Tereza Tykvová and Mariela Borell co-authored a study last fall with the title, “Do Private Equity Owners Increase Risk of Financial Distress and Bankruptcy?” which reaches a paradoxical seeming pair of conclusions. First, they say, yes, distress risk does increase after a buy-out by a private equity firm. Second, they say, no, PE backed companies do not experience higher bankruptcy rates than non-buyout companies.

The apparent paradox is due to selection bias, although Tykvová and Borelli, who are both affiliated with the Centre for European Economic Research in Mannheim, Germany, don’t put it precisely that way.

What they do say is that PE investors “select firms which have a lower financial distress risk than comparable companies.” Since they select low-risk firms, they are selecting firms that can bear some increase of distress while still remaining comparable with non-buyout firms in terms of the likelihood of a bankruptcy. Thus, PE backed companies “do not suffer from higher bankruptcy rates than the control group” within three years after the buyout.

Politics and Easy Credit

Their database is Europe’s, because Europe’s more stringent disclosure requirements give them a richer base of data with which to work, and because Franz Muentefering, former chairman of Germany’s Social Democrats, provided their paper with its epigraph: “Some financial investors … remain anonymous, do not have a face, pounce upon companies like swarms of locusts, graze on them and continue on their way. We are fighting against this form of capitalism.”

Recent political developments in the U.S. would also suggest that suspicion of the modus operandi of PE firms has some salience on this side of the North Atlantic, too.

Of the transactions in the database Tykvová and Borelli employed (all drawn from the period 2000-2008), the largest number took place in France (441) followed closely by the U.K. (414). Considered by industry, roughly a third of these transactions involved the purchase of companies in the manufacturing, mining, and quarrying markets (618 of 1842). The trade, transportation and storage industry is a distant second.

Tykvová and Borelli certainly contribute to one’s sense that the “locust” charge is just a politician bloviating. They note that even “those companies subject to buyouts in years when cheap debt financing was available did not suffer from higher bankruptcy rates than other buyouts and non-buyout companies.” In other words, even when it would have been easiest to load up a takeover target with debt, use that refinancing to pay dividends to the “faceless” PE investors, and then let the firm founder, that course of action was not adopted.

Syndication or Stand-Alone

The paper also addressed the relationship between risk and the syndication of a PE deal. An optimistic reading of syndication might be that it brings in investors with complementary skill sets, so a portfolio company acquires a deeper potential pool of financial resources than it would from acquisition by a stand-alone investor.

A pessimistic reading, on the other hand, might stress that syndication creates agency costs. One investor in the syndicate might be taking another less-well-informed investor on only for the low-quality deals. Once the deal is done, too, there may well arise free-rising or moral hazard issues among the investors.

Their research shows that syndicates generally buy companies in greater financial distress than the companies purchased by stand-along investors. But Tykvová and Borelli didn’t find any factual support for either the optimistic or the pessimistic view of what happens next. So far as their data can illustrate, it is a matter of indifference to a portfolio company whether it is acquired by a stand-alone or a syndicate.

They end with allusion to their continued research in this vein. They expect to “take a closer look at the heterogeneity of private equity investors in Europe,” in particular at the distinction between independent PE investors and bank-related PE investors. They hypothesize that these institution’s “differing goals, know-how and governance structures may have important effects on the way in which they create value in the portfolio companies.”