Do Politics Shape Buyout Performance?

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Reprint: F0811A

A new study of private equity buyouts shows that, on average, U.S. acquisitions made in “red” (Republican) states deliver significantly higher returns than acquisitions made in “blue” (Democratic) ones.

Before your next U.S. acquisition, check how the company’s home state votes. Our research shows that the performance of buyouts in “red” Republican states is likely to be above average, while buyout performance in “blue” Democratic states is likely to fall below the mean. (See map.) This finding held even after controlling for a dozen other factors that could explain performance differences, including the target firm’s size, the historical performance of buyouts in its sector, and the performance of the acquiring firm. We argue that Republican views are better aligned with buyout value-creation strategies (such as outsourcing labor, shutting down less efficient units, lower commitment to social responsibility, and deunionization) than Democratic views are.

This key conclusion of our study, which looked at 5,870 U.S. buyouts by private equity firms made between 1980 and 2003, points to serious inefficiencies in the market for corporate acquisitions. In an efficient market, the average risk-adjusted rate of return on investments in identical target companies located in different states should be the same. Our research, however, found that the average return in red states was 3% above the mean (and as much as 17% above it in the best-performing red state—Oklahoma). The average return in blue states was 6% below the mean (and as much as 21% below it in the worst-performing state—Michigan). Yet most acquirers and sellers don’t seem to accurately consider local factors in the valuation methods they apply. The economic consequences of this oversight can be substantial: Using data on the returns from actual buyouts, we constructed two hypothetical funds—one that invested only in companies located in red states, and the other only in companies in blue states, and found that the first fund achieved a 9% higher annual net internal rate of return.

Private equity firms take advantage of this market imperfection, systematically focusing their investment activity on states that offer a higher risk-adjusted average performance. We found that a company headquartered in a red state was 27% more likely to undergo a buyout than an otherwise identical company based in a blue state.

There are, of course, a few exceptions to the “rule”—states where the presence of an industrial base that is exceptionally attractive (or unattractive) for buyouts overrides red or blue political leanings. Deal makers need to pay close attention to local conditions and adjust their valuation metrics (such as the required hurdle rate or the valuation multiple) accordingly. Acquirers who develop such location-specific valuation skills will be able to generate higher returns than their counterparts who lack such skills. In this respect, private equity firms seem to be well ahead of the crowd.

A version of this article appeared in the November 2008 issue of Harvard Business Review.

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