Ethical issues in international sourcing of capital by Private Equity companies

Contents

1. Introduction
The Initial Research Questions of the Paper Aim to Discover:

2. Background Information
2.1. PE Industry and GS PEG
2.2. Goldman Sachs Private Equity Group
2.3. Illustration of the capital sourcing process

3. Literature Review
3.1. Ethical Issues in the Capital Sourcing Process
3.2. Codes of Conduct and Implementation of CSR
3.3. Philosophical Approaches to Ethics vs. Culture
3.4. Impact of PE on Employment
3.5. Creative Destruction vs. the ‘Modern-day Capitalism’

4. Conceptual Framework

5. Findings, Analysis and Discussion
5.1. GS PEG’s Impact on Employment
5.2. GS PEG’s Public Image Problems
5.3. GS PEG’s Ethical Practice and Image Improvement
5.4. Significance of PE’s Public Image for GS PEG’s Profitability

6. Research Methods
6.1. Evaluation of Information Resources
6.2. Date Limitations

7. Conclusion

References

1. Introduction

“After buying out companies, they load them with debt, take out the cash, and then sell the emaciated carcass a few years later” (Schiller, 2006 in Bendell and Cohen, 2007:8).

In the context of global sourcing and ethical issues, this quotation could be easily associated with the well known problem of the exploitation of developing countries by western corporations. Here however, these words refer specifically to Private Equity (PE) companies acting in the developed countries. Franz Müntefering (2005), the head of German Social Democrat Party, called PE companies "locusts", who “don’t waste any thoughts on the people whose jobs they destroy” (in Spiegel-Online, 2006). The image of locusts highlights the negative image of PE and implies a destructive effect on employment and thus the economy of a country. David Rubenstein, the co-founder and managing director The Carlyle Group, the world’s largest PE firm, has assessed PE’s struggling public image as one of the key challenges which the PE industry has to contend with (McConnell, 2007). Public image seems to become increasingly important for PE companies, who have been severely criticised for their opaque business practices (Grote, 2007).

Being interested in financial industry and politics, I followed media reports of the political and public arguments about the growing power of PE companies, and their alleged threat to global employment and economy. Therefore, I asked myself how PE Companies have attained such a bad image and whether the accusations levelled at them are true. I have chosen to focus my research on the activity of PE Companies in Germany where they have gained substantial power in recent years and where I have observed the process in the media.

The given scope requested a topic related to ethical issues or concerns in international sourcing and its impact on the host country, community or society. The topic chosen is related to international sourcing, given that the paper will address the sourcing of capital by the American-based Goldman Sachs Private Equity Group (GS PEG) into and out of Germany. This process involves a clash of interests, which results in ethical tension between the participants in the process.

This paper explores how multinational PE Companies influence the labour market of a country by buying out shares of local companies. The aim of the research is to explore which ethical issues PE Companies and GS PEG in particular have had in the past and still face while sourcing capital from and into Germany and how they deal with the problem of negative public image. The areas of ethical tension which GS PEG faces while sourcing from a European country will be identified and analysed later in the Literature Review and Conceptual Framework and thus, clearly address the ethical issues and concerns in international sourcing.

Previous papers have concentrated on either the effects of PE on employment or Corporate Social Responsibility (CSR). This study will combine and deepen those two topics in order to analyse how capital sourcing can affect the image of a PE company, which implications it can have on its business, and what particular methods could be used to improve a company’s image in the light of CSR. The addressed ethical tension lies between PE’s pursuit of profit maximisation on the one side and employees’ of PE-owned companies demand for CSR on the other side. The value of this research is the new critical view of the issue from an ethical perspective which examines the relationship between CSR, local socio-economic culture and the PE itself.

In order to understand the circumstances of the research, this paper will start with an explanation of the key terminology and provide background information about PE Companies, PE Industry and GS PEG. This will be followed by the illustration of the capital sourcing process demonstrating the interactions between the parties of the researched topic in order to show the areas of the sourcing process where the ethical tension appears. The main part of the research article will review the previous studies and literature related to the research topic. The ethical theories discovered in the literature review will be used to identify the ethical issues of the sourcing process and build the conceptual framework. This will be applied to the GS PEG Case and finally lead to presentation of the findings together with their analysis and discussion.

The Initial Research Questions of the Paper Aim to Discover:

GS PEG’s Impact on Employment

GS PEG’s Public Image Problems

GS PEG’s Ethical Practice and Image Improvement

Significance of PE’s Public Image for GS PEG’s Profitability

2. Background Information

This section introduces PE Industry and GS PEG and provides an illustration of the capital sourcing process. These are essential for the analysis and discussion of the research topic in the following chapters.

2.1. PE Industry and GS PEG

Private Equity is one of the Alternative Investment asset classes, which has become an increasingly important source of capital in the global financial system. PE is defined as medium to long-term finance provided by “professionally managed partnerships that involve leveraged buyouts or other equity investments with a substantial amount of associated indebtedness” (Steinberg and Bismarck, 2008:iii).

The main parties involved in PE transactions are: a PE Company represented by a “PE fund manager, who manages the pooled money on behalf of the investors in the private equity fund” (Gilligan and Wright, 2008:1 O.) and a Target Company which includes management, shareholders, employees and other stakeholders on the other side. The primary PE investors are international “pension funds, banks, insurance companies and high net worth individuals” (Gilligan and Wright, 2008:2 O.). Debt financing, also called leverage or gearing, forms a significant part (usually over 50%) of the funding and thus increases investors’ profitability and reduces corporate tax, because it can be deducted from profits.

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