June 04, 2007
Private Equity and Mitt Romney's Bid for the Presidency
Posted by Gordon Smith

The NYT story  about Mitt Romney linked by Vic includes a brief reflection on whether Romney ever "ran a corner store." Eric Kriss, a former partner at Bain Capital, is quoted as saying (with the whiff of petulence?), "Mitt ran a private equity firm, not a cement company. He was not a businessman in the sense of running a company. He was a great presenter, a great spokesman and a great salesman."

The author of the piece, David Kirkpatrick, follows this quotation with the following statement: "Supporters of Mr. Romney argue that those skills also equip him for public office, whether as governor of Massachusetts, which he was for four years, or as president."

I am not sure whether this is just sloppiness on Kirkpatrick's part or design, but that is truly ridiculous. Romney's supporters are not convinced that being a "great presenter, a great salesman and a great spokesman" qualify him to be president. That sounds more like Fred Thompson supporters. (Remember that Fred's career consists of being a lobbyist, actor, and U.S. Senator.) Romney's supporters, by contrast, are persuaded by a bevy of real-world accomplishments, including the building of Bain Capital, which is the subject of that NYT story.

I am ambivalent towards Romney's candidacy -- I don't endorse candidates just because they are Mormons, and indeed, may be more reluctant on that ground because I have something personal at stake -- but the notion that running a private equity firm is not "running a company" is sort of silly, isn't it? Perhaps even sillier is Kirkpatrick's suggestion that Romney's business "exposes him to criticism that he enriched himself excessively, sometimes by cutting jobs to increase profits."

First, the charge of excessive enrichment is based in part on the point, made persuasively by Vic, that  partners in private equity firms are undertaxed on their service income. In Vic's words, they "defer income derived from their labor efforts and convert it from ordinary income into long-term capital gain." Vic proposes reforms that would tax those amounts at the higher (ordinary income) rate in the future, but Romney can hardly be blamed for minimizing his tax bill.

The other part of the excessive compensation charge is that Romney managed to negotiate fees of 30% of profits for Bain Capital rather than the usual 20%. I agree with Vic: "Impressive."

The second claim Kirkpatrick lays against Romney is that he enriched himself at the expense of ordinary people, who lost their jobs when Bain swooped in. Ah, the "labor question" again. Many journalists and commentators promote the idea that firing people is prima facie evidence of evil intent. Indeed, Kirkpatrick quotes James E. Post, a BU professor, for
the notion that private equity fund managers are "robber barons." Nice soundbite, but what is the basis for this claim?

With respect to Romney, Kirkpatrick observes: "He made his money mainly through leveraged buyouts — essentially, mortgaging companies to take them over in the hope of reselling them at big profits in just a few years." The word "mortgage" has bad connotations for most people and "big profits in just a few years" sounds like ... what? Gambling? Cheating? Or possibly making the choices that incumbent managers were incapable of making or unwilling to make.

I am not being a Pollyanna, and I am not arguing that every private equity transaction is good for America or whatever. But to insinuate that Romney was engaged in something other than a productive activity by this sort of "connect the dots" argument is offensive. In some instances, companies need to fire employees and that act is not necessarily irresponsible, even if the equity owners of the company subsequently profit from the company. This is the issue I attempted to broach the other day in response to Leo Strine's new article, Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance. 

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Comments (4)

1. Posted by anonymous on June 4, 2007 @ 15:57 | Permalink

I thought it was a great article. Makes you wonder about what the man did to become "successful" in business would be so great for the country.

Flipping companies, not creating but rather paring down someone else's creation, charging then unheard of "special fees" to get the money quickly back... often leaving the company in bankruptcy. I think Romney's quote is he would really be hurt if he made a lot of money, but the company failed.

Somehow, I don't think that's what the country needs. Maybe a lot of ambitious good looking white men can make a lot of quick money, but how does the country as a whole benefit when not much is created (did you read the Staples anectdote -- Romney was lucky to get in, not the other way around), and there's not really a long term promise of health for the company?

I mean, if you're going to risk, don't make yourself too secure at the expense of the enterprise. He's a salesman, sure. It's not because he's a Mormon that many of us object to his ways. Take too much, without earning it, it makes one fat. We don't need more fat in this country.

The capital gains v. income tax contributions, as Fleiser notes in the article is sickening. You want to run a country yet you're shortchanging her based on technicalities? Sorry, bad timing. We've had a good whiff of Cheney-esque "me first" public service, and we don't much like what we see. You'll see it one day; things tend to catch up to you when you play short term and primarily for yourself/your own.

2. Posted by Mike Guttentag on June 5, 2007 @ 10:46 | Permalink

As often two thoughts: First, it is impressive to succeed in such a highly-competitive environment as Bain (standing out at Harvard Business School, if he did, may be a little less impressive).

Second, I’d have concerns about someone who champions the 2 and 30 structure. Sure, it is impressive that you can negotiate this deal, particularly for a new entrant in the market. But is it too greedy? I think so. When negotiating a deal you can often be in a position of power where you can exact particularly high fees, and the most successful businessman may be the one who uses that power. Other businessmen choose in such a situation to stick with what they perceive as the “fair” deal. To my mind 2 and 20 is more than fair. I would rather have someone of the latter type, who is likely to be less arrogant, running the country.

3. Posted by Cliff on June 7, 2007 @ 1:45 | Permalink

"I don't endorse candidates just because they are Mormons, and indeed, may be more reluctant on that ground because I have something personal at stake"

Well said...

4. Posted by Brett McDonnell on June 10, 2007 @ 20:45 | Permalink

One explanation for new owners cutting jobs is indeed that they are making a needed and efficient move that the old managers were unwilling to make. A second explanation is that they are violating an implicit contract with their employees in a way that reduces, not increases, net social value. Both happen frequently. The relative frequency is disputed and hard to measure. Newspaper reporters and politicians are indeed too prone to assume the second scenario. However, corporate law scholars are too prone to assume the first scenario. Which tendency one should emphasize depends on your audience. For your audience, Gordon, I suspect you are preaching to the faithful.

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