Private equity: Job killer or creator?

Presidential hopeful Mitt Romney has released his tax returns.

Kai Ryssdal: Remember how we told you yesterday super PACs are changing the dynamics of presidential campaigns? That they can spend almost as much as they want -- on almost whatever they want -- to further the candidate of their choice?

The super PAC in the news today is called Winning Our Future. It supports -- to the tune of millions of dollars -- would-be Republican nominee Newt Gingrich. And it's doing so most prominently with a 28-minute video it released today criticizing, sharply, Mitt Romney and the private equity firm he founded, Bain Capital.

Those two words -- private equity -- are defining at least this leg of the Republican primaries. But what private equity is and what it does isn't alway that clear. So we've called Josh Rauh to explain. He teaches finance at the Kellogg School of Management at Northwestern University. Good to have you with us.

Josh Rauh: Thanks good to be here, Kai.

Ryssdal: In the simplest possible terms, what is private equity?

Rauh: Private equity is when a group a partners or people with some money buy companies with the idea of selling those companies back to other people in the future for a profit. Simple as that.

Ryssdal: Well, maybe that was a little too short. Is there an analogy that's going to help me understand this?

Rauh: Sure, well I guess it would be kind of like buying a used car, fixing up the car, selling it back to somebody else in the future, but there are some key differences with that. First of all, the people who buy companies and private equity funds, they are raising money from outside investors to do this.

Ryssdal: Right.

Rauh: So instead of buying the car with my own pocket money, I would be out to wealthy investors. In the case of private equity, these are pension funds and endowments -- like the California Public Employee Retirement systems, which invests money on behalf of public sector employees. Other investors include, sovereign wealth funds and university endowments. And raising money from them, buying companies with that money, selling those companies back later -- hopefully for a profit, splitting the proceeds with the investors who gave me the money in the first place.

Ryssdal: All right, but the thing about private equity, though, is that they don't always fix things up. I mean, the big knock -- that surely you've been reading in the papers -- is that private equity goes in and they strip out costs, they get their profit out and then they spin it around and go back to the market.

Rauh: Well, the discussions that are going on around private equity today are happening in a very politicized environment. On one hand you have supporters of Mitt Romney who are painting private equity as being this glorious thing where companies are bought and thousands of new jobs are being created. On the other hand you have opponents who want to paint private equity in a very negative light and argue that thousands of jobs are being destroyed. Now what that really masks is the fact that there is a huge range of activity that goes on in private equity. And academic studies have shown that -- on average -- the employment effects of private equity are really very small. So, on average there's really not much evidence that private equity either creates a lot of jobs or destroys a lot of jobs.

Ryssdal: Well, when private equity sends out a prospectus -- or whatever they send out -- do they list in there somewhere "We're going to create jobs," or prospectus do they say "We're going to maximize return for our investors?"

Rauh: The stated goal of private equity is always the maximization of return for investors. There is no stated objective of private equity to create jobs. And you can imagine profitable investments that involve job creation and ones that don't involve job creation. And the reality is that there is a vast range of types of private equity and different strategies of trying to buy companies and make money from those purchases and sales. The fact that it's called "private equity" reflects the fact that the information of about these transactions is largely private. The only really good source of all of the transactions is going to be the investors themselves.

Ryssdal: The firms themselves, though, they do all right. They get -- what? -- 2 percent of all investments and 20 percent of profits is the standard rule.

Rauh: That's the standard rule.

Ryssdal: Which when your talking big investments is a lot of money.

Rauh: Certainly, but private equity investors also have skills. Anybody who tries to get into the business realizes that it's actually quite difficult to make money in private equity.

Ryssdal: Joshua Rauh teaches finance at the Kellogg School at Northwestern University. Josh thanks a lot.

Rauh: Thanks very much Kai.

About the author

Kai Ryssdal is the host and senior editor of Marketplace, public radio’s program on business and the economy.

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