Private equity firms have an image problem. Long seen as nefarious financial actors, they’ve made headlines in recent years for their roles in high-profile bankruptcies of companies such as Toys “R” Us, Gymboree, and Payless ShoeSource. It’s no secret that the large amounts of debt private equity firms pump into businesses can cause problems down the road. But private equity investors also frequently play an important part in revitalizing companies. That’s particularly true when it comes to buying neglected units of public corporations, according to Wharton management professors Paul Nary and Harbir Singh, as well as Aseem Kaul from the University of Minnesota’s Carlson School of Management.

In their paper “Who Does Private Equity Buy? Evidence on the Role of Private Equity From Buyouts of Divested Businesses,” the researchers argue that when private equity firms buy overlooked units of public companies, they take a unique private-markets approach to reinvigorating them. Private equity firms “may acquire mismanaged or neglected businesses and invest time and resources into nurturing them in a way that would have been impossible under public ownership,” Nary told Knowledge@Wharton.

For their study, published in Strategic Management Journal, the researchers analyzed roughly 1,700 acquisitions of divested business units that private equity firms or other investors bought. PE firms, the researchers found, are more likely than other acquirers to buy business units that are mismanaged or aren’t considered core to their parents’ operations. Those units have potential but may require significant attention to develop.

Because private equity firms aren’t in the public spotlight, they can cultivate the businesses using methods that might not otherwise pass scrutiny by public stakeholders. “A good business may require a more long-term perspective—a long-term investment that may not be appreciated by public-market stockholders or equity analysts,” Nary said.

Private equity firms aren’t under the same short-term pressure as public companies to prove the value of their individual investments in businesses, as long as those investments deliver returns over time. They also typically don’t have the added challenge of integrating the businesses they buy into other operations, as corporate acquirers often do.

The researchers’ findings could help combat the oft-cited image of private equity firms as investors that are willing to strip away value from companies in their quest for profits. That notoriety has stuck since its early days in the 1970s and ’80s. But while the reputation has persisted, the industry has changed dramatically. For instance, PE firms have adapted to expectations by investors in their funds that they will operate with certain levels of stability and accountability.

“We do observe—not in our study, but in general there is a lot of evidence for this—that private equity firms tend to be more professional now,” Nary said. “The private equity firms of today are much different from the private equity firms at the beginning of the industry.”


Published as “Finding Virtue in Private Equity” in the Spring/Summer 2019 issue of Wharton Magazine.