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“Contemporary trends in capital markets have profound implications for corporate social responsibility,” observes Allen L. White in a discussion paper* prepared for Business for Social Responsibility, a not-for-profit organisation based in San Francisco, USA, with offices in Europe and China.



Yet, it is difficult to find even a minor reference to CSR matters among private equity fund managers or analysts. “Issues of human rights, labor standards, environment and even corporate governance are seldom discussed as pros and cons of private equity,” says White.



Private equity is a general term given to a range of financial instruments that fall outside the boundaries of publicly traded securities. As financial instruments, their overarching purpose is competitive profits for their investing partners.



In the past, venture capital for new companies has been a magnet for private equity investors. But, more recently, billions of dollars have been flowing into existing companies that, in the eyes of investors, are under-performing. Here, they see opportunities either for “asset stripping” or for medium-term refinancing and turnaround.



In the former case, private equity funds “buy it, strip it, then flip it”, for quick profits for the fund’s partners. In the medium-term strategy, by contrast, an investment’s duration is typically in the five- to seven-year range, compared to an average of a year or less for mutual funds, and months, weeks or even days for many hedge fund holdings.



A potential attraction of private equity is that the targeted companies can be shielded from the short-term focus on quarterly results that is typical for companies quoted on a stock market. Strategic goals are set for each investee company. Changes are made - in top management, in product focus and in other areas critical to a successful turnaround. New managers may be brought in, possibly with powerful financial incentives in the form of stock options.



“Interestingly,” says White, “public sector funds are the largest single investor in private equity, with public pensions [often with trade union constituencies] representing about 40% of assets invested in private equity funds.” Fund investors can impose certain constraints on how their money is spent. “A public pension fund, for example, may prohibit use of its assets for acquiring shares of weapons or tobacco manufacturers, with the right to opt out of the fund should such agreements be violated.”



What are specific CSR issues? White discusses four: transparency, human capital, stakeholder governance, and the vulnerability of any existing CSR programme.

• Investors in private equity funds may have access to detailed information that exceeds the disclosures for publicly traded companies. But such transparency is not available to a broader range of stakeholders - employees, communities, activists and consumers. Public access to information on funds and their portfolio of companies is much more restricted and unregulated than it is for publicly traded companies. And the complexity of companies in a single fund may hide potential CSR risks from even the fund’s investors.
  
• The temptation of severe cost-cutting through workforce reductions and the termination of any staff development activities is strong, particularly when investor expectations of 25%-30% returns, not uncommon in the private equity world, are driving a fund’s decisions.
  
• Because a fund’s commitment to its portfolio companies is typically limited to from three to five years, little incentive exists to build the stakeholder relationships that CSR leaders at some publicly traded and family-controlled firms have cultivated.

In conclusion, “With new management at the helm and incentive structures aligned towards mid-term performance before sell-off, even a strong CSR culture will likely not survive.”





*Allen L. White, Senior Advisor, BSR: “Invest, Turnaround, Harvest: Private Equity Meets CSR”, October 2006, 12p.