Looting: The Puzzle of Private Equity

In the last generation, executives have engaged in a sort of moral arbitrage, replacing fiduciary with market norms to justify allocating to themselves an ever-increasing share of the corporate pie. The private equity sector has taken this process to its logical conclusion; it has completely abandoned the notion that corporate office brings with it obligations. Instead, it openly celebrates self-enrichment over institution building or public service. Unfortunately, corruption is just as corrosive in the private sector as in the public sector. Office-holders who seek personal enrichment will nearly always find looting more profitable than construction and betraying co-adventurers more lucrative than genuine commitments. The essay proceeds as follows. In Part I, I explain the normative duality of the firm and its relationship to classic understandings of corruption. Part II summarizes the rhetorical devices by which corporate executives have arbitraged between the two spheres in order to escape the bonds of professional and fiduciary duties. Part III applies this analysis to the private equity world: by re-characterizing managers as shareholders, private equity can authorize previously unknown levels of looting. Part IV explores the theoretical and practical crises that result. Private equity accentuates the agency-cost problem by adding another layer of managers with unprecedentedly high pay and increased discretion. Simultaneously, and more importantly for the economy as a whole, it heightens the paradox of the managerial role in a shareholder-centered theory of the firm. Successful corporations require trust: neither employees nor passive investors fully negotiate ex ante contracts. Modem conceptions of the share-centered corporation threaten that trust, by encouraging managers to breach implicit commitments to employees whenever expedient to increase shareholder returns. Contractual understandings of managerial roles, in turn, justify managers treating shareholders with equal cynicism. Private equity heightens the stakes. On the one hand, high-powered incentive pay promises executives extreme payoffs from successful exploitation of employees or other contracting parties. On the other hand, the private equity system offers ideological justification for self-interested looting by freeing managers from any residual sense of obligation to the firm itself, its employees or passive investors. Other corporate participants are likely to respond in the only effective way: by mistrust and withdrawal. The overall effect likely will be to reduce American competitiveness and economic growth prospects. In short, on a practical level, the success of private equity threatens market collapse. On a theoretical level, the success of private equity delivers the final blow to whatever is left of the efficient market paradigm