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- [00:01]
A
You're listening to is business broken? A podcast from the mehrotra institute for business, markets and society at boston university questrom school of business. I'm kurt nickish. We are currently witnessing one of the great migrations of capital in history. Behind the scenes, the public economy we thought we knew is being quietly dismantled in and rebuild. Today, more wealth than ever is flowing out of the more transparent stock markets and into the hands of private equity. A world governed by different rules and much less sunlight. As PE moves into healthcare technology, local utilities, and even your own retirement fund, it has become a bigger part of the economy than most people realize. And as private equity's footprint grows, so does the debate over its social function. Has this industry actually made the economy better, more efficient, innovative and productive? Or is it a plunder machine loading the system with risks and hidden costs? Today we're asking, can private equity be changed to better serve social and economic good? If this is where the money is flowing, what rules and safeguards do we need? Joining us today to talk about this are three experts who are actively engaging with this industry in different ways, starting with Danny Wadhwani, private equity investor and co founder at thinklight. Danny, thanks for joining us.
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B
An honor, sir. Thank you.
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A
We're also joined by Thomas Walman, Associate professor in Markets, Public Policy and Law at BU Questrom.
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C
Thank you.
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A
And Gretchen Morgenson, Pulitzer Prize winning investigative journalist at NBC News and co author of the book these Are the Plunders How Private Equity Runs and Wrecks America. Gretchen, glad to have you here.
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D
Thank you so much.
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A
Tom, can you help set the stage? What is private equity and how does it fundamentally differ from the way a company operates on the New York Stock Exchange?
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B
Sure.
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C
Private equity firms for the most part will raise money from institutional investors. These would be like foundations or pension funds or university endowments. And then they'll deploy that capital by buying firms. Usually they have the idea of exiting those investments or selling them off about three to seven years later. And usually they're employing a lot of leverage, which is to say for every dollar that they put in, they're typically borrowing between about $2 and $3 of other people's money.
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A
When you say they put in, you're talking about the private equity investors themselves or the institutional investors together.
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C
So the private equity firm and the
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A
institutions, so the PE firms put in a little money too, but they're employing
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C
a lot of leverage. And that differs from public equity in that typically you don't see the extreme amounts of leverage that are deployed. And also you could imagine many other things changing. Like, for example, you have very strong incentives usually for the private equity firms to return the capital back to investors quickly and at a high return.
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A
Now, when we look at the sheer scale of this, like, how does the amount of assets under management in PEN compared to public markets, it's tough to
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C
measure because they're coming in and out. But on an acquisition basis, private equity is probably roughly the size of all the M and A that's getting done by public equity companies today.
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A
So it's active, but they're buying and selling.
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C
Precisely.
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A
I've heard 10% of the market is considered private, while 90% is public. Is that way off?
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C
That's probably about right. But I think it's also important to keep in mind that there's many sectors that private equity aren't really investing in, whereas others they're very active in. So there could be somewhere, sure, it's close to zero, like public utilities, for example, but in other areas, like we'll probably get into medical practices or even devices, you see a lot of private equity exposure.
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A
Everybody. Why is so much wealth from pension funds, family offices, institutional investors? Why is that not being invested in the public markets and finding a home in private markets instead?
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C
I think the simple answer is that the. Generally speaking, the reporting requirements are somewhat onerous on public companies, and that has been increasing since the Enron scandals. That makes it expensive to run a public company. You've got auditing costs and otherwise. And as a result of that, many firms have opted to go private.
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A
Gretchen, why is a lot of the money going into private markets from, you know, what you've reported on, what you've seen?
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D
Well, I think part of it is certainly the executives of these companies get huge payouts to sell their companies to private equity. And yes, to some degree, there is a onerous aspect of the public reporting system where investors want. Want to know how the company is doing every quarter. But I think that it's really been driven by the amount of money that has been poured into this asset class, meaning that in the early 2000s, private equity was returning pretty good outsized gains to investors. And so more and more pensions, more and more endowments, et cetera, decided that they needed to get into private equity. And so that demand for those services and for those firms and the business that they conducted, I think played a very big role.
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A
Danny, let me bring you into the conversation. You are in private equity. From your perspective, why is a lot of the money going back to businesses like yours an attractive tool?
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B
So Thomas said It precisely in the beginning, I really think that it comes down to efficiency, efficiency of capital. Once upon a time, the public governance was an access to scale and came at a cost that from a risk return standpoint, it made sense and therefore you would go public. So from an institutional standpoint, the governance has only gotten harder and therefore more expensive. Whether it's expensive in terms of dollars, in terms of energy, in terms of people. So there comes a point where if you were trying to embark on a game and there was a part that was more cost efficient or more cost effective, in the spirit of winning the game, private equity seems to be a better tool.
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A
Well, you've lived this transition, right? Three years ago you took World Energy Services private. And as an investor and a leader, why did you make that move? It sounds like governance is one thing, but it's also you get to be a much more active investor that way than if you are putting your money across a portfolio or into certain businesses
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B
by buying stock 100%. I think this is a perspective that it's something that I've learned only by being a private investor. Growing up admiring private equity, then thinking of it as an evil, then understanding how public companies work, and then realizing beyond all that, it comes down to who is the leader or who are the group of leaders, what are they trying to accomplish and are they serving that goal, that purpose of the business. So World Energy, for example, we dive into that. World Energy is public for over 11 years. They were first Nasdaq listed and they got acquired by Enernoc and then they got acquired by Excel Fleet and they got acquired by Spruce. And we took them private. And we took them private because one cost, it would allow us to allocate that cost more towards growth versus towards governance. We took them private because flexibility. Now we no longer have the pressure of reporting quarterly results, but we have patient capital that can actually build for longer term in the future. So the race became more a marathon versus a quarterly sprint. And we took them private because now we could create multiple waterfalls of income. This was a very well known Esco in the Northeast. Esco is an energy services corporation who essentially worked at the utilities, but they were able to, while being private, add new divisions, expand those divisions, touch new territories, and do it all at a pace that would not have been possible using resources that were once upon a time allocated towards just supporting the public nature of it, and essentially be a lot more efficient. So for every story where private equity has been the big bad wolf, there's also a story where private equity with the right access and intention and spirit of using the private equity tools and leverage that's available have created success stories or good social impact.
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A
It sounds like you're working with the management team at this company to sort out a lot of these business questions and make decisions.
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B
Indeed, it's something that I realized was necessary because the energy flows from the top. And therefore, if there is true intent to expand energy efficiency and create more sustainable projects and scale that in a manner that allows the people to do better work, to break it down, imagine public or private equity is like a lemonade stand. If the goal is to sell good lemonade, then you're not going to cut costs on the lemons and you're not going to use fillers and you're not going to underpay the kids serving the lemonade stand. You're going to do it in a way where everybody wins. And I think that has become something that I realized over time was necessary in writing the new chapter of World Energy, which is why we took them private.
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A
Okay, Tom, let's look at the data. You study this industry as part of your research focus on sort of mergers and acquisitions. When PE works like it does in textbooks, what does that success actually look like? Like, what do researchers look for to see that PE made better lemonade?
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C
If private equity is working well after those acquisitions, we would expect firms to be more productive and more innovative. Broadly, I think the most convincing evidence is that after acquisitions where the private firm is being acquired and it's tight on capital, so these would be periods where, for example, liquidity is relatively tight, we see what we would look for, which is greater labor productivity and an expansion in employment. Although existing studies really haven't demonstrated this yet, what you might go a step further and look for, and I think future scholars will look for, would be lower prices to the consumer, higher quality products out there, and an expansion of output.
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A
Got it. It does seem harder to study, right? Certainly you can't look at profits, you can't look at margin expansion. There are a lot of things that you might get from public company reporting that you just don' when you're looking at PE funds.
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C
Exactly. You've got to go inside the business and look at exactly how productive the capital is and how productive the labor is.
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A
Okay, Gretchen, your latest book doesn't pull any punches. It's titled these are the Plunderers. What's the pattern of behavior that convinced you that this industry wasn't just fixing, improving, growing companies, but in many cases, wrecking them? Plundering Them.
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D
Well, first of all, I'd like to tip my hat to Danny. If he has done what he says he does, and I have no reason to believe he hasn't, then is doing the right thing with his company. Unfortunately, what he has done with that company is not what many of the large private equity firms end up doing with the companies that they take over. I too hope that there is going to be research on what happens to these companies, because when I was researching my book, it was a question that I had for the big firms. I said to them, you know, my thesis is that these companies can destroy jobs. They harm taxpayers, they harm pensioners. They go bankrupt far more often because of the heavy leverage. So please tell me what I'm not seeing, you know, when I'm finding those results. And Blackstone had a very interesting answer for me. Blackstone is one of the most preeminent private equity firms in the country. And so their spokesman said to me, you know, over the past 15 years, we've created 200,000 net new jobs. And I said, well, that's a fantastic number. I would love to learn more. Please supply the data for that. And a couple of days went by, and then I got an email saying, we decline respectfully. So, you know, you see numbers like this thrown around. I've seen actually that figure in press reports about Blackstone, but there's. I have not been allowed to see the data behind it. You know, as Ronald Reagan would say, trust but verify. And I was not able to verify. So the problem to me is that in the cases where private equity is doing the wrong thing, serving itself first and foremost, there is a very large circle of pain around it. So you have very small group of people benefiting substantially, remarkably so. And you have other people, vast numbers, greater numbers of people, who are potentially harmed by these practices. And again, it's employees being laid off. It's consumers really not having high quality goods they once had before the private equity firm was took over the company. In health care, this is especially, especially dangerous. And there has been a tremendous amount of research showing the really pernicious outcomes that occur when health care operations are taken over by private equity companies. If you're a hospital company or some other sort of health care operation, cutting costs so that you can create the efficiencies that your business model requires, that has real negative impacts.
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A
A lot of what you described there sounds familiar because it's also a criticism of just modern capitalism and investor class versus company employees and the tensions between them. There is an issue with wealth Inequality between investors and people who don't own stocks. Right. How does private equity make this worse?
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D
Some people call private equity capitalism on steroids. I think that a big factor here is the heavy debt loads that are loaded onto these companies. When the company goes bankrupt, it is really not the private equity firm that's harmed. And so that's a situation that I think leads to an inequity that is problematic. I believe that there are just a few, a very small slice of winners and just an awful lot more losers.
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A
Tom, your recent paper. We're going to pull out another great title here. It's called Painful Bargaining. It dives into the world of roll ups in the anesthesia industry. What is a roll up and why did that become a common playbook for PE firms?
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C
Yeah, a roll up is pretty simple. So you've got a what in industry jargon would be called a financial sponsor, but is oftentimes a private equity fund. It's going to organize and finance a series of investments in a market. In particular, the private equity fund is going to make a first acquisition in a market. And the target firm there is often called the platform in say, industry jargon. And then what the private equity fund is going to do is inject capital into the platform to acquire other firms in the industry, oftentimes which are competitors. This started out as a sort of niche investment Strategy in the mid-1980s, but it has grown spectacularly since then. I think by most counts, rollups today comprise about 80% of all private equity transactions. And so it is remarkably profitable. If you want to understand private equity, then you've really got to be looking at the roll up as a strategy.
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A
Got it. You looked at the anesthesia industry.
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C
Anesthesia is particularly interesting because it's the site of very recently the first roll up based antitrust case in US history.
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A
Okay. I mean, you found that rollups sharply raise prices.
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C
That's right. So first we looked at market structure. We wanted to know, were rollups the principal determinant of concentration in these marketplaces? That was certainly the case. And then naturally you'd want to study what happens to price. We found that prices upon acquisition rise about 20% and over the next three to four years increase about another 20% for a total of about 35 to 40%. So if you're thinking about nationwide healthcare expenditures, you've gotta be thinking about private equity and in particular roll up transactions. Now, I guess a natural question to follow up would be were there other changes like quality that would, for example, offset these changes? We did not find that. Gretchen had alluded to other studies which have suggested that quality declines, for us, at least in anesthesia, the problem was higher prices.
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A
What would the firm that bought those say? They would say those anesthesia clinics just weren't pricing well enough. Like they just had a poor pricing strategy, and we fixed that.
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C
You know, you could think of this as a sort of business strategy where you go in and you identify practices which were underpricing, but there's really no evidence of that. And one way to think about that is I'd mentioned before, when the private equity fund goes into the market and they do that first acquisition, commonly called an industry jargon, that's a platform acquisition. If the strategy of a private equity fund was to go in and identify practices that were not charging as much as they should, so to speak, we would have expected prices to increase following those acquisitions. Nothing, no impact on prices whatsoever. It was really in that second or that third or that fourth acquisition in the market where competition is being impacted, that's where we saw the price increases.
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A
Okay, so you're saying that, you know, the key for investor returns is to gain the market power so that you can squeeze the consumer, squeeze the hospital, whatever your customer or client is, but just generate better returns through essentially the same business.
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C
Definitely. And in fact, the FTC has alleged exactly that. In the court documents related to the litigation that I described right out of the horse's mouth from internal communications, it appears as if that was exactly the strategy.
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A
Why didn't the FTC block these sooner right when they were first?
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C
That's a good question. I have a lot of work showing that U.S. antitrust enforcement, when they are aware of a transaction, is very good at blocking the harmful deals. The problem is with the rollup. Individual deals are comparatively small, and so they fly below the radar of the agencies. Deals typically today need to be valued at about $100 million, or else they're just not reported to the Federal Trade Commission and the ftc. And so in the litigation that I was alluding to earlier, it took about 10 years for these deals to be discovered.
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A
So Danny, Gretchen and Tom just described a set of ways that roll ups and value extraction caused harm. As somebody who believes in this model, how do you respond to that critique that it's about financial engineering and market dominance at the expense of the public?
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B
So at the end of the day, it's more a governance issue. So in the example Gretchen had given on the private hospital definitely needs more governance because human incentives is what promotes this bad behavior. And It's a fact that the private equity has less supervision. Now with a public company you may also have the greater need to perform in a timely manner. So you cannot have as much patience as the right private equity can afford you. So this publicly traded health company, we might as well have had the same pressure of increasing prices or cutting costs because they have to show good results. No public company stock is going to just go up because they did the right thing. So on both sides of the coin, I think it comes down to the incentive and the incentive is the same. Look at Musk for example. Public organizations, whether you do it in a righteous way or you do it in a greedy way, like some execs who have multimillion or billion dollar pay packages, public company or private company, it's not like the public company is genuinely creating greater welfare or good. It's absolutely outsized returns anyway. So you know, on that I say it really depends on the industry, really depends on the individual. A few years ago, the MGM Springfield was built in Springfield, Massachusetts. This is a casino, privately held but owned by mgm, which is publicly traded. And they had promised the town of Springfield that they would create somewhere between two and 300 jobs within 24 months of opening. So far the total net jobs we've created sits at about 170. Now one of our developments and a partner together with I own the Tower Square commercial office building in Springfield, Massachusetts, privately held. We had told them that we would create about 300 jobs over the next 24 months because we had to bring in some new tenants, some new office spaces, revive it. And with his grace, to date we've created in that building just under a thousand jobs. So you look at what MGM Springfield was supposed to do, public companies seem like a fair number of jobs.
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A
Very regulated industry, right?
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B
Very, very regulated. And you look at private equity and the intention of doing the right thing and essentially becoming a force for good. And then when you zoom out of that, you realize that it didn't really have to do with private equity or public equity or supervision. The private equity gu have less supervision. But at the end of the day, if they are the greedy private equity guys, they will blow up. When they blow up, news is reported. So when you research, what do you get? Obviously you get more bad news than good news. But there's different perspective there, even if you look at it from a global standpoint.
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A
Well, I think that's interesting that you talk about incentives, but also let's talk about solutions or let's talk about alignment between incentives and the public good. You've described ways that private equity can work really well, right? It can create value, create jobs, and create these win, win, win sort of scenarios. How do you fix some of the problems in private equity without killing the innovation, the capital flow, the longer term investment horizons, the relationships with a management team that the industry can provide on its best days? How would you suggest that we better harness the industry?
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B
I don't think there's one single tool or one single regulation that would fix it. At the end of the day, if you look at the ecosystem, there are certain levers or certain tools or certain tactics that can either make the guardrail more effective or less effective. And at the end of the day could prevent something. But if you take a more of a zoomed out view, it comes down to really trusting organizations, trusting governments, and making the right choices is what it comes down to. So the call really is more on let us all be better humans. Because private equity in this game of 5 to 7 years, 2 to 3x, it's just one of the micro games or rules to the game. But the zoomed out game of life is happening across the board. And the perspective is let's fix it at the root level because there's nothing we can do that would fix private equity but not fix anything else.
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A
I get it. Gretchen, what kind of regulation do you think is missing today from the private market?
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D
Well, I don't think regulation is the answer. I have been a reporter for almost 40 years and I've seen what happens when regulation gets involved. I mean, it's you close the window, they open the door. You close the door, they open the window. I think there are ways to attack the perverse incentives. And some of those perverse incentives would be making it more difficult for private equity firms to extract assets from the companies they buy quickly. Meaning that the company is still under their ownership, it is still in the portfolio, but they have taken out a dividend that is very sizable. And often this happens where they raise debt to pay the dividend. It's called a dividend recapitalization. And so what this does is it allows a private equity firm to get their money back completely in a very short time span. And I think that that is a perverse incentive because once they're out of it, then it's sort of like, okay, everything else is gravy, but we really don't need to work hard on keeping our employees happy, keeping our customers happy. So I think that the quick, easy dividend recap situation could be dealt with and that could help. I certainly think the idea of having people who are honest and honorable and want to do the right thing for all of the stakeholders, that is the answer. But as Danny points out, even in public markets, you can't rely on that. So I do think that one other thing that could be done is to really allow for entities that cross the line that do the wrong thing, that really harm a lot of people. In these transactions, they have to pay some sort of price, and that really hasn't happened. And until we start to see people in those positions paying a price that is meaningful to them, then they will just continue to do the things that reward them, whether or not those actions are good for all of the stakeholders.
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A
What about Sunlight? Are there any transparency reporting requirements that you'd love to see as a reporter but you also think would be good for, you know, society at large?
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D
Well, absolutely. I mean, a lot of these, especially in the healthcare field, a lot of private equity's involvement in healthcare is hidden from view. In nursing homes, for instance, a lot of these Companies operate under LLCs that are independent of one another, but that really do report up to the same company. But if there's a litigation, for example, they're able to kind of hive one entity off from the rest. So that prevents litigants from being able to attack it as a larger problem. So, yes, I would like to have way more visibility on the degree to which private equity is involved. For instance, in a hospital, if they're running the emergency department, I think that should be something people are aware of. It's interesting to me that private equity firms don't put their names on the outside of the door of the operations they buy, you know, and obviously they're going to sell it. And maybe that's why, but maybe it's also because people are becoming aware that private equity can have a pernicious impact on the quality of the merchandise and goods, on what they do to their workers and all of that.
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A
Tom, if you were redesigning the system tomorrow, what's the first thing you would change?
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C
That's an easy answer for me, because I think the problem is very clear, at least with respect to anesthesia and many of the markets that resemble it. And that is something that you already mentioned, Sunlight. And in particular, we need to have the DOJ and the FTC informed about these transactions at the point at which they're occurring, that is, in their incipiency. I think if the DOJ and the FTC knew about these deals when they were occurring, they would find it relatively easy to arrest them. And moreover, I think that it wouldn't really cost the government much to do so because a lot of these deals would be deterred in the sense that if you're a private equity firm and you were considering a rollup, you knew that roll up was going to be harmful and you knew you were going to have to report it to the DOJ and the FTC and it was going to be blocked. Almost certainly you wouldn't attempt it in the first place. So I think that's the first place to start, at least when it comes to the problems that are arising due to competitive concerns.
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A
Danny, from inside the industry, Gretchen and Tom just suggested some possible reforms that could help with some oversight of the industry without making them public. Right. Are there some reforms like that that you would welcome? What would you be worried about?
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B
Honestly, I fully agree with both of these reforms. They say, you see, the goal is to create a society where bad acts can be minimized and bad acts should be minimized across the board. You know, if there was a reform I could have, it really comes down to those who are blessed with abundance or those who have wealth. May we all be more responsible with that capital because it is in those choices that things can be better. At the end of the day, we can't fix it all but who we affiliate with or who we choose to invest with or by zooming in beyond the headline return to understand what is this business or person opportunity really doing. And like Thomas said, if you're going to stand in front of an organization and say, I'm about to increase the price of this drug by 5,000% and make myself wealthy, everybody would be like, time out guys, this doesn't make sense. But if it goes hidden, then, you know, that becomes the issue. But therein lies the root of the issue.
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A
All of you, thanks so much for this excellent comment conversations. Really, really, really helpful. Thank you.
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B
That was wonderful. Thank you very much.
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C
Thank you.
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D
Thank you.
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A
That's my conversation with Danny Wodwani, Gretchen Morgenson and Tom Wallman. As we wrap up today, it's clear that private equity is no longer just a niche corner of Wall Street. In some ways, it is a hidden engine driving the economy, economy and our daily lives. We've heard two different versions of PE today. On one hand, Danny showed us the case for private ownership as a way to steer a company like World Energy Services toward long term goals without the frantic short term theater of public quarterly earnings. In this view, PE is a masterclass in operational efficiency and active investing and it can lead to win win scenarios. But then we got a reality check in the data from Tom and the frontline reporting from Gretchen, we learned how stealth consolidation in medical practices such as anesthesia can turn a necessity into a price gouging lever. And we've seen the asset stripping model where the pursuit of a 20% return can leave the underlying company and the community it serves hollowed out. So as we look to the future, the big question isn't whether private equity should exist after all, it's too big to disappear, but rather, what are the rules of the road? Can we transition into a system where private capital builds the AI infrastructure and green energy grid of tomorrow without sacrificing the labor protections and fair pricing of today? If you've enjoyed this episode, please give us a hand by rating and following. Is Business broken? Wherever you get your podcasts, it helps more people find these conversations.