer to take very small positions (three SWFs had average positions of less than one percent of the outstanding shares of individual listed companies), whereas the Qatar Investment Au- thority and the Mubadala Development Company prefer to take large minority stakes in a small number of companies. Overall the portfolio turnover rate was quite low (especially in comparison with hedge funds), but for three SWFs the quarterly turnover rate was around 15 percent (i.e. somewhat more than half the portfolio would be turned over on an annualized basis. Final Data Collection Report as of 24 June 2009 42

Summary Data on SWF Holdings in European Listed Companies (End 2008) SWF Name Nr. Investments in Average posi- Value ($mill) Portfolio Listed European tion size (% end 2008 Turnover Cos. shares in port- Rate folio co.) (last quarter) Abu Dhabi Investment Company 108 0.6 2163.5 5.3% Istithmar World Capital 1 7.7 57.0 16.0% Kuwait Investment Office 122 0.8 1837.2 3.7% Libyan Arab Foreign Investment 1 7.5 13.7 0.0% Company (Lafico) Mubadala Development Company 1 22.7 7.6 0.0% Norges Bank 1588 0.9 74250.0 6.3% Qatar Investment Authority 5 20.0 9598.3 3.1% Government of Singapore Invest- 59 0.6 3420.5 15.4% ment Corp. (UK) Private Ltd. Temasek Holdings Pte. Ltd. 2 4.0 4,621.31 18.7% Source: Own analysis.

3.4.3 Ways of terminating transactions Fotak et al report that termination of transactions for investments in private companies is similar to the acquisition method, i.e. through negotiated sales directly with other large purchasers. For SWF investments in the listed companies analyzed in this report, exits occur through stock sales on the open market or negotiated sales of blocks of shares with other large purchasers.

3.5 Fund-specific SWOT assessments and initial conclusions regarding the impact on industrial change

Any assessment of the impact of the three types of funds which also should include the assessment and evaluation of differences between private equity funds, hedge funds and sovereign wealth funds should start from certain characteristic features of the capital fund specific business models and investment strategies. Arising from the specificities of the respective business models it might be possible to draw the following conclusions with regard to the impact of the three types of funds on industrial change.

3.5.1 Private Equity Funds In contrast to the two other capital funds, the Private Equity business model is exclusively based on the pooling of capital from individual and institutional investors in order to purchase a share in existing productive enterprises. The target companies are for the most part not or no longer publicly traded on the stock market. Private equity funds are engaged in a broad variety of investment activities at different stages of the business development from early stage (start-up and expansion) to different situations of later stage enterprise financing. Final Data Collection Report as of 24 June 2009 43

Since Private Equity Funds show a strong bias towards the provision of seed and venture capital as well as acquiring distressed securities and financing buyouts, this type of investment capital is an important agent of industrial change at the company level. The sharp increase in private equity fundraising between 2004 and 2007 also had significant impacts on industrial change in Europe, in particular by providing capital in the context of leveraged buy-outs, financing mergers and acquisitions as well as the purchase of distressed securities. There are both positive as well as negative impacts of the private equity business model from the perspective of the targeted company as the following SWOT assessment illustrates: One of the most important potential strengths of PE is the ability to provide risk capital to companies at the very beginning of the innovative process (seed and start up capital). PE firms can also provide capital where most other investors would not be willing to (e.g. turnaround or restructuring phases). Most PE firms also have extensive networks of experts and managers that they can draw upon to advise companies, obtain independent advice on new products, and hire new managers to expand or replace existing management teams. Successful PE firms also have experience in introducing for- mal governance structures, which are important as companies grow in size beyond the founder-based startup.

Also on the positive side for PE are the potential wider impacts (i.e. opportunities) for the economy as a whole, including the creation of value, increase in innovativeness, adaptability and competitiveness, and economic growth and job creation. On the weakness side at the micro level for PE is the potential presence of externalities, i.e. the possibility that PE firms will reap financial rewards at the cost of others. PE has also been criticized for having an overly high profit expectation which is not sustainable in the long run, for sometimes having too short of an investment horizon (some industries need more than a 4-5 year perspective). The financial orientation of PE may also lead to a neglect of technical and organizational needs of a company. The need for high profits may also lead PE firms to push for overly risky strategies in its portfolio firms. Potential negative impacts at the macro level (threats) result mainly from the extensive use of leverage in PE deals. If financial targets are not met (e.g. if sales decrease because of a downturn), the potential of bankruptcy and job loss increases because the company is under a heavy debt burden. This threat is accentuated if many deals were driven by the expectation of returns through financial engineering rather than. Finally, PE may de- tract from the competitiveness and innovativeness of an economy insofar as investments which only pay off over a longer-term horizon (e.g. 8-10 years) are neglected.

Final Data Collection Report as of 24 June 2009 44

SWOT assessment Private Equity Funds

Positive impacts Negative Impacts

Strengths Weaknesses - Seed money - Often exaggerated profit expectations - Expertise/network knowledge - Financial costs / externalities - Governance structure - Middle-term orientation only - Financial resources for mergers and ac- - Strong financial/shareholder orienta- quisitions and growth strategies tion

Micro Dimension - Often high risk strategy

Opportunities Threats - Value creation - Leverage strategy - Increase in competitiveness - Financial re-engineering - Growth and job creation - Risk for stable development - Increase in adaptability - Employment and labour conditions - Lack in long-term orientation

Wider Dimension - Bankruptcy

3.5.2 Hedge Funds Though there are similarities in the way of obtaining money and using leverage the business model of hedge funds differs from private equity significantly: Investment in equity only is one focus of these funds along a broad spectrum of other investment instruments (commodities, options, futures, derivates, debt etc.). Furthermore, the investment horizon of hedge funds is much shorter-term and the focus is much more on liquidating financial assets rather than by active restructuring the target companies. This also results from a further difference between private equity and hedge funds: While private equity in most cases is aiming at controlling a company by majority stakes, hedge funds in most cases only buy minority stakes, typically in “event-driven situation”, i.e. exploiting investment opportunities in the context of restructuring processes such as mergers and acquisitions. Another example of event-driven investment strategies of hedge funds are investment in “distressed securities”: Before the current economic crisis hedge funds were the largest buyers of distressed securities and thereby functioning as “last resorts” of firms facing crisis situations or even bankruptcy. Though often, only a small and speculative investment is made, there are also significant and “activist” investments where one or more hedge fund(s) (“herding” behaviour) is playing a significant role in accelerating restructuring and change at the company level. Positive impacts of activist HF investors at the micro level (strengths) include the potential to increase the value of listed companies through pushing for more efficient governance structures or organizational structures (e.g. spinning off non-core areas). Especially recently HF have been one of the most significant actors as a "buyer of last resort" willing to purchase risky/distressed securities. At a macro level, HF may increase liquidity in markets by their willingness to buy and sell over very short periods of time. HF may also help overcome macro-level market failures in governance Final Data Collection Report as of 24 June 2009 45 through their activity as active investors on a wide scale. HF have also been credited with support for innovation in financial products, e.g. through their willingness to trade in derivatives markets. Potential negative impacts at the micro level (weaknesses) include a very short term orientation, which in the case of some funds can be measured in months or days and minutes. The simultaneous pursuit of short term strategies by a multitude of HF can lead to herding behavior, which can distort incentives at the micro level. The lack of transparency of many HF can also make it difficult if not impossible for investors to evaluate the risks they are facing. Finally, HF may achieve short-term profits by shifting costs to others without any additional value creation (externalities). At a macro level, threats through HF include systemic risks caused by leverage (particularly to banks providing loans to HF), which can be accentuated through the pursuit of high-risk strategies or a focus on financial engineering. HF may also have strong incentives for market manipulation due to an orientation to short-term returns. Activist HF strategies on a large scale for special dividends and share buybacks may also lead to an exhaustion of companies' financial reserves overall. SWOT assessment Hedge Funds

Positive impacts Negative Impacts

Strengths Weaknesses - Value increase of listed companies - Short-term orientation - Orientation towards efficient markets - “Herd mentality”/”herding” behaviour - Buyer of “last resort” - Transparency of risks - Purchase of risky assets / distressed secu- - Externalities Micro Dimen- rities

Opportunities Threats - Liquidity in financial markets - Leverage/system risks - Overcoming market failures (in the case - Manipulation of markets of active investors) - Exhaustion of financial reserves - Financial innovations - Focus on financial engineering

Wider Dimen- - High risk strategy

3.5.3 Sovereign Wealth Funds Both with regard to ownership, investment horizons as well as major objectives of investing in company stakes, the business model of Sovereign Wealth Funds differs significantly from both private equity as well as hedge funds (though sovereign wealth funds also invest in these two capital funds types): As state-owned financial institutions Sovereign Wealth Funds operate on a long-term agenda aiming not only at stable long-term financial returns but also following wider national economic policy goals. Furthermore, investments of sovereign wealth funds in most cases are not leveraged and the strategy as a stakeholder is rather “patient” in contrast to the often aggres- sive and activist strategy of private equity and hedge funds. Final Data Collection Report as of 24 June 2009 46

Against the background of a rapid expansion over the last decade, sovereign wealth funds have become a financing source for investments and market liquidity which is generally highly welcomed by companies as well as national economic actors in situations of difficult economic framework conditions. In particular in the context of the current crisis, sovereign wealth funds play an important role in easing financial problems of many larger companies. A potential positive impact of SWF at the micro level (strength) is the longer- term orientation of SWF compared to many other financial investors. SWF are also increasingly the buyers of last resort for many companies, particularly in the financial sector during the current financial crisis. Their sheer size as well as their willingness to take significant equity positions in large companies means that they are one of the few investor types capable of providing significant new capital to large distressed banks. They may also help deal with imbalances in the global flow of funds by returning capital from countries with surpluses to deficit companies. Finally, SWFs can potentially help strengthen industrial links between developing and developed countries through merging companies in the same sector. At the macro level SWF offer opportunities insofar as they take a longer-term stakeholder orientation towards investing and also avoid leveraged strategies. They may also help entrance to and the development of new markets through their role as pioneer investors.

At a micro level SWFs however have potential negative impacts (weaknesses) insofar as they threaten the autonomy of national stakeholders and increase the potential of conflict due to cultural differences. This conflict potential may be increased due to the lack of transparency in the activities of many SWF. At a macro level, SWF may represent a potential threat insofar as they pursue strategic national and political interests, rather than purely financial interests, in their investment activity. Furthermore, many SWFs are based in countries with weak democratic traditions, raising the threat of wealth concentration outside of democratic control. Sovereign Wealth Funds

Positive impacts Negative Impacts

Strengths Weaknesses - Long-term orientation - Lack of autonomy of national stake- - Buyer of “last resort” holders - Increase in financial resources - Lack of transparency - Strengthening the link to industrial Micro Dimen- markets

Opportunities Threats - Stakeholder orientation - Focus on political objectives - uncertain - Sound financial engineering long-term intentions - Entrance to new markets - Wealth concentration outside democratic control

Wider Dimen- Final Data Collection Report as of 24 June 2009 47

4 The impact of Private Equity, Hedge Funds and Sover- eign Wealth Funds on industrial change

Already the brief SWOT assessment in the previous chapter revealed a rather divergent picture of likely impacts of the three types of capital funds on industrial change at the company level but also in the wider context. This mixed picture is also displayed in the debate and literature available on this issue. On the one hand, reports and surveys undertaken by institutions closely connected to the capital fund industry consistently claim that companies which have been bought out by private equity for example create more jobs and generate faster growth in employment than other companies. On the other hand, literature and case studies carried out by trade union sponsored research institutes and more critical authors stress the negative impact in particular of private equity and hedge funds on employment and working conditions resulting from the objective of these funds to generate high returns to owners and fund managers in a short-period of time. Against this, the main purpose of the following chapters is to address on the basis of a comprehensive review of relevant literature and data available the simple question of what we know and what we don’t know with regard to the impact of the three types of capital funds on the various dimensions of industrial change.

4.1 Dimensions of industrial change and the impact of alternative investments There are many dimensions of industrial change depending on the specific point of view of the observer: industrial change not only occurs at the company level but also beyond, by affecting certain industry sectors, regions and localities differently. Industrial change also affects certain company types in different ways and has different effects on certain model of industrial and labour relations as well as specific national or transnational traditions and models of social dialogue, corporate governance and/or employee participation. With regard to the impact of capital funds on industrial change, in the context of this report a dual concept is applied focusing in particular on the impact on industrial change at the company level. First, the impact on business reorganization and employment both in quantitative (number of jobs) as well as qualitative terms (wages, working conditions, labour relations). This dimension today often is defined as “restructuring” and the permanent need of companies to adapt to changes in demand, the introduction of new processes or the entrance of new companies which are necessary to remain competitive. Here, many companies fail: According to the EU Commission23, every year, 10% of European enterprises are set up and destroyed. It is estimated that between 5 000 and 15 000 jobs are cre-

23 European Commission (2005): “Restructuring and employment”, Communication of the Commis- sion of 31st March, COM(2005) 120 final. Final Data Collection Report as of 24 June 2009 48 ated and destroyed every day on average in each of the Member States. At the same time there are opportunities as evidenced by the creation of over 12 million new jobs across the EU from 2000 to 2007.24 There is also a second dimension of industrial change which is important to address since it also influences industrial change at the enterprise level: The economic, financial as well as socio-political environment enterprises are act- ing in, i.e. financial markets and their stability, regulatory regimes as well as frameworks of corporate governance and industrial relations which affect more or less directly the ability and potential of companies to adapt to change and stay competitive. Both dimensions of industrial change will be addressed in the following chapters: The issue of industrial change at the company level in this chapter and the issue of financial stability and business environments in chapter 5. The following table summarises major topics and issues of concern reflected in the debate on enterprise level impacts of the three types of capital funds – however, the public debate very much concentrated so far on the private equity and hedge fund industry. Impacts of capital funds on industrial change at company level

Company Employment and Other impacts performance labour relations

- Efficiency and profitability - Employment growth - Acceleration of necessary - Value creation - New opportunities for employ- industrial change - Financing for growth strate- ees in terms of career devel- - Increasing economic effi- gies opment, training and compe- ciency and competitive- tence ness of companies as - Availability of financial re- well as industry sectors sources - New forms of employee participation (including financial - More efficient models of Positive - Adaptability and innovation participation) corporate governance capacity and management - Management capacities and corporate governance

- No “real” value creation - Job losses due to accelerated - High social burden due to - Lack of long-term objec- restructuring (also in profit- accelerated restructuring tives able firms) - Decrease in national - Wrong decisions due to sin- - Wage cuts and extending autonomy and weakening gle minded profit orienta- working time resulting from of national patterns of tion higher profit goals and trans- value creation and eco- fer payments nomic development - High financial burden / externalities - Lack of longer-term invest- - Increased instability of ment in human resources the financial market due - High risk strategy and dan- - Weakening of employee in- to the use of leverage

Negative ger of insolvency due to the use of leverage formation and consultation - Shareholder value orientation instead of taking - Lack of information and transparency into account stakeholder and further interests - Weakening of national models and traditions of labour relations Source: Own

24 European Commission (2008): “Restructuring and employment the contribution of the European Union”, Commission Staff Working Paper, COM(2008) 419 final, p. 2. Final Data Collection Report as of 24 June 2009 49

4.2 Overview of existing research and analyses Estimates of the “real” impact of funds investment on companies (employment and other impacts such as wages, profits) vary widely, from quite positive to very negative. The most positive studies have been produced by the venture capital industry (associations or consultants for the industry). The literature on Private Equity is most extensive, with the oldest studies already some decades old. Although the earlier literature focused on the US, more and more studies have been done in Europe. These studies have focused on a variety of outcomes, including returns for investors in Private Eq- uity, and the employment, sales and profitability outcomes of Private Equity investments in portfolio companies. Beside literature with a broader scope there are also studies which focus on concrete case studies. Relevant literature on Hedge Funds is less extensive, and due to the lack of transparency regarding most Hedge Funds investments, focuses mainly on returns to investors. Some recent econometric work, however, has looked at significant shareholdings by Hedge Funds in listed companies. There is only very limited literature regarding the influence of Hedge Funds on employment issues. Similar to the PE literature most work concentrates on the US or Great Britain. E.g. for Germany only one recent study exist dealing with the effects of activist hedge fund activities on industries.25 More extensive is the literature concerning regulation of Hedge Funds. Nevertheless both categories complain a lack of sufficient data. In the past few years Hedge Funds increased their activities in equity-focused investments. Research about hedge fund activism and effects on industrial change, i.e. restructuring and employment is still not very extensive. Most studies focus on the U.S. (and to a lesser degree the UK) due better availability of data. One study is known which focuses on both the U.S. as well as Europe.26 For the German case also only one general study is known.27 Admittedly these studies focus mainly on the companies' stock market value and their share price development after the Hedge Fund's acquisition. Unlike the research on PE, quantitative data or surveys about the influence of Hedge Funds on industrial change like restructuring and employment issues are missing.

Finally, scientific interest in Sovereign Wealth Funds, has been quite recent. The literature here is quite thin, particularly on econometric studies on the impact of Sovereign Wealth Funds investments. Due to the uncertainty of the effects of Sovereign Wealth Funds on the international finance system or on the economy respectively companies, a wide range of literature is concentrating on possible dangers of these investment vehicles. In the case of Sov- ereign Wealth Funds this is relevant because some of the biggest funds are managed by states which enjoy full confidence in the international community of state. Due to this there is also literature dealing with international relations and the influence possibilities of states they gain by their funds. At

25 Holler, Julian and Bessler, Wolfgang (2008): “Capital markets and corporate control: Empirical evidence from hedge fund activism in Germany”, Discussion Paper University of Giessen. 26 Stockman, Nick (2007): “Influence of hedge funds activism on the medium term target firm value”, Working Paper University of Rotterdam. 27 Holler / Bessler (2008). Final Data Collection Report as of 24 June 2009 50 the recent point of research no studies are known dealing with effects of Sovereign Wealth Funds on employment topics or industrial change in general. In general, most existing studies focus on the issue of employment development and little research have been done on the impact of funds on wages and working conditions or on the influence of such investments on the coor- dination with worker representation. Concerning such issues most results can be drawn from case studies because large-scale empirical studies have not been done .

4.3 Methodological problems and other limitations of analyzing the impact of funds on industrial change In assessing the impact of the business models of the three type of funds on companies taken over or invested in and their employees, nearly all data sources and studies face significant problems in providing feasible and “neu- tral” conclusions. As a further general note, large-scale quantitative studies on the economic and social impact of Private Equity and Hedge Funds have been rendered quite difficult due to the lack of transparency of the industry. Finally, it has to be noted that research into private equity and other alternative investments is at an early stage and there is still a significant lack of studies using large numbers of cases. This situation becomes more difficult still when considering the problems of data availability and reliability. On the fund level Private Equity Funds are generally not forced to publish data accessible to the public at large, and the quality and accuracy of information that can be gained through (as a rule quite expensive) data bases is questionable. On the company level (i.e. level of the firms that PE funds invest in) the reporting requirements for private (non-listed) companies vary considerably from country to country, as does the mode in which this information is made available to the public. Furthermore, companies often change name when they change ownership in the context of a Private Equity transaction. As a result, it is virtually impossible (the only partial exceptions here are the U.S., and to a lesser extent the UK) to simply download a large dataset of PE-related companies with more information than sector, address, date of investment, etc. from the typical online data services – quite unlike the case for other kinds of studies, such as of listed companies, for which detailed information is available due to extensive publicity requirements. This lack of large-scale quantitative data has forced empirical studies of private equity to follow one of these three strategies: (1) Using standard databases while accepting the accompanying danger of biased results,

(2) Relying on self-reported or “private” data from funds and/or institutional investors in Private Equity Funds, or Final Data Collection Report as of 24 June 2009 51

(3) Carrying out case study based qualitative fieldwork. The first two strategies run the danger of providing overly-optimistic estimates of the impact of Private Equity (as the more scientific studies in this group of studies admit), due to a number of systematic biases: firstly, the “survivorship bias”, since failed portfolio companies (in the worst case involving a total loss of jobs) are as a rule excluded from the analysis; second, there may be additional “selection bias”, as the better firms among the sur- vivors are overrepresented. Finally, in the case of self reported data, there is a strong danger of “reporting bias”, since the reporting PEF firms understand the potential public policy impact of the study and their self-interest in exag- gerating the positive impacts of Private Equity Funds. The third strategy also runs the danger of examining non-representative cases, particularly when there is quite a small sample size. Also a further methodological problem has been stressed: The “question of the counterfactual”: “What would have happed to the company concerned, or the economy more generally, in the absence of PE involvement. Where we have data on company performance, against what benchmark should it be measured? How do we account for the fact that the companies taken over by PE are far from being a random sample?”28

Any study of the effects and impact of a specific phenomenon, such as alternative investment funds, would need to establish what difference that factor makes. Information and data on industrial change in companies with alternative investments therefore need to be compared with data on other similar companies which have not changed ownership. Such comparisons are sometimes made with trends in the whole economy, but should be made between companies in the same sector – otherwise the comparison may simply reflect the fact that companies with private equity investors for example - are in faster-growing sectors. Against this, an analysis of empirical findings on the influence of private equity financing on industrial employment comes to the following conclusion: “The major surveys suffer from a number of flaws, both in sampling and in data quality, ren- dering their estimates of employment impact effectively worthless. Most of the assertions made by commentators, and some made by the reports themselves, cannot be justified on the basis of the evidence from existing surveys. The most reliable results suggest that buyouts generally depress wages but there is no clear overall effect on employment compared with other forms of ownership. Problems of self-selection and the difficulty of verifying data on employment arise from the information opacity which is a systematic feature of private equity buyouts”29

With these methodological problems in mind, the following sub-chapters review the available quantitative evidence on the major issues of concern of our research: firm performance and value creation, employment development, wages and working conditions, social dialogue/information and consul-

28 Hall, David (2007): “Methodological issues in estimating the impact of private equity buyouts on employment”, PRISU, Department of International Business and Economics, Business School of Greenwich. 29 Ibd. Final Data Collection Report as of 24 June 2009 52 tation as well as corporate cultures and governance. At the end of this chapter we also summarize research findings and results from case studies with regard to non-quantifiable aspects such as the likely impact of short-term versus long-term investment strategies.

4.4 Empirical evidence on the impact on industrial change at company level

4.4.1 Firm performance, profits and value creation Since the basic aim of private equity is to make profits, it should be obvious that private funds – at least in the aggregate - try to add value to the target companies. This assumption is confirmed by extensive anecdotal evidence about massive financial gains over relatively short periods of time and the ability of Private Equity Funds to raise the capital value (sale price, share capitalisation) of the firms invested in. However, this evidence leaves open two important questions which have been addressed in a recent overview of available evidence:30 First, evidence of adding value to a target company might not (only) result from genuine value creation by improvements in the performance of the target company itself (for example by better management, new investments, restructuring, higher productivity and other value-enhancing measures resulting in high sales and profits) but (also) from transfers from other sources such as: Transfers from national governments, in particular the replacement of equity by debt, transfer of profits abroad and/or the taxation of income as capital gains. Most controversially, there might be also a transfer of financial resources and value from employees by cuts in employment, increased in- tensity of work, cuts in pay and benefits etc.

Secondly, value adding may also be due more to the ability to spot under- priced companies and/or to “hoodwink” buyers into over-paying than to genuine value creation.31

One has to take these open questions into account when assessing the results of a growing number of surveys covering the value creation and effects of private funds on the performance of target firms.

A study carried out by Ernst & Young on large private equity deals in the EU and US32 finds faster growth in ‘enterprise value’ than in firms considered comparable. In particular with regard to this comparison group the study shows significant weaknesses (for more details see sub-chapter on employment effects below). The British Venture Capital Association (BVCA) is publishing annual reports on the economic impacts of private equity of which the latest version was published in 2008 (BVCA 2008). The study analyzed 1,013 answers from a survey of 6,100 potential respondents from buyout-financed or venture-

30 Watt, Andrew (2008): “The impact of private equity on European companies and workers: Key issues and a review of the evidence”, Industrial Relations Journal, Vol. 39(6), p. 548-568. 31 Ibd. 32 Ernst & Young (2008): “How do Private Equity investors create value? A Study of 2006 Exists in the US and Western Europe”. Available on www.ey.com Final Data Collection Report as of 24 June 2009 53 capital financed companies. This study estimated recent average sales growth at PE-backed firms at 8% per year. Employment growth in these companies was also found to be an average of 8% per annum. However, there are significant methodological problems with the BVCA impact studies. In addition to the survivorship and potential self-reporting bias, another major weakness in this study is that the methodology used was not revealed in detail. Many recent studies on the impact of private equity on firm performance and value creation have been carried out with the involvement of the Centre for Management Buyout Research in Nottingham (CMBR), which is financed by the private equity industry. Some of the studies have relied at least in part on self-reported data from Private Equity Funds gathered under conditions of confidentiality. A plant-level study of UK based Management buy-outs found that productivity increased substantially - 70% in the short run, 90% in the long run, together with an output reduction of about 50% and also a significant reduction in employment (see below).33 Regarding the German situation, a study by PriceWaterhouseCoopers in co- operation with the German Venture Capital Association BVK is overall positive on the impact of private equity, in particular with regard to the effects coming from venture capital. The effects of buyout investments are described more critically.34 According to the study, the profitability (EBIT) of companies in the case of buyouts excluding “turnaround situations” (i.e. companies that make significant losses when they are purchased) actually decreased by 1.9% per annum. In contrast, for buyouts involving turnaround situations, profitability on average improved considerably. Resulting from these results it can be concluded that profitability in “normal”, i.e. non-turnaround situation of buyout situations has according to empirical evidence not been improved. Here, the question arises in contrast to the results of the other studies arises whether the studies on the impact of Private Equity in the UK and Europe are too optimistic, or whether the impact of Private Equity in Ger- many is less positive than in the UK and Europe as a whole. A major conclusion with regard to survey results on Private Equity Funds' effects on average value added to target firms is that the results do not explain to which extent the value creation monitored is arising from “genuine” creation processes of rather due to “value appropriation”. Surveys and research projects trying to overcome this knowledge gap come to much more cautious conclusions with regard to value creation resulting from private equity activities. Based on a survey of almost 500 “reverse” LBOs (i.e. the sale to the public of firms that had previously bought under an LBO) a study35 found out that these performed significantly better than other

33 Harris, Richard / Siegel, Donald S. / Wright, Mike (2005): “Assessing the impact of management buyouts on economic efficiency: Plant-level evidence from the United Kingdom”, in: The Review of Economics and Statistics (87), p. 148–153. 34 PriceWaterhouseCoopers (2005): „Der Einfluss von Private Equity Gesellschaften auf die Portfolio- unternehmen und die deutsche Wirtschaft“. 35 Cao, Jerry and Lerner, Josh (2006): “The performance of reverse leverage buyouts”, Working Pa- per, Swedish Institute for Financial Research Conference on The Economics of the Private Equity Market. Final Data Collection Report as of 24 June 2009 54

IPOs and the market as a whole. However, the authors are extremely cautious in drawing general conclusions from this since the sample is not regarded as representative. Furthermore, the survey revealed a significantly larger variety in the longer-term performance of former LBOs than those in other IPOs. In a report for the European Parliament, various measures of private equity performance have been examined and compared with a control group.36 Though the report reveals enhanced average performance in terms of sales and profitability, the author again is very cautious in drawing general conclusions mainly for the following reasons: The variance again is significantly greater and the analysis was based – for reasons of data limitation, not on a large sample but on just around 60 buyouts. Therefore, the study concludes that at least no evidence was found that buyouts have a negative impact on performance and profitability. The problem with drawing clear and evident conclusions is becoming even more evident in the case of Hedge Funds and Sovereign Wealth Funds: With regard to Hedge Funds, a survey at the University of Rotterdam on the basis of 188 Hedge Funds activism events was carried out in order to analyse the influence of Hedge Funds activism on the medium term target firm value of 94 companies each in the US and Europe.37 According to the study equity- focused hedge fund assets rose 30%, or $173 billion, in 2006 to $743 billion. This development causes new challenges for the affected companies as well as for their employees. In contrast with the popular view that Hedge Funds have no positive effects on the companies value, the survey came to the conclusion that the investment of Hedge Funds lead to an increase in shareholder value for the target firms. Similar findings are reported in another study about Hedge Funds activism and firm performance in the US: “Hedge Funds target profitable and healthy firms, with above-average cash holdings. The target firms earn significantly higher abnormal stock returns (…) than a sample of control firm. However, they do not show improvements in accounting performances in the year after the initial purchase. Instead, hedge funds extract cash from the firm through increases in the target’s dept capacity and higher dividends.”38

These findings are especially interesting because literature on other institutional investors than Hedge Funds finds little proof of systematic wealth creation as a result of activist investors. Similar results are arising from empirical evidence analysed in Germany. A recent survey here concluded that the engagement of activist shareholders such as Hedge Funds increase shareholder value in the short and in the long run. The survey was based on the evaluation of a sample of 324 events in Germany between January 2000 and June 2006. The survey also concluded that the increase in value is stronger in the case of companies that are subject to more information asymmetries prior to the event. Moreover, the study

36 Gottschalg, Oliver (2007): “Private equity and leveraged buyouts”, Study for the European Parlia- ment (IP/A/ECON/IC/2007-25). 37 Stockman, Nick (2007): p. 4. 38 Brav, Alon / Jiang, Wei / Randall, Thomas S. / Partnoy, Frank (2006): “Hedge Fund Activism, Cor- porate Governance and Firm Performance”, Working Paper, p. 2. Final Data Collection Report as of 24 June 2009 55 shows that there are some indications that the identity of the investor mat- ters in the short run. Despite the increased interest in the effects of Sovereign Wealth Funds, little research has been done according to the impact of Sovereign Wealth Funds on industrial change. There are few studies focusing on the impact of Sover- eign Wealth Funds on firm performance and the stock market price. The most comprehensive one analyzes firm profitability, proxied by stock returns, over two years subsequent to the initial Sovereign Wealth Funds investment.39 The study finds evidence that Sovereign Wealth Funds are associated with deteriorating firm performance: The survey concludes that due to negative buy-and-hold returns Sovereign Wealth Funds investment have a negative impact on firm profitability.

A more differentiated conclusion is documented in another study40 which concludes that, although Sovereign Wealth Funds investments may lead to poor performance because political aims may be more important than profit maximization, the firm’s market value rises after the Sovereign Wealth Funds investment announcement. Furthermore the study finds that investors react negatively to the announcements of Sovereign Wealth Funds exiting the firm.

4.4.2 Impact on employment development The effects of private equity and other funds on employment levels in target firms is probably the most controversial issue of the current debate on these funds. Speaking about hedge funds and private equity groups in April 2005, Franz Müntefering, then chairman of the German Social Democratic Party publicly compared these investors with locusts “who feasted on German firms for profit before spitting them out”. With view on employment he remarked: “Some financial investors don’t waste any thoughts on the people whose jobs they destroy”.41 Contentions like these have not gone unchallenged. Private equity associations and other groups have released several recent studies that claim positive effects of private equity on employment. Examples include studies by the European Venture Capital Association42, the British Venture Capital Asso- ciation43 or A.T. Kearney.44

A recent review of these studies summarizes major limitations and problems 45 of these studies:

39 Fotak, Velkjo / Bortolotti, Bernardo / Megginson, William L. (2008): “The Financial Impact of Sov- ereign Wealth Fund Investments in Listed Companies”. The study focuses on financial impact and wealth effects of sovereign wealth fund investments in the stock of listed companies around the world. 40 Kotter, Jason and Lel, Ugur (2008): “Friends or Foes? The Stock Price Impact of Sovereign Wealth Fund Investments and the Price of Keeping Secret”, FRB International Finance Discussion Paper No. 940. 41 The Economist (20.10.2007): “Locusts in Lederhosen – Business in Germany”. 42 EVCA (2005): “Employment Contribution of Private Equity and Venture Capital in Europe”, EVCA. 43 BVCA/IE (2006): “The Economic Impact of Private Equity in the UK”, BVCA. 44 AT Kearney (2007): “Creating New Jobs and Value with Private Equity”, AT Kearney. 45 Davis, Steven J. et al. (2008): “Private Equity and Employment”, in: World Economic Forum (Eds.): The Global Economic Impact of Private Equity Report 2008, p. 43. Final Data Collection Report as of 24 June 2009 56

Reliance on surveys with low response rates, giving rise to concerns that the data do not accurately reflect the overall experience of employers acquired by private equity groups. Inability to control for employment changes in comparable firms. When a firm backed by private equity sheds 5% of employment, the interpretation depends on whether comparable firms grow by 3% or shrink by 10%. Difficulties in disentangling organic job growth from acquisitions, divesti- tures and reorganizations at firms acquired by private equity groups. The prevalence of complex ownership changes and reorganizations at these firms makes it hard to track employment using only firm-level data. Lim- iting the analysis to firms that do not experience these complex changes is one option, but the results may then reflect a highly selective, unrepre- sentative sample. Inability to determine where jobs are being created and destroyed. Policy makers are not indifferent to whether jobs are created domestically or abroad. Some view foreign job creation in China, India and other emerging economies with alarm, especially if accompanied by job cuts in the domestic economy. In general its is very difficult to distinguish between jobs created through growth, jobs transferred to other companies by splitting companies and selling part of the holdings and jobs lost by restructuring processes. Therefore it is no surprise that the studies mentioned above and further ones not only emphasize the positive effects of capital investments on employment development but also show a large variety of concrete results. The studies carried out by the British BVCA for example estimates an employment growth in buyout-financed companies at an average of 7% per year in the period under examination, i.e. five years up to 2005/2006. A survey of Ernst & Young (2008) on buyout-backed firms in Europe observed an estimate of 5% employment growth per year in the 200 largest Private Equity exists in North America and Europe in 2006 (100 largest in each of the two regions).46 The survivorship bias in this study is exacerbated by serious selection bias: The largest (by deal value) exits were chosen, leading by definition to an overrepresentation of the most successful deals in this sample.

With regard to Germany, a study of PriceWaterhouseCoopers/BVK observed an average 4.4% employment growth “per financing round” in the sample of buyout cases excluding “turnaround situations”. Since buyout financing rounds often lasts considerably more than a year, this average employment growth range would be in the 1–2% p.a. range. In contrast, for buyouts involving turnaround situations, an average of 29% of employment was lost. Similar to the results with regard to profitability, this study therefore suggests that employment is not increased in buyout-financed companies in Germany.

46 Symptomatic of transparency problems in the Private Equity industry is the fact that Ernst & Young were able to get detailed financial information on only 112 of these 200 transactions, even though they were all rather large. Final Data Collection Report as of 24 June 2009 57

With regard to employment effects also the CMBR studies - although financed by the equity industry – came to mixed results: Parallel to the reduction in outputs in MBOs the plant-level studies observed significant employment reduction of about 61%.47 In contrast to this a firm-level survey of MBOs in the UK and the Netherlands came to much more positive conclusions.48 Another firm-level study of MBOs and MBIs in the UK found that employment relative to non-buyout firms increased on average for MBOs (0.51% p.a.) but decreased for MBIs (-0.81% p.a.).49

One million jobs created by European private equity and venture capital-financed companies between 2000 and 2004? The European Private Equity & Venture Capital Association EVCA published a research report in 2005 on the employment contribution of private equity and venture capital in Europe which had been prepared by an academic research institute.50 The research paper concluded with some remarkable results regarding the employment contribution of private equity in Europe. The report in particular highlighted the following impacts of private equity: - Private equity and venture-backed companies according to the report employed close to 6 million people in Europe in 2004 – this represents 3% of the economically active population in Europe. - European private equity and venture capital-financed companies created around 1 million new jobs between 2000 and 2004. - 420,000 new jobs were created by buyout-financed companies in this period of time, net of any reduction in headcount in the years following the buyout investment. - Venture-backed companies between 2000 and 2004 created 630,000 new jobs according to the study. - Employment in buyout-financed companies grew by an average rate of 2.4% annually over the period between 1997 and 2004. This is nearly four times the annual growth rate of total employment in the EU-25 (0.7%) between 2000 and 2004. - 67% of those buy-out financed companies surveyed either kept their headcount the same or increased the number of employees overall. Underlying these impressive figures presented as “key findings”, there are some severe methodological and data problems, some of which are already noted in the annex to the report itself and others noted in a critical review of the findings.51 Some of the most significant problems in the context of assessing the employment impact are in particular the following: The overall figures, which are most commonly quoted, include venture capital companies; figures on employment levels are only estimates based on assumptions, not observations; the figures of employment growth are based on unverifiable data from a small and self-selected sample of companies; and the full results of the comparisons with non-PE companies are not published. The first limitation is that the data on employment levels are not based on the study of actual employment of even a sample set of companies – the study is based on a survey of 99 buyout companies and 102 venture capital financed companies. They are calculated from (a) data on the distribution of buyout companies by bands of numbers employed (b) assumptions about the average size of companies within each band, and then (c) multiplying these estimates by the number of companies in which PE funds have invested. These employment estimates are then split between buyouts and venture start-ups, not on the basis of any data about actual companies, but by a simple rule of thumb assumption that companies with more than 200 employees are buyouts and companies with less than 200 are start-ups.

47 Harris / Siegel / Wright (2005). 48 Bruining, Hans et al. (2005): “The impact of business ownership change on employee relations: Buyouts in the U.K. and Netherlands, International Journal of Human Resource Management”, in: ERIM Report Series Reference No. ERS-2004-021-ORG, p. 345–365. 49 Amess, Kevin and Wright, Mike (2006): “The Wage And Employment Effects Of Leveraged Buyouts in the UK”, in: International Journal of Economics and Business Vol. 14(2). 50 Achleitner, Ann-Kristin and Klöckner, Oliver (2005). 51 Hall, David (2007). Final Data Collection Report as of 24 June 2009 58

The second limitation is that the data on employment growth came entirely from PE groups themselves. The PE groups decided which companies they wanted to include – worse performing companies may be less likely to be included, thus skewing the sample. The PE groups also decided whether to answer themselves, or ask the companies to answer – in either case, the data submit- ted by the groups was not publicly verifiable. The third weakness lies in the comparisons between buyout companies and other companies in the same sector. This sectoral comparison is important because buyouts are likely to concentrate on growth sectors, and growth companies within these sectors, and so are likely to show a faster growth profile than the economy as a whole. There is a general weakness, because the set of non-PE companies chosen for comparison were the largest companies in each sector, and therefore not necessarily the fastest growing group in each sector. As the report itself acknowledges, the buyouts do not perform better than the largest listed companies in every sector: indeed, transportation and computing may be the only two out of ten sectors in which buyouts do better.

In contrast to the impressive figures presented in surveys sponsored by the private equity industry more independent research is drawing much less spectacular or even contrarily conclusions with regard to the employment impact of private equity. Probably the most comprehensive study to date on employment effects of Private Equity was commissioned by the World Eco- nomic Forum (WEF) presented in the 2008 World Economic Forum meeting in Davos. The study was led by senior researchers of Investment Banking at Harvard Business School.52 One impressive conclusion of the study is that private equity investments experienced larger job losses than was the case for companies in the control group. The study observed that, particularly in the first five years after investment, job losses are higher than in the control group. This appears to be generated via higher gross job reductions as the new Private Equity owners shed presumably unprofitable segments of the target firm. However, one can argue that Private Equity funds often take over weaker companies whose employment situation before the takeover was not sustainable and therefore redundancies, i.e. restructurings where either way necessary.53

Methodology of the Davos study The study is based on used the Longitudinal Business Database (LBD) at the US Bureau of the Census, which covers all non-farm private companies, to follow employment at PE-backed companies in the US between 1980 and 2005, before and after PE takeover. The study looked at employment changes in actual workplaces owned by these firms – factories, offices etc – as well as employment changes resulting from new establishments, the closure of existing establishments, and further takeovers or disposals by the firms. It identified about 5,000 PE-backed firms, covering 300,000 US establishments, and also a control group of 1.4 million other establishments and firms, selected for being of comparable industry, age, and size to the PE-backed establishments and firms at the time of their takeover. The study looked at employment changes for 5 years before and after the PE takeover. This approach does not suffer from the methodological problems of the private equity association surveys. It provides data on changes in employment in actual workplaces, and, separately, employment changes in the firm as a whole, including the effects of acquisitions and disposals. It excludes venture capital companies and management buyouts where private equity was not involved. It covers all private equity buyouts in the USA since 1980, not a selected sample. It provides a set of ‘control’ firms with similar characteristics for meaningful comparisons. The main limitation is that it covers only the USA.

In particular the following results are arising from the survey: Employment shrinks more rapidly in target establishments than in control establishments in the wake of private equity transactions. The study shows

52 World Economic Forum (2008): “Globalization of Alternative Investments. The Global Economic Impact of Private Equity Report 2008”, p. 43-64: “Private Equity and Employment”. 53 Watt, Andrew (2008). Final Data Collection Report as of 24 June 2009 59 that employment shrinks more rapidly in establishments after a PE takeover, than in control establishments. The study found that the actual change in employment in the establishments subject to PE takeovers was about 7% worse after 3 years, and 10.3% worse after 5 years, than it would have been without the takeovers. The study found significant differences in the impact between sectors. The cumulative effect after 5 years was lowest in manufacturing (-2.4%), around 10% in retail and services, and highest of all in finance, where the report only states that the effect is ‘very large’.54 At the same time employment also grows more slowly at target establishments in the year of the private equity transaction and in the two preceding years. The average cumulative employment difference in the two years before the transaction is about 4% in favour of controls. In short, employment growth at controls outstrips employment growth at targets before and after the private equity transaction. Gross job creation (i.e. new employment positions) in the wake of private equity transactions is similar in target establishments and controls, but gross job losses are substantially greater at targets. In other words, the post transaction differences in employment growth mainly reflect greater employment reductions at targets. However, the study also stresses that the pattern of employment growth and decline are similar for both the PE workplaces and the comparators, as shown in the graph. The report points out that this shows the importance of having a matched sample, to avoid the false conclusion that the pattern is special to PE. It also points out that the broad pattern is typical of all employment data (“if one randomly observes establishments at some fixed point in their lifecycle, they will, on average, exhibit growth up to the point and will, on average, exhibit decline from that point on”). So the decline by itself shows nothing about the effect of PE. It is the gap between the two lines at the end, after 5 years, which shows the impact of PE. Employment: targets vs normalized controls before and after event

Source: World Economic Forum 2008: Globalization of Alternative Investments. The Global Economic Impact of Private Equity Report 2008, p. 57.

In the manufacturing sector, which accounts for about a quarter of all private equity transactions since 1980, there are virtually no employment growth

54 World Economic Forum (2008): pp. 50-51, footnotes 17 and 19. Final Data Collection Report as of 24 June 2009 60 differences between target and control establishments after private equity transactions. In contrast, employment falls rapidly in target establishments compared with controls in Retail Trade, Services and Finance, Insurance and Real Estate (FIRE). Greenfield job creation in the first two years post-transaction is 15% of employment for target firms and 9% for control firms. That is, firms backed by private equity engage in 6% more greenfield job creation than the controls. This result says that bigger job losses at target establishments in the wake of private equity transactions are at least partly offset by bigger job gains in the form of greenfield job creation by target firms. However, we have not yet performed an apples-to-apples comparison of these job losses and gains. As mentioned above, our firm-level analysis – including the part focused on Greenfield job creation – relies on a restricted sample. A further major result of the Davos study is related to more qualitative impacts with regard to enterprise level restructuring which is referred to in the report as “creative destruction”: As the report points out, the rate of acquisitions, sales, new plants and closures are all about twice as high in PE firms as in others. Though described as “creative” the acceleration of industrial change inevitably will result in an increase in insecurity for workers. In 2 years following a PE takeover, 24% of employees will have experienced their workplace being closed, sold, or reduced – double the uncertainty compared with a firm which has not been the subject of a PE takeover. In the context of the 2009 World Economic Forum a follow-up study was conducted by the authors of the 2008 study.55 This study involves a massive effort of matching data on 5,000 US PE deals with data on millions of business establishments in the US (Longitudinal Business Database). The major results of this survey are: As in the 2008 studies (which reported an average net employment loss of 7 percent over 3 years in PE target firms), this study confirms net employment loss at PE firms. Whereas the control group had employment growth of 2.6 percent over two years, PE target firms had a loss of 1.9 percent (i.e. net negative difference of 4.5 percent for PE firms) The average productivity gain from PE investment is not impressive (two year productivity gain of 1.98 percent relative to the control group). Wages also appear to suffer somewhat under PE investment. Whereas wages are 1.1 percent higher (relative to the control group) at PE target firms at the time of acquisition, two years later the wage premium over the control group is reduced to zero. Interestingly enough, on average the companies acquired by PE have HIGHER productivity and higher wages than the control group – whereas the expectation would be that it is the underperformers that would be disproportionately bought up by PE

Lack of similar impact surveys on Hedge Funds and Sovereign Wealth Funds

55 World Economic Forum (2009): “Globalization of Alternative Investments. The Global Economic Impact of Private Equity Report 2009”, Working Papers Volume 2. Final Data Collection Report as of 24 June 2009 61

Both with regard to Hedge Funds as well as Sovereign Wealth Funds there are no studies known so far analysing the effects of these funds or specific deals with regard to employment effects or other aspects of industrial change at the firm level.

4.4.3 Wages and working conditions When a company is affected by a private equity-backed buyout or by the entrance of other forms of alternative investment in a situation of change, eve- rything from high-level management strategies to day-to-day operational procedures at the workplace is subject to change. In the section above findings with regard to a general acceleration of restructuring and insecurities at work have already been noted. However, similar to the issue of job creation, the impact of alternative investment strategies on wages and other aspects of working conditions are highly controversial and there is a large variation between messages of business orientated surveys and studies on the one hand and more critical studies on the issue, which often are based on case study evidence. As in the case of the employment development issue, industry sponsored studies come up with overall positive messages: A recent survey amongst 190 private equity-owned companies that were subject to a buyout between 2002 and 2006 conducted by the Centre for Management Buyout Research (CMBOR) on behalf of the European Private Equity & Venture Capital Association (EVCA) has drawn an overall positive conclusion with regard to the impact of private equity on working conditions and labour relations: “This study demonstrates that the interests of employees are given the same or greater weight under private equity ownership than was the case under the previous owners. For the majority of respondents, private equity investment meant a greater likelihood of access to a corporate pension scheme, higher earnings, more consultation across a number of issues and representation by trade union bodies.”56

Beside the methodological problems already mentioned with regard to these type of surveys, a major limitation of the EVCA/CMBR survey on employee relations of course is that the survey is not based on employees responding to the questionnaire but only on replies received by senior management representatives (CEO or HR director). Similar problems are characterising also other surveys, e.g. the Ernst & Young study which reports an expansion of financial incentives for employees.57 Also suffering from management self-reporting of data, a firm-level study of MBOs in the UK and the Netherlands claimed that MBOs in both countries lead to improvements in working conditions, including wage levels, with these effects being stronger in the UK than in the Netherlands.58

56 EVCA/CMBR (2008): “The Impact of Private Equity-backed Buyouts on Employee Relations”, Re- search Paper, p. 29. 57 Ernst & Young (2008). 58 Bruining, Hans et al. (2005): p. 345–365. Final Data Collection Report as of 24 June 2009 62

In contrast to this, the UK survey of MBOs and MBIs cited above59 concluded that, in comparison to a relative to a non-buyout control group, the impact of Private Equity investment on wages was negative for both MBOs (-0.31%) and MBIs (-0.97% per year). The study shows that, particularly when external management is brought in, the LBO “will lead to management breaking implicit agreements and transferring wealth from employees to new owners” (Amess/Wright 2006: p. 22). An evaluation of empirical evidence and research findings on HR practice and workplace labour relations in private equity backed companies in the UK draws quite negative conclusions with regard to the situation in these companies as compared to others: “Greater stress, job insecurity, a lack of collective communication, low trust, and markedly hostile attitudes towards trade unions (de-recognition rises after entering PE), appear to features of life at work in PE-owned businesses.”60

However, until today there has been little systematic study on the development of wages and working conditions in PE, HF or SWF backed companies trying to avoid the well-known methodological limitations mentioned above. Against this, we have to rely on case study evidence mainly (see below chapter 4.5) which have been carried out during this decade in particular by trade unions and other “critical” institutions, e.g. the Hans-Boeckler-Foundation in Germany. 61 In these case studies as well as in most of the cases reported in the context of the analyses of hedge funds and private equity undertaken on behalf of the Socialist Group in the European Parliament,62 it is reported that workers have been forced to accept pay cuts and other reductions in working conditions. However, the representativeness of such case studies always is a problem and with regard to case study findings the lack of any counterfactual is of course limiting the results of individual case studies.

4.4.4 Social dialogue and information and consultation at firm level Similar to the issue of wages and working conditions there has been hardly any significant research on the impact of PE, HF and/or SWF investments on social dialogue and information and consultation practice at the company level. Since the capital fund industry itself has shown no real interest in this issue, our knowledge on this topic mostly relies on reports by trade unions, works councils and (trade union orientated) case study work. Most of the case studies carried out on behalf of the Hans-Boeckler- Foundation are particularly critical of issue regarding the respect of workers representation and co-determination rights (see Faber 2006).

59 Amess, Kevin and Wright, Mike (2006). 60 Thornton, Phil (2007): “Inside the Dark Box – Shedding a Light on Private Equity”, The Work Foundation, p. 5. 61 Faber, Oliver (2006): „Finanzinvestoren in Deutschland. Portraits und Investitionsbeispiele“, Hans- Böckler-Stiftung Arbeitspapier 123. Further case study reports and company statements are available on the homepage of the Foundation. www.boeckler.de 62 PSE (2007). Final Data Collection Report as of 24 June 2009 63

Also the IUF Private Equity Buyout Watch provides company cases and re- peatedly identifies cases where trade unions, collective bargaining structures and worker participation are not respected by new owners.63 A problem frequently reported by employee representatives and trade unions is the fact that the European Acquired Rights Directive, which protects workers’ terms and conditions in the case of takeovers, does not apply in the case of PE, HF or Sovereign Wealth Fund acquisitions – this of course results from the fact that the capital fund merely takes over the share with the identity of the employer not changing. However, from the point of view of trade unions and works councils, this creates a situation of “invisible employers” were it is extremely difficult to carry out any consultation and negotiation process, as the following quote from an IUF handbook on Private Equity illustrates: “This has far-reaching consequences for unions, since the absence of any legal recognition of a change in ownership allows private equity firms to evade responsibility at an employer in the collective bargaining process. When pushed by unions to enter into collective bargaining negotiations, private equity funds have claimed that they were only involved in ‘refinancing’ the company and are just another ‘shareholder’.”64

However, there is also evidence that the concrete economic situation as well as the position and role played by the works council or trade union structures at the company level to a large degree also determine the development of social dialogue and management-employee relations after a capital fund takeover or majority investment. Where trade unions and/or works councils have a strong organisational position, they often can bargain effectively with new investors. This chance improves in the context of favourable economic conditions. Also, national traditions are likely to be relevant as case study examples in Germany illustrate. Even in the case of corporate turnarounds, there are cases where private equity funds have regarded works councils as a positive resource and actor in restructuring situations.65

4.4.5 Management practice, corporate cultures and governance A review of management practice in private equity backed companies in the UK carried out by the “Work Foundation” summarizes the empirical evidence and relevant research results on the specificity of private equity with regard to changes in management practice and HR as follows:66 PE backed companies favour a distinct cocktail of human resource practices – stressing performance-based reward, and regular performance appraisal. Other favoured practices are broadly consistent with ‘hard HRM’ – self managed teams, individual communication, delayering, training, and making workers responsible for their own jobs and advancement. At its best, these practices are able to contribute to enhanced performance and productivity. However, some aspects of this highly geared PE

63 http://www.iuf.org/buyoutwatch. 64 IUF (2007): “A Workers Guide to Private Equity Buyouts”, International Union of Food, Agricultural, Hotel, Restaurant, Catering, Tobacco and Allied Workers’ Associations, p. 18. 65 Scheytt, Stefan (2006): „Glück im Unglück“, in: Die Mitbestimmung, No. 6, p. 10-15. The article describes the experience of the employees at MTU Aero Engines in Bavaria with the Private Equity Fund KKR. 66 Thornton, Phil (2007). Final Data Collection Report as of 24 June 2009 64

people management culture may not be consistent with the notion of ‘good work’.

In the context of the 2009 World Economic Forum meeting in Davos, a second set of studies on the impact of private equity was released in January 2009.67 Like the first set of studies (released in 2008), this volume, entitled, summarizes research coordinated by the respected PE academic Josh Lerner (Harvard Business School) and carried out by respected academics in financial, industrial and labour economics. One of the four studies conducted focussed on comparing the management practices in firms with different types of ownership structures (PE versus listed firms, family-owned firms, etc.). This study is based on a large-scale telephone survey of managers in over 4,000 companies in a number of countries. A critical review of this study would pick out the following points: Management practices (as defined by the study) are not significantly better at PE target firms than at listed companies with dispersed ownership (here: no blockholder with at least 25% of the shares) or, on most measures, than family-owned firms with an external CEO (summarized in Ta- ble 2, p.14 of the study) The higher score for management practices in PE firms relative to firms owned by the state, managers, founders, private individuals, and families (with an internal CEO) is explained by a larger proportion of companies with very low scores in the other ownership categories, rather than worse performance of “typical” firms (displayed in Figure 3, p. 12 of the study) In general the “positive effect” of management practices in PE is much lower when control variables (industry, size, etc.) are included (summarized in Table 3, p. 15) A breakdown of the individual management practices examined shows that PE firms had higher scores on only 8 of the 18 practices examined, and that the significance level was weak in 3 of the 8 significantly different practices. PE firms were not significantly better in management practices such as: modern manufacturing, management of human capital, attracting, retain- ing and managing human capital, and promoting high performers PE firms had strong significantly higher scores only in the following five practices: process documentation, performance tracking, performance review, performance dialogue, and removing poor performers Overall a careful reading of the study seems to suggest that the major impact of PE on management practices is to heighten monitoring of performance and to remove employees and plants that do not reach performance benchmarks. PE owned firms’ higher scores overall are explained by the lack of portfolio companies that have very low management practice scores, rather than better practices at “typical” firms

With regard to the debate on “shareholder versus stakeholder” orientation and the prevalence of the Anglo-Saxon corporate model against more so- cially balanced models (“Rhineland Capitalism”) it is important to bear in mind that financial investors and fund managers do not operate on an “ideo- logical” basis. In this regard any conclusions with regard to direct impact of

67 World Economic Forum (2009). Final Data Collection Report as of 24 June 2009 65 the three types of funds on corporate governance models or industrial relations models should be made very cautiously. Reflecting on existing evidence, a senior research of the European Trade Union Institute in this context has drawn the following conclusion: “The evidence, which seems plausible even if anecdotal, suggests that PE, with its narrow focus on obtaining its operating goals, is ‘unideological’, if unsentimental, in its approach to issues such as collective bargaining and worker participation. Worker representation institutions will come under threat, and may be destroyed if they are perceived, rightly or wrongly, as inimical to PE’s goals. But the fund will carefully weight the likely costs of such action.”68

4.5 Evidence from case study research There are a growing number of case studies carried out by academic researchers and others on the background, effects and impact of private equity in the context of concrete single cases. For the purpose of our core research interest – providing an overview of existing knowledge on the impact of the three types of funds – both case study documentations and analyses are highly interesting, since most case studies directly address the impact on industrial change, employment and work. At the same time there are some traps to be avoided when interpreting case study findings. Considering the methodological shortcomings of relying on case studies summarized above (see chapter 4.3, in particular the generalisation of non- representative, individual case study findings and the lack of matched-pair comparisons), the representivity of case study finding is always an issue. In this context the following presentation of results should be regarded as an overview of the impressive variation in findings with regard to industrial change at the company level as it arises from case study fieldwork.

For the purpose of our study, the results of approximately 80 case studies on the effects of private equity buyouts and hedge fund activism on enterprise development were taken into account.69 With regard to sovereign wealth funds no case studies were identified. There is significant variation in these case studies with regard to the depth of information provided, ranging from the presenting of available information and a purely descriptive character to comprehensive case studies on enterprise development and restructuring based also on primary information such as interviews with key actors.

4.5.1 Evidence on the impact on industrial change at enterprise level Any change of company ownership has an impact on economic change within this company – this is simply a commonplace. Will this change will be positive for the short, medium and/or long term economic performance of the company or not, and will this change be positive for owners and shareholders mainly at the cost of employees (e.g. due to wage cuts, redundancies, outsourcing etc.)? These are questions which very much depend on the one hand both on the economic situation of the company and the challenges it is

68 Watt, Andrew (2008): p. 548-568. 69 In particular the following sources contain case study documentations: Kamp/Krieger 2005, Blome-Drees (2006), Faber (2006), Scheytt (2006), Thornton (2007), Kaserer et. al (2007), van den Burg/Rasmussen (2007), World Economic Forum (2008), IUF (2007). Final Data Collection Report as of 24 June 2009 66 facing at the time of ownership change and on the other hand on the business strategy of the new owners. It is important to have this general relation in mind which relates to any change of ownership, not only to change resulting from PE, HF and SWF investment and ownership. As in all cases of ownership transfer the basic mo- tive of investors and new owners generally is to increase the value of the company. However, as we have seen in the context of comparing the different business models of the three types of investments analysed here, there are significant differences between PE, HF and SWF with regard to concrete expectations of value creation as well as with regard to the practice of actively influenc- ing/managing industrial change at the company level. There are also significant differences in the timeframe of investment horizons, with a stronger focus on short-termism at hedge funds and private equity and a much longer time horizon at sovereign wealth funds. The available case studies illustrate both findings with regard to the principal features and differences in the business models of the three types of funds.70 At the same time, case studies replicate the broad and controversial debate about the overall impact of private equity takeovers/buyout investments on industrial change at the company level. This debate, which broadly is divided in two major strands, is also mirrored in the available case study evidence.

The first strand stresses the positive impact of private equity investments and activist hedge funds on industrial change. In particular, case study evidence provided by the PE business community itself and sponsored research, as well as case studies carried out by research institutions which are regarded as being more critical, find many individual “success stories.” These cases illustrate how PE and/or HF driven takeovers, buy-outs and majority investments contribute to a successful management of change and increase in profitability, adaptability and reorientation within the enterprise, resulting in an increase in competitiveness, growth and efficiency. Depending on the concrete background and the challenges an enterprise is facing (ranging from management inefficiency, enterprise structure and business orientation to acute crisis situations) exemplary case study evidence illustrates that private equity has improved management efficiency, more efficient allocation of capital and greater production efficiencies. As a result, the value of the firm increased through growth and employment creation, which benefitted both shareholders, employees and the society as a whole. Cases illustrating the successful management of necessary change in enterprises facing problems and/or undeveloped opportunities are documented by

70 It has to be noted here again, that no significant case study evidence with regard to SWF investments are available. Therefore, our knowledge on this type of investment necessarily has to rely on anecdotal evidence as provided in newspapers and/or other sources on SWF investments. Final Data Collection Report as of 24 June 2009 67 the PE business itself71 but also in documentations of case studies which have been carried out by independent or even “critical” research institutes.72 What is striking in these case studies is the significant variety of private equity investment strategies and the degree of active involvement of implementing change. The strategies described in the case studies range from rather passive strategies (which focus on providing capital for growth and expansion of business either in the context of internationalisation or the development of new products and services with little of no direct involvement in the operational management) to strategies which are very much focussed on internal restructuring processes at the enterprise level with the PE majority investor actively involved. These differences confirm the observation of three basic strategies with regard to industrial change at the enterprise level observed elsewhere: First, growth only strategies; secondly an activist strategy focussing on growth and enterprise restructuring and thirdly strategies concentrating only on restructuring of the enterprise (Gottschlag 2007). These three broad types of strategies follow the single common aim of increasing the value created by the business and have significant impact on micro- economic change at the workplace level. Cases here illustrate a wide range of impacts, ranging from hardly any change to significant change for example resulting from outsourcing of parts of the business, relocation, reorganisation of work and production processes, etc. 73

More recently, case study evidence and practical examples illustrating the impact of hedge funds on industrial change at the company level have been published.74 As these cases illustrate, activist hedge fund practice in general follows the three basic strands identified above with regard to industrial change. However, a marked difference might be seen in the character of the situation of the target firm (with a strong bias towards enterprises in acute crisis situations) and a stronger orientation towards high-risk investments. Depending on the specific situation of the target company and the challenges/problems the enterprise is facing, private equity investments and activist strategies with regard to restructuring may also result in failure, i.e. bankruptcy and closure. Cases of such experiences have also been docu-

71 For example, around 25 successful cases PE investments and active management of change are described on the website of the German Association of Capital Investmens (Bundesverband Deut- scher Kapitalbeteiligungsgesellschaften): www.wir-investieren.de. 72 For example, the 20 cases presented briefly in the PE/HF report of the Socialist Group in the Euro- pean Parliament (Van den Burg/Rasmussen 2007) also include examples of active PE investments which have resulted in a successful management of restructuring and change at the enterprise level. Case study analyses prepared by the German Hans-Böckler-Foundation also illustrate positive cases of management of industrial change, growth and/or turnaround triggered by PE investments (see Kamp/Krieger 2005, Faber 2006). Finally, the documentation of cases in the 2008 report of the World Economic Forum contains examples of PE investment strategies contributing to a positive development of the respective enterprises (e.g. Messer Griesheim and New Look). 73 A study for the Federal Government in Germany analyzed six cases of PE and HF driven buyouts and came to the conclusion that, in five out of the six cases, the investments resulted in a positive implantation of change and an improvement of the economic prospects of the respective firms (Kaserer 2007). 74 The documentation of the Socialist Group in the European Parliament already contains some HF examples (Van den Burg/Rasmussen 2007), e.g. Deutsche Börse, DIS. A further documentation of six concrete cases of activist hedge funds and their impact on the management of the respective companies and changes at the enterprise level was published in 2009 by the IRRC (IRRC 2009). Final Data Collection Report as of 24 June 2009 68 mented in case study descriptions75 but there are only a few case studies focussing in particular on the underlying reasons and the specific impact of private equity and activist investment strategies on failure. In stark contrast to this lack of empirical case study evidence, most case studies finding a negative impact of private equity and hedge fund activism on industrial change at the enterprise level focus on negative effects on labour relations, working conditions and other employment related issues.

4.5.2 Impact on employment, working conditions and labour relations In contrast to the success stories with regard to a positive impact of private equity on managing and implementing change at the enterprise level prepared by the industry itself or sponsored studies, there are many case studies stressing the negative impact of private equity on labour related issues. In particular, case studies sponsored or prepared by trade union organisations stress that restructuring and industrial change triggered by private equity and activist investors is implemented at the cost of employees. The major strategy with regard to restructuring and business reorientation is charac- terised by a “low road” strategy, i.e. reducing wages, cutting employment, and possibly reducing R&D and capital investment to increase profits in the short run at the expense of long-run innovation.76 Besides evidence provided by trade union organisations, more in-depth evidence on a worsening of labour relations and working conditions (in particular wages and working time) based mainly on interviews with employee representatives is provided by case studies prepared by the Hans-Böckler- Foundation in Germany (Blome-Drees 2006). The case study examples in the PE/HF report prepared by the Socialist Group of the European Parliament also focuses very much on the impact of PE/HF activist investment on labour relations and working conditions (Van den Burg/Rasmussen 2007). In general, the cases presented in the studies mentioned above and other studies document a decrease in employment levels and a deterioration in working conditions as well as in the in the extent to which employee rights to information and consultation are respected when a private investor steps in. While some of the German case studies stress a particular negative impact of re-orientated management strategies on information, consultation and co- determination rights at the company level, the IUF Private Equity Buyout Watch also provides many examples of cases where trade union rights, collective bargaining structures and information and consultation rights have been disregarded by the new owners. Other case study evidence (e.g. Thornton 2007) also supports the conclusion that private equity driven change in management practice often results in an increase in hostility to trade unions and works councils, including trade union de-recognition.

75 See for example, Blome-Drees/Rang 2006 on Edscha, Van den Burg/Rasmussen 2007 on Märklin and Stork. 76 Case study examples illustrating these impacts are presented for example by the “Private Equity Buy-out Watch” of the IUF (International Union of Food, Agriculture, Hotel, Restaurant, Catering, Tobacco and Allied Workers Association), see IUF 2007; or the PE/HF report of the Social Group in the European Parliament (Van den Burg/Rasmussen 2007). Final Data Collection Report as of 24 June 2009 69

However, with regard to labour relations and employee participation, existing case study evidence is not unanimously negative. The European Parliament report includes some examples illustrating cases of PE takeovers which leave the existing culture and structures of employee participation and industrial relations for the most part untouched, or even result in improved labour relations.77 Similarly, some of the cases documented by the German Hans- Böckler-Foundation also describe change processes where employee rights of information, consultation and negotiations have been respected by the new owners or even improved.78 And even the rather critical study mentioned above (Thornton 2007) includes case study evidence on positive effects on HR management and labour relations, such as increase in autonomy or increased investments in training and personnel qualifications of employees. While the majority of case studies indicate rather negative effects of restructuring processes in enterprises taken over by PE or activist hedge funds, resulting in a worsening of working conditions and labour relations, it is important to stress that this phenomena of course is not only limited to private equity investment. As many cases throughout Europe illustrate, increasing competition in the context of globalisation and change has also resulted in new pressures on working conditions and labour standards in companies of all sectors, sizes and ownership structures. And in this context, both in PE and/or HF controlled firms as well in other companies confronted with restructuring, the ability of trade unions and employee representatives to retain their rights and influence on management decisions seems to depend in the first place on their organisational position and strength within the company. In those cases where employee organisations have retained such organisational strength they also can bargain effectively with new owners – PE, HF or Sovereign Wealth Funds or other groups of investors. Furthermore, as evidence from some case studies from Germany (but also from Denmark79) shows, the respective national context of labour relations and industrial relations seem to have an significant impact on the behaviour of PE and other private investors taking over a company. Against the background of a national system of strong employee/trade union involvement through collective bargaining (Denmark) or legal co-determination rights (Germany), private equity investors aiming at implementing a restructuring process in the relevant company regard worker representatives as an important and positive resource in the change process.

4.6 Conclusions: What we know and what we don’t know It is not possible to draw a clear-cut résumé of results regarding the impact of private equity and other financial investors covered in our study on industrial change and in particular on employment, working conditions and wages presented in this chapter.

77 See the cases of Eircom, Picard and New Look in Van den Burg/Rasmussen 2007. 78 See Scheytt 2006 on the case of MTU Aero Engines. 79 See the case of ISS Denmark in Van den Burg / Rasmussen 2007. Final Data Collection Report as of 24 June 2009 70

Though there are also no clear results regarding the impact of the three types of funds on company performance and value creation it is quite obvious that the emergence of PE, HF and SWF as a European-wide phenomenon has contributed to an acceleration of restructuring, performance benchmark- ing and efforts to increase the competitiveness of companies and work. Research findings and in particular available case study evidence – although nuanced – on labour relations, working conditions, wages and bargaining processes at company level suggest that workers in target companies are on average are treated as one source of “value creation” and thus profits for private equity funds. However, one should be extremely cautious to conclude from this that employees in funds backed companies are treated worse or “squeezed harder” against the lack of any matched-pair comparison and/or counterfactual. In particular in the context of the economic environment and the general acceleration of industrial change and restructuring during the last two decades in the context of globalisation and the entering of new actors onto the world market, there are many examples of a worsening of work conditions and labour relations throughout Europe where capital funds are not playing any role. Given this bankground, a challenge for social sciences research in the future will be to obtain and analyse, on the basis of sound methodological approach, comprehensive and reliable data that shed more light on the impact of capital funds on these topics. This also relates to the interesting question which is only touched slightly in the context of our study: The impact of private equity, hedge funds and sovereign wealth funds on different national social models as well as the Euro- pean Social Model of labour relations and the relationship between labour and capital. The crucial question here is whether capital funds will contribute to a harmonization of industrial relations with a strong bias towards the An- glo-Saxon model or other developments are more likely to happen. On the basis of results of previous research on the impact of multinational companies on industrial relations in Central and Eastern Europe it seems also likely that capital funds are adapting to national systems and alter the respective behaviour and management style according the existing company specific conditions and national frameworks.80

80 See for example: Kluge, Norbert and Voss, Eckhard (2003): "Managementstile und Arbeitnehmer- beteiligung bei ausländischen Unternehmen in Polen, Tschechien und Ungarn", in: WSI- Mitteilungen, Heft 1/2003. Voss, Eckhard (2006): “Laboratories of the new Europe: trade unions, employee interest representation and participation in foreign investment enterprises in central and eastern Europe, in: Transfer. European Review of Labour and Research, Vol. 12, No. 4, p. 577- 591. Final Data Collection Report as of 24 June 2009 71

5 The financial crisis and Private Equity: Implications for industrial change

5.1 Introduction This chapter analyses the impact of the financial crisis on PE and its implications for industrial restructuring. Although much of the analysis of the financial crisis to data has focused on the US subprime mortgage market, problems in other types of credit markets are becoming increasingly apparent. Currently a major crisis is developing in the leveraged buyout (LBO) industry in Europe, where PEFs have used approximately EUR 500 billion in loans to supplement their own equity investments of EUR 280 in European companies. Due to the deterioration in the economic climate many of the companies PE invested in will not be able to make scheduled interest payments. Estimates are that companies may default in up to half of this LBO debt in the next few years. Furthermore, even many companies that meet interest payments may be in trouble, since PE firms cannot find buyers to sell them to and refinancing is difficult, meaning that the principal on term loans has to be repaid by the target company. Even under favourable macroeconomic conditions PE investment results on the whole in job and wage losses, and this pressure is increasing under the strain of the financial crisis.81 However, this growing crisis threatens not only employment, working conditions and the quality of industrial relations in many companies, but also the goal of regaining financial stability. Large banks hold a significant portion of this LBO debt on their own books (estimates run between EUR 50-80 billion), and this amount is highly concentrated among a few major participants in leveraged loan origination. Further losses on these loans will result in more erosion in the capital of large banks and thus reduced ability to make new loans. Institutional investors (e.g. pension funds) also hold substantial LBO debt, and will have to sell off liquid assets such as publicly traded equities to meet cash obligations, putting further pressure on financial profits. Recent press reports on specific countries indicate that HF are major buyers of distressed debt, and that in some cases SWFs are being called upon to provide equity capital. As more and more target companies cannot repay their loans and/or PE-related loans reach maturity and cannot be paid back, the pressure for industrial restructuring – including a more extensive involvement of HF and SWF – will build.

5.2 The Current Situation in Private Equity As reviewed in Chapter 2, European private equity activity has been increasing at a very rapid pace over the past two decades. This activity reached a peak of about EUR 74 billion of private equity invested in 2007. By the end of 2007 the total value of the European private equity portfolio was estimated at just short of EUR 260 billion. 82

81 See here for example: Watt, Andrew (2008). 82 Although figures for 2008 were not available from EVCA at the time of writing of this report, information from other sources indicate that investment activity decreased dramatically in 2008. Final Data Collection Report as of 24 June 2009 72

Since the proportion of LBO deal financing provided by equity is roughly one third, then the value of LBO debt outstanding should be roughly twice the value of the equity portfolio. Since this was likely in the neighbourhood of EUR 280 billion by the end of 2008, then a very rough estimate of the face value of European LBO debt currently outstanding is EUR 500 billion. In fact the list of loans issued to finance LBO deals in Europe between 2003-2008 totals USD 627.2 billion – given the exchange rate and the fact that not all LBO loans are included in this data base, this comes close to the figure of EUR 500 billion. Given the structure of LBO debt financing, some of this debt would still be held by banks, some by institutional investors as outright loans, and some by institutional investors as CDOs (“collateralized debt obligations”). Since late August/early September 2008, however, the value of much of this outstanding debt has been severely devalued given a sea change in the market perception of risk. Investors’ estimates of the probability of default have increased greatly over the past year. Furthermore, the decrease in the value of the stock market by roughly half has made it more difficult for PE to exit target companies at a large profit. Larger packages of leveraged loans trade actively in a secondary market, and the current market price of this debt is a good indicator of the market perception of the probability of default of the issuers of this debt. As reviewed in Chapter 2, whereas this leveraged debt was trading at roughly 90-95 percent of face value at the beginning of 2008, the mark-to-market value of this debt had plunged to less than 65 percent by the end of 2008. Based on similar data, a study by the Boston Consulting Group and IESE business school found out that the loans of roughly 60 percent of LBO debt were trading at distressed levels, i.e. at levels reflecting market judgment of a very high probability of default (operationalized as a 10 percentage point spread above short-term interest rates (see graph). Distribution of Pricing of LBO Debt (end 2008)

Source: BCG-IESE Report (2008: 3).

Based on this data, the study derived the three-year cumulative default probability on the outstanding LBO debt (see graph below). This estimate is Final Data Collection Report as of 24 June 2009 73 that 49 percent of the issuer companies would go into default over the next three years.83 Cumulative default probability for 328 portfolio companies

Source: BCG-IESE Report (2008: 4).

Given the estimate of roughly EUR 500 billion of European LBO debt outstanding derived earlier, this would translate to defaults on approximately EUR 250 billion of this debt. In addition, approximately EUR 140 billion in equity investments by PE would have to be written off.

5.2 The crisis in Private Equity and its implications for financial stability Although some commentators have downplayed the dangers of PE for financial stability, the figures presented in the previous section show that PE activity has in fact generated a major risk for the financial system. Given the complexity of the PE financing process this risk is distributed along different parts of the system, including originating banks, institutional investors that have purchased LBO debt from originators, and also institutional investors who have invested directly in PE. The LBO debt problem contributes to the current financial crisis not only directly, through the partial writedown of LBO debt by originating banks. The financial system is also indirectly affected, as institutional investors are not realizing expected cash flow from LBO-related investments and resort to forced selling of other assets in order to meet funding obligations. These risk points are analyzed in turn. Large banks Large banks in Europe and the US have in large part shifted from a strategy of holding loans on their books until maturity to an “originate-to-distribute” financing model. In principle this allows banks to focus on generating income from the fees involved in loan origination. In syndicated loans, a particularly

83 BCG-IESE (2008): “Get ready for the private equity shakeout: will this be the next shock to the global economy?”. Final Data Collection Report as of 24 June 2009 74 large proportion of fees goes to the lead syndicator. As a result, originating banks are in principle not faced with the long-term default risks of this debt, and also do not have to tie up capital that would have to be set aside to act as a buffer for loan losses. It is widely understood that the Basle II capital adequacy agreement for banks has contributed to this process by setting low capital requirements for this type of activity.

Europe, Middle East & Africa: Leveraged Loan League Table, 2007 Rank Bank Holding Company Arranged # deals Mkt Share Loans (billion $)

1 Royal Bank of Scotland 123.4 295 7.70% 2 BNP Paribas 112.1 414 7.00% 3 Citi 87.1 232 5.40% 4 Barclays Bank 80.5 209 5.00% 5 Calyon 76.0 243 4.70% 6 Societe Generale 68.7 220 4.30% 7 Deutsche Bank 61.1 138 3.80% 8 JP Morgan 59.8 117 3.70% 9 HSBC 53.5 166 3.30% 10 ABN AMRO 52.4 169 3.30% Source: Reuters LPC (Loan Pricing Corporation).

Some large European banks have been very active in this activity, both within and outside of Europe. Figures from Reuters indicate that eight of the top ten banks in terms of volume of syndicated loan volume in the EMEA (Europe, Middle East and Africa) region in 2007 were based in Europe (see above table). On a global level, seven of the ten top banks were based in Europe. Although in principle risk is shifted to other investors by selling off the loans, in fact originating banks are subject to “warehouse risk” caused by lags between the time when they make a loan commitment and the time when the loans are actually sold. This time lag is greater for loans that are intended to be securitized, since the bank may have to wait awhile until loans from other LBO deals are available for packaging.84 A survey done by the European Central Bank shows that this risk is concentrated on the balance sheets of a few large banks.85 The net exposure to LBO debt for the top quartile of EU banks by exposure amounted to roughly 25 percent of Tier 1 capital. Furthermore, large banks are highly exposed to a small number of deals. The median exposure to the top five LBO deals in the portfolios of large banks following the “originate to sell” model amounted to 60 percent of the total LBO portfolio (see charts below).

84 Bank for International Settlements, Committee on the Global Financial System (2008): “Private equity and leveraged finance markets”, CGFS Paper No. 30. 85 ECB (2007): “Large Banks and Private Equity-Sponsored Leveraged Buyouts in the EU”.

Final Data Collection Report as of 24 June 2009 75

Source: ECB “Large Banks and Private Equity-Sponsored Leveraged Buyouts in the EU” (April 2007).

Since 2007 the degree of warehouse risk has increased dramatically, since institutional investors have been less willing to buy leveraged loans and banks have built up a considerable backlog of this debt on their balance sheets. As the value of outstanding leveraged loans plunged dramatically in the fourth quarter of 2008, banks have written down part of these losses. Due to lack of transparency in reporting, however, it is difficult to ascertain how much of this debt is still on banks’ balance sheets. The BCG-IESE report estimates that this amount is probably somewhere between EUR 50-80 billion, i.e. still a substantial risk to bank balance sheets and thus to financial system stability. Institutional investors Institutional investors are affected by the developing PE crisis in two ways: as purchasers of LBO debt, and as investors in PE funds. The LBO debt problem contributed to the current financial crisis directly, through the partial write-down of LBO debt, which reduced the value of institutional investors’ assets. However, institutional investors that invested directly in PE funds were affected in a second way due to the nature of the PE investment model. PE funds are generally established for a fixed period of time (typically for 10- 12 years), and during the fundraising process institutional investors make financial commitments up to a certain maximum amount. As limited partners (LPs) in the PE fund, institutional investors have little control over the timing and realization of PE investments. The firm managing the day-to-day activities of the PE fund (the general partner, or GP) can use this commitment flexibly by require institutional investors to provide cash on an as-needed basis. Furthermore, many investments are realized before the end of the PE fund’s lifetime. This introduces considerable uncertainty for the institutional investor regarding the timing of cash draw-downs and distributions. Since the financial crisis rendered projections of PE investment cashflows as much too optimistic, institutional investors were forced to sell other assets in order to meet funding obligations. As losses will continue to mount, institutional Final Data Collection Report as of 24 June 2009 76 investors may be forced to continue their selling of these other assets, keeping downward pressure on securities market prices.

5.3 Implications for the Micro Level In addition to the financial stability concern, another concern regards the impact of PE on employment levels and industrial relations at portfolio companies. Employee relations at many PE portfolio companies have been adversarial. As reviewed in Chapter 4, the most comprehensive study to date on the impact of PE on employment concludes that jobs are lost at many companies, with net employment falling an average of seven percent in portfolio firms in the two years after investment (compared to a control group).86 Given that these figures are averages, the actual job loss at many portfolio firms has been considerably higher. An extensive set of case studies has documented that industrial relations at many PE-owned companies has been adversarial, with rights to information and consultation being violated and extreme pressure exercised on employment levels, wages and working conditions in order to achieve profitability goals.87 A recent study by Moody’s of the largest PE firms also confirms the picture of considerable heterogeneity in financial strategies pursued (see table below). Although this study focused on US investments, many of the PEFs active there are also major investors in Europe. Furthermore, the situation of PE in Europe is similar to that of PE in the US. Some PEFs are less patient and more dependent upon financial engineering than others. In 46 percent of the companies analyzed dividends were extracted from the portfolio company prior to exit. For 20 percent of the companies dividends were extracted from the portfolio firm within one year of the initial investment, and in 28 percent of the companies total dividends extracted amounted to at least 80 percent of the value of the initial investment. As a result of this activity, the default probability of many portfolio companies increased, and credit ratings were downgraded at 33 percent of the companies. Given that these are average figures, the record of some PE firms was considerably worse than others. The PE firm Thomas H. Lee extracted dividends in less than one year from 38 percent of the companies it invested in, and also extracted total dividends of at least 80 percent of the value of investment in 38 percent of the cases. Not surprisingly, the credit rating was downgraded at a total of 63 percent of the companies this firm invested in. The PE firms Cerberus and Blackstone extracted total dividends of at least 80 percent of investment value in 57 percent and 40 percent of the firms they invested in, respectively.88

86 Davis, Steven et al. (2008). This study involved matching PE investment data with records for 5 million US firms and comparing employment changes to a control group of companies. 87 See here for example the report of the PSE group as well as the documented case studies sponsored by the Hans Boeckler Foundation (www.boeckler.de). 88 Moody’s Global Corporate Finance (2008): “Private Equity: Tracking the Largest Sponsors”. Final Data Collection Report as of 24 June 2009 77

Summary Data from Moody’s Study of Large PE Firms

5.4 Upcoming Problems in PE Target Companies Based on an analysis of data from SDC Platinum, it is possible to identify the magnitude of the refinancing problem over the next ten years as well as which companies will be running into refinancing problems in the next few years. The SDC Platinum “New Issues” database provides a list of LBO loans indicating the date on which the loans were made, the maturity date of the loan, the characteristics of the loan (term or revolving loan, seniority of loan), and the issuing company i.e. debtor. Based on this data, the following amounts of LBO debt for European companies will be coming due over the next decade. In all SDC Platinum identifies USD 627 billion of debt issued to finance LBOs in Europe between 2003-2008 (see table below). For USD 146.6 billion no maturity date was identified. Given that LBO loans typically have a maturity of 5-10 years, the first debt from the 2003-2008 period is starting to come due – in all USD 8.5 billion in 2009, but thereafter rising rapidly to a peak of USD 148.2 billion in 2014. Maturity Schedule for European LBO Debt Issued between 2003-2008 Year of Maturity Amount (USD billions) 2009 8.5 2010 20.5 2011 41.2 2012 59.4 2013 97.4 2014 148.2 2015 134.8 Final Data Collection Report as of 24 June 2009 78

Year of Maturity Amount (USD billions) 2016 81.4 2017 29.8 2018 6.0 not identified 146.6 Total 627.2 Source: SDC Platinum.

Furthermore, the timing of maturity and amount due can be identified for individual companies with SDC Platinum. The table below shows companies for which LBO-related loans of over USD 500 million are coming due from now until the end of 2011. Given that LBO debt is typically divided up in a number of trenches, the individual entries in almost all cases represent only a fraction of the total debt outstanding for the company. Maturity Schedule for LBO Debt over USD 500 Million Until Dec 2011 Maturity Issue Issuer Nation Principal Type Date Amount of ($ mil) Security

06/30/09 01/16/04 UPC DISTRIBUTION Netherlands 1,326.4 Term Loan HOLDING BV

09/10/09 09/10/04 QinetiQ Group PLC United King- 539.3 RevCred/Term dom Ln

09/23/09 09/23/08 Securitas Direct AB Sweden 974.3 Term Loan

10/31/09 10/31/06 France Printemps SA France 738.9 Bridge Loan 04/08/10 04/22/05 East Surrey Holdings United King- 825.0 Term Loan PLC dom 05/14/10 05/14/04 Debenhams PLC UK 556.9 Term Loan A 06/16/10 04/02/05 Arindo Global Netherlands 600.0 Term Loan

06/22/10 03/03/04 Auna Spain 4,241.9 Term Loan 09/06/10 09/06/04 Cholet Acquisitions Ltd United King- 1,059.0 Term Loan dom

09/21/10 09/21/05 National Car Parks Ltd United King- 588.0 Term Loan dom

12/21/10 03/03/04 Auna Spain 1,212.0 Rev Cred Fac 02/18/11 11/30/05 TDC A/S Denmark 2,762.1 Bridge Loan 06/09/11 06/07/08 Angel Trains Ltd United King- 1,605.5 Term Loan dom

06/24/11 06/24/04 Automobile Association United King- 730.2 Term Loan dom

07/23/11 01/16/04 Vivarte SA France 512.0 Term Loan A

08/03/11 08/03/06 SAUR France 550.6 Term Loan Final Data Collection Report as of 24 June 2009 79

Maturity Issue Issuer Nation Principal Type Date Amount of ($ mil) Security 10/27/11 10/27/08 Porterbrook Acquisition United King- 805.0 Term Loan dom

11/15/11 11/15/04 Automobile Association United King- 784.7 Term Loan Ltd dom

12/08/11 10/29/04 Saga Holdings Ltd UK 505.9 Term Loan

12/12/11 12/07/06 Wind Acquisition Fi- Luxembourg 1,793.3 Term Loan nance SA

12/12/11 12/07/06 Wind Acquisition Fi- Luxembourg 500.0 Term Loan nance SA

12/15/11 12/15/06 Herkules Group Germany 1,151.1 Term Loan

12/21/11 12/21/04 Corleoni Investment United King- 985.2 Term Loan LTD dom

Source: SDC Platinum. Final Data Collection Report as of 24 June 2009 80

6 Conclusions

The rapid growth of private equity funds, hedge funds as well as sovereign wealth funds in recent years in the context of the globalisation and in particular the internationalisation of financial markets has caused an increased interest in the question of the impact of these investment vehicles on industrial and economic change in Europe. In particular the practice of activist investors actively involved in restructuring processes and change at the enterprise level has also resulted in research activities and controversial debates on the concrete impacts on employment, labour relations and working conditions. The global financial and economic crisis has resulted in a further debate on the role of private equity and hedge funds in particular both in the context of accelerating crisis and economic downturn as well as with regard to developing suitable solutions for recovery. From the analyses and evaluations carried out in this data collection report some general conclusions with regard to the functioning of private equity funds, hedge funds and sovereign wealth and their impact on industrial change in Europe can be drawn which are summarized in this final chapter. There is a growing importance of PE, SWF and HF as investors amongst industries and economies in Europe. However, the lack of transparency and availability of data hinders sound impact analyses. While the relative size of HF, PE and SWF may seem modest at a global level, the relative importance of the first two types of investors is increased by the use of leverage of 2-3 times own capital and by the concentration of many activities within certain markets. Our analyses of the most important funds of each of the three types reveals a significant variety of investment strategies and targets as well as common features. At the same time the lack of transparency in PEF, HF and SWF reporting is striking, which creates a serious problem for evaluating the impact of these funds. On the fund level decision makers are generally not required to publish data accessible to the public at large, and the quality and accuracy of information that can be gained through data bases is uneven. On the company level the reporting requirements for private (non-listed) companies vary considerably from country to country, as does the mode in which this information is made available to the public. Furthermore, companies often change name when ownership is transferred due to an investment transaction. As a result, it is virtually impossible to present the large and comprehensive dataset of private companies with the detailed information needed for a sophisticated econometric analysis. Likely impacts on industrial change differ according to differences in business models Private Equity, Hedge Funds and Sovereign Wealth Funds in general follow different business models which also influence their behavior and specific expectations as investors and/or owners. Differences exist for example in the Final Data Collection Report as of 24 June 2009 81 type of investment made and in the time horizon, which is in some cases very short-term and focusing on liquid financial assets. In contrast Sovereign Wealth Funds generally pursue a long-term agenda which follows not only financial but also national economic policy goals. Beside these general differences between the funds it is also important to stress differences within certain types of funds and differences with regard to the role of these funds in different stages and situations of business development, e.g. a start-up situation, growth phases, merger and acquisitions, turnaround and crisis situations. Since these forms of business development all either will follow or result in industrial change at the enterprise level it is important to assess the role of the three types of funds taking into account these different stages/situations of company development. Private Equity With regard to investment strategies, our study confirms the general observation that, with regard to micro-economic change, only the private equity business strategy of majority investments and actively managing and influence change of the target companies has a direct impact on industrial change at the operational level in the enterprise.

One of the most important potential strengths of Private Equity is the ability to provide risk capital to companies at the very beginning of the innovative process (seed and start up capital). PE firms can also provide capital where most other investors would not be willing to (e.g. turnaround or restructuring phases). Also on the positive side for PE are the potential wider impacts (i.e. opportunities) for the economy as a whole, including the creation of value, increase in innovativeness, adaptability and competitiveness, and economic growth and job creation. On the weakness side for PE at the micro level is the potential presence of externalities, i.e. the possibility that PE firms will reap financial rewards at the cost of others. PE has also been criticized for having an overly high profit expectation which is not sustainable in the long run and for sometimes having too short of an investment horizon (some industries need more than a 4-5 year perspective). Potential negative impacts at the macro level (threats) result mainly from the extensive use of leverage in PE deals. If financial targets are not met (e.g. if sales decrease because of a downturn), the potential of bankruptcy and job loss increases because the company is under a heavy debt burden. Hedge Funds It is important to stress crucial differences between hedge funds and private equity investments and specificities of the HF business model. Hedge funds generally are not an investment vehicle seeking majority ownership or directly influence management decisions and restructuring at the enterprise level. While hedge funds invest in a broad variety of asses classes with investments in private companies only being one optional target, most investments are minority share with buying and selling in a very short period of time without any active influence on economic change. The only HF type of activity having a direct impact on restructuring processes at firm level are Final Data Collection Report as of 24 June 2009 82

“activist hedge funds” which directly seek to influence economic change by gaining a majority influence on the decision making process. Positive impacts of Hedge Funds at the micro level (strengths) include the potential to increase the value of listed companies through pushing for more efficient governance structures or organizational structures (e.g. spinning off non-core areas). Especially recently HF have been one of the most significant actors as a "buyer of last resort" willing to purchase risky/distressed securities. At a macro level, HF may increase liquidity in markets by their willingness to buy and sell over very short periods of time. Potential negative impacts at the micro level (weaknesses) include a very short term orientation, which in the case of some funds can be measured in months, days or even minutes. The simultaneous pursuit of short term strategies by a multitude of HF can lead to herding behavior, which can distort incentives at the micro level. The lack of transparency of many HF can also make it difficult if not impossible for investors to evaluate the risks they are facing. Finally, HF may achieve short-term profits by shifting costs to others without any additional value creation (externalities). At a macro level, threats through HF include systemic risks caused by leverage (particularly to banks providing loans to HF), which can be accentuated through the pursuit of high-risk strategies or a focus on financial engineering. Sovereign Wealth Funds

Sovereign Wealth Funds differ significantly from both private equity as well as hedge funds (though sovereign wealth funds also invest in these two capital funds types). As state-owned financial institutions Sovereign Wealth Funds operate on a long-term agenda aiming not only at stable long-term financial returns but also following wider national economic policy goals. A potential positive impact of SWF at the micro level (strength) is the longer- term orientation of SWF compared to many other financial investors. SWF are also increasingly the buyer of last resort for many companies, particularly in the financial sector during the current financial crisis. At a micro level SWFs however have potential negative impacts (weaknesses) insofar as they threaten the autonomy of national stakeholders and increase the potential of conflict due to cultural differences. This conflict potential may be increased due to the lack of transparency in the activities of many SWF. At a macro level, SWF may represent a potential threat insofar as they pursue strategic national and political interests. A significant patchwork of empirical evidence on impacts on industrial change Analyzing the findings of empirical surveys as well as case study evidence one can see that there is not a black or white picture of real and/or likely impacts on industrial change. One can find proof and arguments for a short term negative impact on employment at company level. But there is also proof for a weak positive long term impact on the overall employment level in general. Similar to the issue of job creation, the impact of alternative investment strategies on wages and other aspects of working conditions is highly controversial and there are large variations between conclusions of business- Final Data Collection Report as of 24 June 2009 83 oriented surveys and studies on the one hand and more critical studies on the issue, which are often based on case study evidence. Additionally we find there is hardly any significant research on the impact of PE, HF and/or SWF investments on social dialogue and information and consultation practice at the company level. Though there also are no clear results regarding the impact of the three types of funds on company performance and value creation it is quite obvious that the emergence of PE, HF and SWF as a European wide phenomenon has contributed to an acceleration of restructuring, performance benchmark- ing and efforts to increase the competitiveness of companies and work. Research findings and in particular available case study evidence – although nuanced – on labour relations, working conditions, wages and bargaining processes at company level suggest that workers in target companies are on average are treated as one source of “value creation” and thus profits for private equity funds. However, one should be extremely cautious to conclude from this that employees in fund-backed companies are treated worse or “squeezed harder” against the lack of any matched-pair comparison and/or counterfactual. In particular in the context of the economic environment and the general acceleration of industrial change and restructuring during the last two decades in the context of globalisation and the entering of new actors onto the world market, there are many examples of a worsening of work conditions and labour relations throughout Europe where capital funds are not playing any role.

This also relates to the interesting question which is only touched upon slightly in the context of our study: The impact of private equity, hedge funds and sovereign wealth funds on different national social models as well as the European Social Model of labour relations and the relationship between labour and capital. The crucial question here is whether capital funds will contribute to a harmonization of industrial relations with a strong bias towards the Anglo-Saxon model, or whether other developments are more likely. On the basis of results of research on the development of corporate culture and labour relations in Central and Eastern Europe it also seems likely that capital funds are adapting to national systems and alter their respective behaviour and management style according to the existing company specific conditions and national frameworks. In this respect a challenge for social sciences research in the future will be to obtain and analyse on the basis of sound methodological approach, comprehensive and reliable data that shed more light on the impact of capital funds on these topics. Impact of the current crisis An important question to be addressed in the context of the current economic situation regards the impact of the financial crisis on private equity and other forms of capital investment and the implications for future industrial change in Europe. Final Data Collection Report as of 24 June 2009 84

Based on existing evidence it seems likely that PE activity has in fact generated a major risk for the financial system. Given the complexity of the PE financing process this risk is distributed along different parts of the system, including originating banks, institutional investors that have purchased LBO debt from originators, and also institutional investors who have invested directly in PE. Large banks and institutional investors are effected. On the micro level, the default probability of many portfolio companies is increasing, and credit ratings were downgraded. These facts will destabilize PE firms and the companies in which they are invested. We have tried to identify the magnitude of the refinancing problem over the next ten years as well as which companies will be running into refinancing problems in the next few years. On the macro level the risks for banks who have made these investments is considerable. The amount to write off loans is still a substantial risk to bank balance sheets and thus to financial system stability. Political recommendations In particular also against the background of the current economic crisis situation the following measures should be discussed: The transparency of the PE, HF and SWF industry needs to be increased through the passage of binding reporting requirements regarding strategies of funds, level of risk, and detailed information on the financial and employment status in each portfolio company. A binding regulatory framework creating a level playing field for all collective investment vehicles (i.e. including PE, HF and SWF) needs to be created and enforced. A detailed and immediate assessment of the ownership of LBO debt (as well as other high-risk debt) and the extent of its risk to financial stability needs to be carried out. The legislative and regulatory environment needs to be reformed to re- strict the use of high-risk LBO finance (including covenant-light and high leverage financing models), to ensure that stakeholders retain a voice in restructuring and recapitalization operations (e.g. special dividends), and to discourage tax-driven LBOs. A European rating agency should be considered, which would provide objective ratings on the financial soundness and default probabilities of issuer companies, as well as on a broad range of environmental, social and governance (ESG) criteria. Ratings should be mandatory for all issues above a certain size (e.g. EUR 100 million). European institutional investors should be allowed to make substantial investments (e.g. EUR 100 million and up) only in foreign companies that have also been rated by this agency. Finally, with regard to the regulative gap in the context of ownership transfer and employee’s information and consultation practice it seems necessary to adjust information, consultation and participation rights in Europe according to the need of workers being informed about the economic status of their company and more effective bargaining rights before PE deals are consummated, during the restructuring process, and before exit.

Final Data Collection Report as of 24 June 2009 85

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