[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
                        PRIVATE EQUITY'S EFFECTS 

                          ON WORKERS AND FIRMS 

=======================================================================

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                              MAY 16, 2007

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 110-31

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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            RICHARD H. BAKER, Louisiana
CAROLYN B. MALONEY, New York         DEBORAH PRYCE, Ohio
LUIS V. GUTIERREZ, Illinois          MICHAEL N. CASTLE, Delaware
NYDIA M. VELAZQUEZ, New York         PETER T. KING, New York
MELVIN L. WATT, North Carolina       EDWARD R. ROYCE, California
GARY L. ACKERMAN, New York           FRANK D. LUCAS, Oklahoma
JULIA CARSON, Indiana                RON PAUL, Texas
BRAD SHERMAN, California             PAUL E. GILLMOR, Ohio
GREGORY W. MEEKS, New York           STEVEN C. LaTOURETTE, Ohio
DENNIS MOORE, Kansas                 DONALD A. MANZULLO, Illinois
MICHAEL E. CAPUANO, Massachusetts    WALTER B. JONES, Jr., North 
RUBEN HINOJOSA, Texas                    Carolina
WM. LACY CLAY, Missouri              JUDY BIGGERT, Illinois
CAROLYN McCARTHY, New York           CHRISTOPHER SHAYS, Connecticut
JOE BACA, California                 GARY G. MILLER, California
STEPHEN F. LYNCH, Massachusetts      SHELLEY MOORE CAPITO, West 
BRAD MILLER, North Carolina              Virginia
DAVID SCOTT, Georgia                 TOM FEENEY, Florida
AL GREEN, Texas                      JEB HENSARLING, Texas
EMANUEL CLEAVER, Missouri            SCOTT GARRETT, New Jersey
MELISSA L. BEAN, Illinois            GINNY BROWN-WAITE, Florida
GWEN MOORE, Wisconsin,               J. GRESHAM BARRETT, South Carolina
LINCOLN DAVIS, Tennessee             JIM GERLACH, Pennsylvania
ALBIO SIRES, New Jersey              STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire         RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota             TOM PRICE, Georgia
RON KLEIN, Florida                   GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida                 PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio                 JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut   MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida               KENNY MARCHANT, Texas
JIM MARSHALL, Georgia                THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma

        Jeanne M. Roslanowick, Staff Director and Chief Counsel

























                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 16, 2007.................................................     1
Appendix:
    May 16, 2007.................................................    29

                               WITNESSES
                        Wednesday, May 16, 2007

Frank, Dr. Robert H., Johnson Graduate School of Management, 
  Cornell University.............................................    15
Lowenstein, Douglas, President, Private Equity Council...........    12
Luther, Jon L., Chairman and Chief Executive Officer, Dunkin' 
  Brands Inc.....................................................    10
Stern, Andrew L., President, Service Employees International 
  Union..........................................................     9

                                APPENDIX

Prepared statements:
    Marchant, Hon. Kenny.........................................    30
    Frank, Dr. Robert H..........................................    31
    Lowenstein, Douglas..........................................    41
    Luther, Jon L................................................    51
    Stern, Andrew L..............................................    55

              Additional Material Submitted for the Record

Frank, Hon. Barney:
    New York Times article, entitled ``Unkind Cut For Janitors At 
      Hilfiger.''................................................    63


                        PRIVATE EQUITY'S EFFECTS 

                          ON WORKERS AND FIRMS 

                              ----------                              


                        Wednesday, May 16, 2007

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10 a.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Present: Representatives Frank, Waters, Maloney, Watt, 
Meeks, Moore of Kansas, Hinojosa, Clay, McCarthy, Baca, Lynch, 
Scott, Cleaver, Moore of Wisconsin, Davis of Tennessee, Klein, 
Wilson, Perlmutter, Boren; Bachus, Baker, Pryce, Castle, Royce, 
Gillmor, Manzullo, Shays, Feeney, Hensarling, Barrett, Pearce, 
Neugebauer, Roskam, and Marchant.
    The Chairman. This hearing of the Committee on Financial 
Services will come to order.
    The subject of today's hearing is the question of private 
equity and specifically the effect that purchases of existing 
companies by private equity has on the workers and on the 
firms. There have been a number of concerns expressed about 
various new forms of activity in the economy, and this 
committee has had some hearings, and will have more, on the 
question of hedge funds.
    Today, we are talking very specifically about private 
equity and one special area of concern. I will say, in general 
that I have not seen any argument that it is a matter for which 
public policy ought to be concerned as to whether people choose 
to own a company through a public shareholder method or 
privately. That seems to me to be a decision that ought to be 
left entirely up to the people who are making the investments, 
but we do have concerns about the impact on workers.
    The committee, myself and many others, have been concerned 
for some time about increasing inequality in America. A year 
ago, we were debating the question about whether wages, real 
wages, were seriously lagging growth. We were debating 
inequality. That debate is largely over. There is general 
agreement that we have increasing inequality and that real 
wages have, in fact, lagged. There was a period earlier this 
year when they began to go up. That is now once again in 
jeopardy. I find the situation in which this country prospers 
overall, but the increased wealth is enjoyed by a relatively 
small number of people, to be troubling. It is morally wrong 
because it takes the efforts of most people to produce that 
wealth, and it should be shared fairly. No one is talking about 
equality. We are talking about degrees of inequality. I believe 
that the case for being concerned about this excessive 
inequality goes beyond moral considerations.
    There is a big debate in this country now about 
immigration. There is a debate about trade. We are engaged in 
the question about how welcoming we should be to foreign 
investment, direct foreign investment. As more and more 
Americans have become convinced that economic growth, 
globalization, and technological change do them very little 
good, and in some cases, harm, you have seen increasing 
resistance to the kind of public policies that many in the 
business community believe are in the interest of economic 
growth, and until we are able to diminish this trend of 
increasing inequality, I believe that resistance will grow.
    Now, with regard to private equity, I assume that the 
market is rational and that the private equity method increases 
value. I do not think people make deals in large numbers for no 
good reason. The question we have is does any of that increased 
value accrue to the people who work for the companies. 
Conversely, there is the fear that, to the extent that private 
equity is accompanied by significant increases in debt in some 
cases, this may have a negative effect on workers.
    Now, what goes into some of the other concerns we have had 
in terms of compensation--and we are talking here not about 
compensation paid by shareholders, which is a matter we dealt 
with elsewhere, but the compensation that some individuals get 
when a small number of individuals benefit from a particular 
deal in the tens and sometimes hundreds of millions of dollars, 
and, concurrently, workers are laid off. We have a situation 
which seems, to me, wrong. Now the question then is, well, what 
are we going to do about it?
    It is not clear. There may or may not be public policy 
implications, but to the extent that there are public policies 
that have an effect on the private equity situation, some of 
which would come before this committee, some which would deal 
with taxation which would come before other committees, and to 
the extent that we see gross imbalances, then we are going to 
have to act.
    As an example of that, I would ask to put into the record 
the article from today's New York Times with the headline, 
``Unkind Cut For Janitors At Hilfiger,'' which says that one 
consequence of a $1.6 billion buyout of Tommy Hilfiger is that 
janitors making $19 an hour were fired to be replaced by 
janitors making $8 an hour. The Hilfiger Company was bought for 
$1.6 billion. Janitors show up to work, and they make $19 an 
hour, union wages. They are fired, and they are going to be 
replaced by people getting $8 an hour. Mr. Hilfiger got $66 
million as the result of the sale and will get $14.5 million a 
year through 2010. Workers in their 40's and 50's have been 
laid off with 1 day's notice.
    I do not know, as I said, whether public policy can do 
anything about that, but I do know that this is the sort of 
pattern that will make many of us determined to do something. 
So the point is a very simple one. If we have a situation, 
private equity, where enormous values are created, as 
apparently they are, and if only a few people get these large 
sums of money, and the workers are either no better off or 
worse off, then from a public policy standpoint that seems to 
me to be undesirable. Whether or not there are public policy 
remedies is the second question, but the first question I want 
to focus on today is whether there is such a pattern.
    I must say, and let me say in closing, that in many of the 
areas of private equity, we are talking about hotel workers; we 
are talking about service employees in buildings; we are 
talking about janitors. These are not people who are competing 
with low-wage workers elsewhere. These are people serving in 
very low-wage capacities in a market that cannot move.
    I think America can do better. Whether or not there should 
be a public policy response, we will find out, but we might 
find out with respect to policies involving unionization, 
taxation, and elsewhere. But the question remains, does the way 
in which private equity deals go forward exacerbate what is 
already an unfortunate trend in America for growth to go 
forward, for wealth to increase, but for inequality to increase 
even faster.
    The Chairman. The gentleman from Alabama.
    Mr. Bachus. Thank you, Chairman Frank, for holding this 
hearing.
    This is the second hearing the committee has held on 
alternative investment vehicles, and, of course, this hearing 
is on private equity industry. Private equity is not a new 
phenomenon. It has been used, at least with some frequency, 
since the 1960's. More recently, the industry has drawn 
attention, you could say scrutiny, because of several 
blockbuster transactions: earlier this week, DaimlerChrysler; 
and earlier than that, Clear Channel, Sallie Mae, and Equity 
Office Products, just to name a few.
    In 2006 alone, U.S. private equity transactions totaled 
$406 billion and accounted for 27 percent of all U.S. mergers 
and acquisition activity. One telling barometer of the growth 
of the industry is that, in 2001, private equity firms 
purchased 324 companies. By 2006, that number had more than 
tripled to over 1,000 acquisitions.
    Several factors appear to be driving the explosive growth 
in private equity. Institutional investors, including public 
and union pension funds and university endowments and 
foundations, are turning more and more to private equity 
investments to generate higher returns for their stakeholders. 
In addition, publicly traded companies face an environment in 
which burdensome or overly burdensome regulations result in 
frivolous shareholder lawsuits and demands of activist 
shareholder groups, and all of those things have made going 
private an increasingly attractive alternative. And I think the 
executive compensation legislation that we considered just a 
few weeks ago may even accelerate this trend towards private 
financing if it empowers activist shareholders even more.
    Private equity can be a valuable tool for providing capital 
and expertise to underperforming companies or to companies 
struggling to generate quarterly growth and meet Wall Street 
expectations. The overwhelming majority of publicly traded 
companies are single-mindedly focused on one thing right now, 
and that is June the 30th, or the end of the next quarter, 
which is most usually June the 30th, with the second quarter. 
Are they going to meet or beat estimates? Has the market 
already accounted for the company's possible growth?
    Additionally, taking a struggling public company private 
gives its managers the opportunity to address strategic 
concerns free of day-to-day competitive pressures. To improve 
corporate performance, private equity firms typically recruit 
top managers often drawn from the ranks of senior management at 
publicly traded companies and directly tie their compensation 
to long-term performance and growth, not to short-term stock 
price gyrations. Indeed, our former Treasury Secretary, John 
Snow, verified this trend when he described his firm's 
acquisition of Chrysler as providing ``management with the 
opportunity to focus on their long-term plans rather than 
pressures of short-term earnings expectations.''
    We must, I think, support the continued growth of private 
equity and other alternative investments in our marketplace. An 
overly proscriptive, rules-based approach to regulation of 
private pools of capital could stifle the industry and drive 
private equity firms and their capital offshore or to 
investments in other countries, potentially compromising the 
competitive standing of our capital markets.
    Concerns have been expressed about the treatment of workers 
at companies that are taken private, as the chairman did 
earlier. While I intend to carefully listen to the testimony of 
today's hearing on this point, it is at least not clear to me 
at this point that privately managed companies act any 
differently with respect to worker retention or compensation 
than publicly traded companies.
    To conclude, we have heard anecdotal accounts of 
differences in workers' wages in private versus public 
companies--the chairman read one this morning--but we have yet 
to see any definitive empirical evidence in this area.
    Further, we should not automatically concede the premise 
that taking action to increase efficiencies in a privately held 
company is always unfair, unwarranted, or not in the best 
interest of the company. The actions of new management may, in 
fact, restore a company to competitive health, preserving most 
workers' jobs that would otherwise be lost, maintaining 
pensions and providing other benefits.
    We must also not lose sight of the fact that, according to 
a recent study, private equity created 600,000 jobs in the 
United States from 2000 to 2003. Given the increasingly 
competitive nature of the global economy, our policy should be 
to ensure that American public and private companies can 
survive.
    So, in closing, Mr. Chairman, I will look forward to 
hearing the testimony of the witnesses and to learning more 
about the ways in which this committee can play a constructive 
role or if there are ways of enhancing the competitiveness and 
vitality of our U.S. capital market.
    The Chairman. The gentleman from Massachusetts, Mr. Lynch.
    Mr. Lynch. Thank you, Mr. Chairman, and thank you for 
holding this hearing.
    First, I would like to say I am pleased to notice that a 
constituent of mine is here today to testify, Mr. Jon Luther of 
Dunkin' Brands, a Canton, Massachusetts-based company, who 
probably, I think, will offer a positive example of private 
equity involvement.
    I am also very pleased that we are exploring the impact of 
the growth of private equity firms on the U.S. economy and 
financial system. I think it is important that this committee 
has a solid and accurate understanding of the modern workings 
of private equity funds given the recent concerns about fund 
executive compensation, the treatment of capital gains tax 
benefits on their profits, and also their ability to exploit 
the debt market to make those profits, sometimes to the 
detriment of companies and their employees.
    I am going to be interested in a number of questions, but 
one of those is related to the modern-day private equity 
investment framework and how does it differ from the corporate 
raiders and leveraged buyouts of the 1980's given that the same 
big names are still involved.
    Also, I think this committee, which recently held a hearing 
regarding hedge funds, would like to know what the difference 
in investment strategies is between the two. That is the 
private equity firms--a more long-term strategy or a more 
short-term, such as the hedge funds have exhibited. I think the 
common connector seems to be making a profit, and there seems 
to be a lot of industry overlap these days.
    The second issue that I will raise regards the pensions and 
benefits of the workers at the companies that are acquired by 
private equity firms. Yesterday's Wall Street Journal said that 
Cerberus, which has announced its takeover of DaimlerChrysler, 
has pledged to work with the UAW, and I am a former employee of 
the General Motors Corporation at their plant in Framingham, 
Massachusetts, so I have a particular interest there; but they 
have assured the UAW that the $18 billion owed to autoworkers, 
my brothers and sisters, in benefits will still be honored, and 
they refer to this deal as a watershed moment for the private 
equity industry in global finance dealings. I would like to 
have confidence in that, and perhaps the panelists can sort of 
expand on that concept if they are able to.
    My third issue that I would raise is regarding the pension 
funds that invest in private equity firms. Mr. Lowenstein 
mentioned in his testimony that millions of retirees are 
benefiting from private equity investments through their 
pension funds, and that pension funds have at least $111 
billion invested in private equity. I would like to hear a 
description of the allure in private equity investments and 
what are the benefits specifically to pension funds and being 
involved.
    Those are the issues that I would like to raise in a 
general sense, Mr. Chairman, and with that, I yield back.
    The Chairman. The gentlewoman from Ohio is recognized for 3 
minutes.
    Ms. Pryce. Thank you, Mr. Chairman.
    Thank you to our panel for being here today.
    Already this year, 33 U.S. companies worth $160 billion 
have made equity buyout deals. The Chrysler deal serves as an 
example that private equity can go anywhere, even buying the 
most symbolic of American brands. Hitting close to my home, 
Limited Brands, based in Columbus, Ohio, announced yesterday 
that they would sell off their Express line to a private equity 
firm, Golden Gate Capital.
    The timing of this hearing could not be more appropriate. 
Thank you, Mr. Chairman, for holding it. The maintenance of our 
capital markets is paramount to our continued economic growth.
    I want to thank our witnesses for helping us demystify a 
market that has become an increasingly important source of 
funds for public firms seeking privatization, for companies in 
financial distress, for start-up enterprises, and for companies 
looking to spin off parts of their operations. There are often 
short-term losers with job losses tied to the public companies 
that had, for perhaps too long, delayed badly needed 
restructuring, but long term, a healthy, growing private 
company is better than a stagnant, underperforming public one, 
for the investors, the employees, and the economy.
    Mr. Chairman, I think we should be focusing some of our 
energy on what is making it advantageous for these companies to 
go private or, to put it another way, what is making it 
disadvantageous for companies to be public. Going private frees 
companies from the short-term pressures of the stock market, 
and as the U.S. Chamber and others have pointed out, quarterly 
earnings per-share statements are a centerpiece to this 
problem. Companies often sacrifice, creating long-term value if 
it means missing quarterly earnings' projections. Even if they 
believe that the cuts are destroying business value over the 
long term, they are not investing in things in which they 
should be investing. We should be focusing on decreasing the 
regulatory burden on public companies, not increasing the 
burden on private equity.
    I want to thank the witnesses once again and the chairman 
for having this hearing, and I yield back.
    The Chairman. The gentleman from Louisiana is recognized 
for 5 minutes.
    Mr. Baker. Thank you, Mr. Chairman. I appreciate the 
interest in the matter in calling the hearing.
    Although there is really no clear definition of ``private 
equity,'' there are some characteristics of funds which I think 
are important to point out. Although sophisticated investors, 
those with a net worth in excess of $1 million, are certainly 
participants, it is financial institutions, insurance 
companies, mutual funds, and pension funds that provide the 
overwhelming bulk of the financial resources deployed by 
private equity. So, when we are contemplating regulatory 
constraint, we need to realize it is not just millionaires we 
are going after in this case, it is the CalPERS pensioners--by 
the way, CalPERS holds direct investment in private equity 
funds--and millions of others who, either through mutual fund 
investment or pension funds, have a share in the profits of 
private equity.
    I was surprised to learn that in households with average 
annual incomes of $35,000 or less, 18 percent are invested in 
mutual funds--who would imagine?--and that if those families 
want to improve their quality of life, it will come through the 
democratization of investment opportunity.
    As an example, Power Shares lists this morning in 
SmartMoney.com that they, by fall, may be a new ETF that will 
allow individuals to buy shares in an index that follows a 
benchmark of 30 traded private equity companies, companies that 
invest in private equities. This is similar in operation, I 
understand, to hedge funds, which offer the same opportunity to 
individual investors.
    So, in the search to help working people, we need to be 
very careful about how fat we make this regulatory book. It may 
fall right on top of them and deny them the opportunity to 
share in economic growth. Well, how big is this thing? Private 
equity investment in 2006 was just over $400 billion. That 
compares with $1.1 trillion to hedge funds in a single period. 
Although big, the two together are the source of enormous 
liquidity in a highly competitive international marketplace.
    Hedge funds are going to act very quickly. They are going 
to see imbalances in the market, whether overpriced or 
underpriced. They are going to move, bring about market 
discipline, and get out. The churn rate for hedge funds is 
typically about 9 months. Where private equities are different 
is that they buy into the company and bring in management 
sometimes, and it can be there for 2 or 3 years. For them to 
turn their profit, it means the underlying economic value must 
be improved, and the company itself must grow and prosper. This 
is not just about squeezing just a little inefficiency out; 
this is about providing jobs that otherwise might disappear. 
So, in engaging about concerns over workers' fate, often it is 
better to have a healthy company grow over time than it is to 
let a staggering company fall under the weight of its failed 
economic model.
    So what happens if the U.S. rulebook is unreasonably 
fattened? There is a high probability that money will go 
elsewhere. The view that we are an economic island from which 
there is no escape is a very limited view of the world. London, 
Bombay, and Hong Kong are experiencing extraordinary growth. I 
have heard many members of this committee concerned about 
London's passing New York as the primacy trading location for 
securities. The private equity firms in India enjoyed a 21 
percent rate of return on equity last year. India passed China 
with $1 trillion, $239 million of private equity investments 
last year, and they, India and China, are modifying their 
rulebook to make their investment world all the more attractive 
to potential investors from the United States.
    So we need to be very careful about how we act here. The 
Dow Jones Index of India, called CNX, is up 42 percent year 
over year. This is not an illiquid, overregulated market from 
which people are saying to outside investors, ``Do not come.'' 
Instead, they are saying, ``Come on down. Bring your money and 
your suitcases. We will make you a nice hotel room offer, and 
you can stay here for as long as you like.''
    How does that contrast with a market discussion where we 
are contemplating restricting the rules that enable smart 
people to deploy important resources to help grow our economy?
    You know, we need to go slow. Maybe we need to go really 
slow, or maybe we do not need to go at all. Maybe we need to 
just watch for a while and make sure we understand market 
function before we unintentionally take it backwards in an 
enormous step.
    Said another way, sometimes in Washington, people see a 
profit. So, first, they regulate it. If that does not stop it, 
then they tax it, and if that thing is still going, then they 
sue it. It is the three-step recovery plan to profit in 
America.
    I think we need to get past that. I think we need to 
realize that working families, employed by companies, will 
change jobs, and new opportunities will come, but investing in 
the corporate growth for the long haul, not the next 10 
minutes, is what grows value. That is what builds wealth in 
American families, and that is what American workers need.
    The Chairman. The gentleman from California, for 4 minutes.
    Mr. Royce. Thank you, Mr. Chairman.
    Mr. Chairman, I also want to thank you for holding this 
hearing to examine the effect that private equity has on the 
U.S. economy.
    Recently a great deal of attention has been focused on 
private equity due to the increased role that it is playing in 
the capital markets, and I understand the committee's interest 
in exploring this topic. I am very concerned, though, that 
statutory exclusions from Congress are unwarranted. It could be 
very dangerous for the economy, and I think we have had some 
very cogent arguments from Congressman Baker. I am going to add 
a few additional points to this that I think we should be 
concerned about.
    If the goal of our hearing today is for Congress to have a 
better understanding of this recent boom that we are seeing in 
private equity, then we should be asking ourselves and we 
should review some of the failings of our public equity 
markets.
    For example, what is driving money out of the public into 
the private equity markets? One is the Sarbanes-Oxley 
legislation, frankly, coupled with abusive shareholders' 
lawsuits, and that has created a terrible operating environment 
for many firms in this country. Companies have become more 
risk-averse, resulting in less investments and new business 
ventures. Of course, this means fewer opportunities for 
employees and an inefficient capital structure for investors.
    In my view, private equity is playing an important role in 
our financial system. As we have seen in recent years, private 
equity firms provide stagnant corporations with a viable 
alternative to public markets in a public market right now that 
is beset with enormous costs when associated with Sarbanes-
Oxley. Private equity provides growth capital to these 
corporations, which frequently results in a properly 
capitalized corporation, which frequently means more 
investments in employees, and usually means the development of 
new business lines for that company.
    In conclusion, I believe the presence of private equity is 
an important component of our financial system, and any attempt 
to regulate the industry will be harmful to our capital markets 
and to our economy as a whole.
    Again, Mr. Chairman, I would like to thank you for 
exploring this issue today, and I look forward to hearing from 
our witnesses.
    The Chairman. I thank the gentleman.
    We will get to the witnesses, but I do want to ask one more 
question.
    People may hear something that sounds like the gavel. It 
will be my cast inadvertently knocking against the wall. If you 
do not see the gavel, ignore the noise.
    With that, we will begin with our witnesses. We will begin 
with Mr. Andrew Stern, president of the Service Employees 
International Union.

  STATEMENT OF ANDREW L. STERN, PRESIDENT, SERVICE EMPLOYEES 
                      INTERNATIONAL UNION

    Mr. Stern. Thank you, Mr. Chairman, and members of the 
committee. My name is Andy Stern, and I am president of the 
largest union, the Service Employees International Union, CTW, 
CLC.
    The story of America's success is a story of work and 
working people. The greatness and promise of America has always 
been that if you work hard, you will have your work valued and 
rewarded. America's gift has been that every generation has 
done better than the previous one, but we are now at a moment 
when the promise of the American dream is in jeopardy.
    A majority of Americans, sadly, say that they believe their 
children will actually be worse off than they are, and the 
facts are beginning to prove them right. People are working 
harder and harder for less wage increases. Opportunities are 
disappearing for access to jobs leading to the middle class. 
This is happening during an unprecedented period of prosperity 
in America. Some even have named it America's new, ``Gilded 
Age.'' We have the highest rate of income inequality in this 
country since the Great Depression. Productivity is up, but 
wages are down. Profits are up, but Americans have less 
healthcare, less savings, and less stock ownership than they 
had the year before.
    Private equity, as Steven Pearlstein wrote today in the 
Washington Post about the Chrysler deal, has become, ``the most 
powerful force in business and finance.'' Today, private equity 
is buying and selling larger and larger companies and reshaping 
whole industries. It is engineering financial deals on a scale 
that, until a few years ago, seemed unimaginable. But the real 
story of private equity is the incredible wealth being created 
amongst its partners and the incomes being accumulated as a 
major contributor to the concentration of wealth amongst the 
top 1 percent of all Americans.
    Private equity activity is raising significant concerns 
about the impact on workers, on companies, and on the financial 
markets. First, there is the increasing practice of quick flips 
and sell-offs that undermine the industry's claims that it 
seeks to promote long-term business growth. When private equity 
firms work with the managers and directors of companies that 
are targeted to buy and then offer those managers and directors 
ownership stakes in the new private company, it raises all 
kinds of questions of conflict of interest. And in discussing 
the conflicts between the banks and the private equity firms, 
the vice chairman of Morgan Stanley said, ``We are totally 
conflicted. Get used to it.''
    We have seen the problems of the economic exuberance of 
Enron and high-tech industries in the past. As some of the 
experts have said, even if one major deal fails, there is very 
serious concern raised about its impact on the credit markets, 
on investors such as pension funds, and not least of all on the 
workers of the affected companies.
    In terms of the workers, these risky deals at times put 
workers and companies at risk when high debt levels involved in 
buyout deals and high fees can create pressures to cut costs 
that are counterproductive to the stated goals of private 
equity firms to create long-term value and productivity. There 
are concerns about transparency and disclosure and concerns 
that, obviously, not everyone is sharing in the success of 
these deals.
    For all of the hundreds of millions of dollars of fees and 
billions of dollars of profits taken out of these deals by 
private equity firms, the workers at most of these companies 
have seen no increases in benefits and no increases in wages. 
If we had just taken the $4.4 billion in fees paid to the 
private equity firms in the 10 largest buyout deals, just the 
10 largest buyout deals in the last 2 years, we could have paid 
for family healthcare for over 1 million American workers. You 
do not have to take my word for it. As the chairman said, look 
at what financial leaders and experts are saying about the 
private equity economy.
    But here is the opportunity. The opportunity is we are 
creating value. The question is, are we sharing in the value? 
For working people today in the private equity world, there 
have been far more misses than hits in the private equity 
buyouts. There have been far more fees raised than paychecks 
raised. It would be best if the industry made its changes 
itself and took steps to self-regulate to make sure that 
private equity did work for working people in the rest of the 
country.
    For workers in communities, the industry should also be 
expected to play by the same set of rules as everyone else. We 
should eliminate the conflicts of interest. If unions exist at 
a company being bought, like Chrysler, they should be at the 
table as soon as possible, and if no union exists, the private 
equity firms should make sure that workers have the right to 
form unions. But the private equity firms will not self-
regulate, Mr. Chairman, or take their own steps to change, and 
we think it is necessary that Congress legislate.
    America has been at its best when a broad group of people 
have shared in the prosperity being created in the economy. We 
have gotten away from that in recent years. The greatest 
country on Earth can do much better to make sure that everyone 
shares in the success and in the prosperity that workers help 
create. There is more than enough wealth in the buyout business 
for private equity firms to continue to prosper, while also 
adapting their existing business model to expand opportunities 
for communities, workers and our country. The incredible wealth 
that exists in the private equity buyout industry presents an 
historic opportunity. It is an opportunity to repair the 
American dream.
    Thank you, Mr. Chairman.
    The Chairman. Thank you.
    [The prepared statement of Mr. Stern can be found on page 
55 of the appendix.]
    The Chairman. Next is Jon Luther, the chairman and CEO of 
Dunkin' Brands, Inc.

   STATEMENT OF JON L. LUTHER, CHAIRMAN AND CHIEF EXECUTIVE 
                  OFFICER, DUNKIN' BRANDS INC.

    Mr. Luther. Thank you, Chairman Frank, and members of the 
committee.
    As you mentioned, my name is Jon Luther, and I am the 
chairman and chief executive officer of Dunkin' Brands. Dunkin' 
Brands is the parent company of Dunkin' Donuts, Baskin-Robbins, 
and the sandwich brand out West called Togo's. I appreciate 
this opportunity to share with you the Dunkin' Brands' 
experience with private equity ownership.
    Our talented team of executives and employees, together 
with our thousands of franchisees and licensees, predominantly 
small businesspeople, has built a $6.4 billion enterprise 
operating in 47 States and in 50 countries. Thanks to their 
effort and commitment, our brands are known and loved by 
consumers around the world.
    When I joined Dunkin' Brands in January of 2003, we were 
owned by Allied Domecq, a publicly traded spirits and wine 
company headquartered in the United Kingdom. In November of 
2005, Allied Domecq was acquired by Pernod Ricard, another 
spirits and wine company, based in France. Shortly thereafter, 
because Dunkin' Brands was perceived as a noncore asset of 
Pernod Ricard, Pernod put our company on the auction block for 
sale. In March of 2006, we were acquired by a consortium of 
three United States-based private equity firms: The Carlyle 
Group; Bain Capital Partners; and the Thomas H. Lee Partners.
    During the period when we were an Allied Domecq subsidiary, 
we were considered, for lack of a better term, a ``cash cow.'' 
We were assigned yearly growth targets. We were usually last in 
line for attention, and certainly for capital to fuel our 
growth. Significant decisions required that I go to London. Our 
cash was swept every night, and our focus was usually on the 
next quarterly numbers. Our acquisition by Carlyle, Bain, and 
Thomas H. Lee has liberated our company. Our new owners 
expressed confidence in our management team, our leadership, 
our strategies, our vision, and our values.
    Our three goals are to take Dunkin' Donuts national over 
time, transform Baskin-Robbins into a neighborhood ice cream 
shop once again, and to expand internationally, but rather than 
tell us to change our goals and our plans to achieve them, our 
new owners ask how they can support and how they can fuel our 
growth.
    Finally, we had the attention and the resources that we 
needed to realize our goals. The benefits of our new ownership 
to our company have been enormous. Their financial expertise 
has led to a groundbreaking securitization deal that has 
resulted in very favorable financing at favorable interest 
rates. This has enabled us to make significant investments in 
our infrastructure and in our growth initiatives. In addition, 
they have helped us create new franchisee financing programs 
that provide flexible, convenient, and competitive financing 
options to our franchisees, those small businessmen and women 
of every size in all of our markets. They have opened the door 
to opportunities that were previously beyond our reach.
    For example, they have introduced us to a real estate 
development firm that is assisting our Baskin-Robbins growth 
and are finding great real estate opportunities. They have done 
so well that we are now considering using them for our Dunkin' 
Donuts growth and development as well.
    Our acquisition and the expansion plan for which we now 
have the resources have put us also in the national spotlight. 
Countless news stories about it have caused us to be sought out 
by many new potential franchisees, small businessowners, and 
also new employees who want to join our company.
    As a result of our franchising efforts, the engine for our 
growth has taken off. We are a 100 percent franchised 
enterprise. Every Dunkin' Donuts, and every Baskin-Robbins, 
store represents the achievement of a dream for an entrepreneur 
somewhere in America. A new Dunkin' Donuts means approximately 
25 to 30 jobs per store, and a new Baskin-Robbins means 
approximately 12 to 15 jobs. Over the next 15 years, because of 
this growth vehicle we now have, you can expect 250,000 jobs, 
jobs for young people, and jobs with good career paths in 
restaurant management, making it possible for others to achieve 
the American dream.
    Our new owners have never asked us to cut costs or to 
reduce our head count. Any reductions in staffing that we have 
had over the past 4 years have been as a result of our efforts 
to be more productive and more efficient. This year we expect 
to divest of Togo's, our west coast brand, because it generated 
only $200 million in annual system sales, and this decision we 
had considered prior to our new ownership because we wanted--
because of its size, we wanted it to have the same attention 
that we were getting from our new owners, and we could not do 
that while focusing on our two larger brands.
    You know, recently I was asked by a Boston Globe columnist 
whether Dunkin' Brands would follow the path of many companies 
and move to a location where the cost of doing business would 
be lower. I was pleased to say, Mr. Chairman, that 
Massachusetts is our home. We are not going anywhere. I have 
700 or 800 families who work for Dunkin' Brands who rely on us 
for their employment. We believe in those strong community 
roots, and last year, together with our franchisees, we 
established the Dunkin' Brands Community Foundation, and we 
have given $1 million to that foundation out of our pockets, 
with no resistance from our new owners.
    The mission of our foundation is to support those who serve 
our communities, especially in times of crisis, and this 
mission is true to our brand heritage and the values of the 
entire system, employees, franchisees, and our customers.
    In conclusion, as a result of our relationship with 
Carlyle, Bain, and Thomas H. Lee, our business has benefited. 
Our franchisees and employees have benefited, and wealth-
creating opportunities have been spread among hundreds of 
entrepreneurs and careerists associated with Dunkin' Brands.
    Thank you.
    [The prepared statement of Mr. Luther can be found on page 
51 of the appendix.]
    The Chairman. Next is Mr. Lowenstein, who is the president 
of the Private Equity Council.

  STATEMENT OF DOUGLAS LOWENSTEIN, PRESIDENT, PRIVATE EQUITY 
                            COUNCIL

    Mr. Lowenstein. Thank you, Mr. Chairman, and members of the 
committee.
    The Private Equity Council represents 10 of the leading 
private equity firms in the world, and we are pleased to be 
invited to participate in the beginning of this dialogue with 
this committee on private equity.
    Before addressing the issues that the committee has raised, 
I think it would be helpful to just take a brief second to 
demystify private equity, because private equity is about 
hundreds of thriving companies contributing to the economy in 
numerous positive ways. You just heard that if you get a cup of 
coffee at Dunkin' Donuts, you are interacting with private 
equity. When you see a movie produced by MGM Studios, and then 
buy pizza for your kids afterwards at Domino's, you are 
interacting with private equity. When you buy a new outfit at 
J. Crew, or you buy toys for your kids at Toys-R-Us, you are 
interacting with private equity. When you watch a movie or a 
sporting event at home, or when you use your cell phone, the 
chances are you are interacting with a semiconductor chip 
produced by a private equity-owned firm.
    Furthermore, private equity investments directly and 
indirectly benefit tens of millions of Americans. As we have 
heard this morning, public and private pension fund foundations 
and university endowments have chalked up returns from private 
equity investments that far exceed those available from the 
stock market.
    Between 1991 and 2006, private equity firms worldwide have 
distributed $430 billion in profits to these and other 
investors. That is $430 ``billion'' with a ``b.'' These returns 
translate into stronger public employee pension programs, more 
funds for college financial aid and scholarships, and more 
funds for research and other causes supported by charitable 
foundations. Private equity, indeed, is about a lot more than 
enriching a handful of people.
    Let me turn briefly to address a few of the questions that 
the committee has asked about. First, do private equity firms 
invest in the businesses they own and operate? Well, we have 
some examples in our testimony which are, I think, quite 
typical of private equity practices.
    Sungard, for example, the software maker, has invested in 
its business. R&D projects since the private equity firm took 
ownership are up from 10 to over 50 today, and employment has 
grown by 3,000 people since the acquisition by private equity. 
Axel-Tech, with a 37 percent job growth and a 16 percent sales 
growth since the private equity firm acquired the company and 
the company moved into a new line of business, builds 
suspension systems and axles for vehicles, and it moved into 
servicing the United States military, which needs heavier 
suspension systems for the heavily armored vehicles serving our 
troops in Iraq, and Axel-Tech was a maker/supplier of those 
suspension systems. ITC Holdings, a Michigan utility, has seen 
private equity help grow the business, with job growth from 28 
at the time of acquisition to 230, and capital spending up from 
$10 million to $200 million annually.
    These are not the exceptions in any of these examples. You 
must understand one central fact about private equity which 
often gets lost in all of the rhetoric and debate. They only 
succeed if they improve the performance and increase the value 
of the companies in which they invest. The entire business 
model rests on selling investments at a gain. Firing workers 
and stripping assets is hardly the best way to show future 
buyers that you built something of greater value.
    The second question raised by the committee concerns the 
impact of private equity on working men and women. Aside from 
case studies, which I think are helpful evidence of the impact, 
and there are hundreds more like it, it is true--data on 
private equity investments' impact on employment in the United 
States is, in fact, anecdotal at this point, but research in 
Europe does suggest that private equity investments do, indeed, 
result in long-term job growth. A study by the international 
management consulting firm A.T. Kearney found earlier this year 
that private equity firms worldwide generate employment on 
average at a much faster pace than comparable traditionally 
financed firms.
    That said, the simple truth is that, as with any other 
acquisition involving a public or private company, private 
equity transactions can and do sometimes result in layoffs. In 
some cases, the most affected employees are the management 
level, and in other cases they are not. In some cases, the 
layoffs may eventually be offset by new hires over the long 
term when business grows stronger. Nor should we lose sight of 
the fact that even when there are layoffs, the willingness of 
the private equity owner to even acquire and invest in a 
troubled firm probably results in the savings of jobs that 
might otherwise have been lost.
    There is no one-size-fits-all pattern to private equity. 
There is no pattern of busting unions and laying off workers in 
private equity. It is simply not there. By the way, these 
limited partners are pension funds, public employee pension 
funds, and I ask you: Does common sense tell you that if they 
saw private equity firms gutting employees and gutting workers 
that they would really continue to support this asset class the 
way they have?
    The final area of interest to the committee is the impact 
of private equity on income inequality. Undeniably there are 
those in private equity who do very well. Equally undeniable is 
the fact that we have an income inequality problem in this 
country. Private equity is not the reason American companies 
and workers are under pressure or why wages and benefits are 
stagnant; these are based on pervasive global forces at work. 
Private equity alone cannot and will not and should not redress 
the income disparity problem in this country. That requires 
national will and national policies, and we are prepared to be 
part of any effort to attack that problem cooperatively and 
creatively either with government or with the SIRU and others 
in organized labor.
    At the same time, I believe that ensuring the firemen and 
teachers of the income they expect when they retire or that 
kids get scholarships to college they might not otherwise have 
gotten suggests that private equity does more than just distort 
income disparity at the high end. I noted earlier the $430 
billion in profits to limited partners and how these flow to 
average Americans, but let me give you one very concrete 
example.
    The excess returns generated by private equity investments 
by the Washington State Investment Board for over 25 years has 
been $26,000 per retiree. Put another way, these returns have 
fully funded retirement plans for 10,000 WSIB retirees.
    In sum, private equity makes significant contributions to 
the American economy. It is innovative and flexible. It is not 
a silver bullet, but it is a part of the system, and it is a 
good part of the system.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Lowenstein can be found on 
page 41 of the appendix.]
    The Chairman. Dr. Robert Frank.

 STATEMENT OF DR. ROBERT H. FRANK, JOHNSON GRADUATE SCHOOL OF 
                 MANAGEMENT, CORNELL UNIVERSITY

    Dr. Frank. Thank you, Mr. Chairman. I am grateful for the 
opportunity to speak to you today about the consequences of the 
broader inequality problem.
    I am an economist at Cornell University. I have been 
writing about the causes and the consequences of rising income 
inequality for the past several decades in books, including 
``The Winner Take All Society,'' ``Luxury Fever'' and, next 
month, ``Falling Behind: How Rising Inequality Harms the Middle 
Class.''
    Much of the testimony you have already heard. I think 
private equity is part of a whole complex of forces that have 
made the U.S. economy much more competitive in the last several 
decades. One consequence of greater competition is that money 
tends to flow to the players that have the greatest impact on 
the bottom line. If you look at Jon Luther, he is a perfect 
case study of how high rewards at the top of the corporate 
ladder are not primarily, as many people seem to think, a 
result of corporate malfeasance, vivid cases to the contrary 
notwithstanding. Typically, somebody who is in charge of a big 
organization and who is making good things happen needs only to 
make 2- or 3 percent better decisions in a year's time in order 
to have an impact on the bottom line of tens of millions of 
dollars. So, if the economy is getting more competitive, the 
expectation is that the rewards will flow to individuals who 
can make that happen. That is just the way the market is.
    The market produces a bigger pie. No economist ever claimed 
that the market guaranteed that a bigger piece of pie would 
automatically go to every person as a result of greater 
competition. Even though people in the middle have slightly 
higher incomes than they had before, one of the practical 
consequences--and here, I agree with Chairman Frank that we 
have to focus on the practical consequences of inequality 
rather than the moral ones if we want to see anything done 
about it--of higher incomes at the top is that people in the 
middle will have a much harder time meeting basic middle-class 
goals.
    Let me describe quickly a process that I call ``expenditure 
cascades.'' People at the top have vastly more money than 
before. People of middle income do not seem offended by that. 
That is one of the nice things about the United States. People 
are not jealous of the success of the rich. People at the top 
are spending more because they have more money. People just 
below the top are influenced by their spending. Maybe it is now 
the custom to have your daughter's wedding reception in the 
home rather than in a rented club, so you need to build bigger. 
People just below those just below the top build bigger in 
response to that, and so on. Now the median house newly 
constructed in the United States is about a third bigger than 
it was in 1980.
    The rub for the middle-class family, which has no more real 
income now than in 1980, is if you do not buy the median-priced 
house for your area, your children will go to below-average 
schools. That is the way it works. So the median family is 
forced to save less, work more, commute longer distances, and 
work longer hours, in short, to be squeezed on every margin in 
order to meet the minimal goal of sending their children to a 
school of average quality. There is no pretending that this is 
not a genuine burden on the middle class.
    If we are to do something about this, it is a fool's error 
to castigate corporate pay boards for not showing individual 
restraint. There is no such thing as individual restraint in a 
perfectly competitive system. You pay the market rate, or you 
do not get the talent that you need to be able to compete 
successfully. The only lever we have is tax policy in this 
arena if we are not happy about the way income distribution 
changes have been going. Most countries that have rising 
inequality have attempted to lean against it by increasing tax 
rates on top earners and increasing benefits for those who have 
been failing to keep up.
    For some reason in this country, we have moved in precisely 
the opposite direction by reducing tax rates at the margin for 
top earners and cutting the social safety net. This is a 
testament, I think, to the mysterious power of trickle-down 
theory, that if we cut the taxes on the top earners, we will 
somehow cause the economy to grow much more quickly. I do not 
have time to go into it in detail, but it has been widely 
discredited by economists of all political persuasions. Bruce 
Bartlett, in The New York Times last month, said that it is 
time for the supply-side economists to stop saying that tax 
cuts for the rich generate increases in tax revenues.
    So, again, I think there is no indictment of the people who 
are reorganizing businesses to make them more competitive and 
generate expansions in profits, and there is nothing morally 
improper about their being paid the going rate. There is, 
however, something morally questionable about a society that 
allows people's fate to hinge solely on market outcomes. That 
has never been a prescription for a sound society. Societies 
that have tried that in the past have failed to prosper in the 
long run. Even the rich, the ostensible beneficiaries of tax 
policy in recent years if you reckon the consequences of those 
tax cuts, have actually been harmed by them.
    The tax cuts have enabled the rich to build bigger houses. 
What we know now is that, when everybody builds a bigger house, 
that just redefines the standard for what constitutes an 
acceptable dwelling. So you have more money after taxes, and 
you build larger. No gain. It is not really a tax cut. It is a 
loan financed by borrowing from China, Japan, Korea, and other 
nations that will have to be repaid in full with interest. In 
the meantime, we have been cutting the Energy Department's 
project for rounding up loose nuclear materials in the former 
Soviet Union. We have been cutting back on a whole array of 
public services. This is not intelligent public policy. I 
think, in another 50 years, people will look back and say, 
``What on Earth could they have been thinking to do that?''
    [The prepared statement of Dr. Frank can be found on page 
31 of the appendix.]
    The Chairman. Thank you.
    Let me begin by asking Mr. Stern: There is a lot of top 
equity. We have talked about this, that there are acquisitions, 
office buildings, hotels, and places that employ a large number 
of workers. We are not competitive with manufacturing workers 
elsewhere. Dunkin' Donuts would be the same.
    One of the things that concerns many of us has been the 
hostility to unions, and I am just wondering what your 
experience has been, and I would say people are ready to talk 
about it. I would say for many of us--and obviously, there is a 
difference between parties on this--but the unions do seem to 
be one way to deal with this without government intervention, 
collectively bargaining for chambermaids and janitors, and this 
is a new class of people. These are the people who sit in the 
lobbies of office buildings and make me show them my driver's 
license so that I will not blow up the building. I do not know 
if that works very well, but it does not pay a whole lot, and 
that is probably the best job we have had since the WPA.
    What has been your experience in terms of trying to get 
collective bargaining agreements with these new owners?
    Mr. Stern. Well, first of all, I should say in response to 
the broader question, there have only been three ways we have 
distributed wealth in America historically: one has been the 
market, which as Alan Greenspan is saying is no longer working; 
two has been the government; and three has been unions. You 
know, unions are just a way to distribute wealth and end 
inequality. So, when you see a purchase like Cerberus, as 
Congressman Lynch said, you are glad the union is at the table, 
because you wonder what would happen if they were not.
    And so I do think there is an issue here of how, not 
through government regulation, but by private activity that 
goes on. I would say, you know, the private equity people have 
to make a decision of whether they are going to proceed in a 
way that too many employers have been proceeding as owners, 
which is to not let workers make a free and fair choice about 
whether they want to have an organization.You know, that is a 
conversation we would love to have with a new owner.
    The Chairman. What has your experience been?
    Mr. Stern. There have been no better than the private 
equity field, but there is now a growing--they are much more 
involved in the economy today, and so we are going to get to 
see again, you know, as they go from owner-distressed companies 
to very successful companies like Equity Office Properties or--
you know, how they are going to behave as the new owners. Time 
will only tell, but so far there is no difference.
    The Chairman. Let me ask you. I do want to make one 
comment, and that is that one of the things we hear is that, to 
the extent that, for instance, we did our executive 
compensation bill, and to the extent that there were concerns 
about the compensation of the CEOs of public companies, that 
becomes an incentive for them to go into private equity. I must 
say that is the most serious attack on the morals of those 
people that I have ever heard. What it says is that they are so 
concerned with their own pay that they will make a fundamental 
decision about the form of ownership. It is the notion that 
someone is running a public company with his or her obligations 
to the shareholders who says, ``I can make a lot more money if 
I sell out my shareholders and go to private equity,'' and that 
would be a motive for making a change. I am shocked that people 
would think so ill of these people.
    Now let me ask Mr. Lowenstein. I agreed when you said that 
private equity did not cause this, but sometimes there are 
opportunities for the inequality, and I appreciate your 
acknowledging it. You say that private equity would be willing 
to participate in the dialogue. Let me ask, for instance, with 
regard to unionization, is there any general principle, is 
there any kind of general predisposition one way or the other? 
I must say, if we saw that there was some willingness to enter 
into those kinds of agreements, that would be relief for a lot 
of us.
    Mr. Lowenstein. Well, I think it is difficult, obviously, 
for me to speak in the context of, you know, hundreds of deals 
and transactions that are being done involving dozens and 
dozens of private equity firms.
    My sense in the little time that I have been involved with 
this sector is that there is an openness to meeting and to 
talking with people from a variety of different stakeholder 
groups, including organized labor. There is no sort of 
antilabor, antiunion bias in private equity. There are plenty 
of private equity companies where union employees are a central 
part of the business, and those jobs have grown as part of the 
basic business plan. So, beyond that, I think it is difficult 
for me to generalize other than to, as we have in recent weeks, 
make clear that we are more than open to opening constructive 
and cooperative discussion with all stakeholders on these kinds 
of issues.
    The Chairman. Well, I appreciate that. My time is up. I do 
think, from the standpoint of many of us workers, particularly, 
frankly, low-wage workers in some of these occupations, they 
are a particularly important group for stakeholders, and it 
does seem to be--you say you are prepared to enter a dialogue. 
Some concern for the workers sharing in this value created 
would be very helpful.
    The gentleman from Alabama.
    Mr. Bachus. Thank you, Mr. Chairman.
    Mr. Chairman, I saw and the members of the committee saw a 
``Dear Colleague'' that the chairman sent out yesterday.
    It says, ``Dear Colleague, I appreciate the concern 
expressed by many about why my arm is in a sling. In order to 
avoid having to repeat the same conversation, I am sending out 
this `Dear Colleague.' I ruptured a tendon in my left arm using 
a curling machine in the gym, and had it surgically repaired 
yesterday at Bethesda.''
    My staff went to that gym, found the curling machine, and 
found that it was manufactured by a private equity company. 
Now, we all know why we are here. His arm will be out of a 
sling in a week or 2, and we can maybe put the focus on 
something else.
    Mr. Lowenstein. Perhaps it was a stronger curling machine 
than one made by a nonprivate equity firm.
    Mr. Bachus. All right. Mr. Luther, I noticed as I was 
reading the history of Dunkin' Donuts that it seems like, since 
it has been taken private, the number of franchises has 
expanded. Has being owned by private equity investors been 
something that is financing that, or has there been a change in 
corporate policy?
    Mr. Luther. Yes. Under the Allied Domecq regime, and 
shortly with the Pernod Ricard regime, they would sweep our 
cash every day to fuel their wines and spirits business. Our 
good cash generated--our good cash flow would go to them to 
build a Beefeater gin brand. For example, since private equity 
and since the ownership, they focus on our growth and enable us 
to go forward, meaning that they invest in infrastructure, 
which is something that we were not able to do before, meaning 
our IT systems and technology, so we can remain competitive 
with our competitive segment. Because of their brilliance in 
financing and the financial world, it has enabled us to put a 
program together, a franchisee financing program, which is more 
convenient for them to apply so they can build these stores to 
add the jobs and to get in these communities and do good work, 
and if it were not for their great expertise in that area 
enabling us to do that, our franchise system would be slower in 
growth, and that is important. Since we are 100 percent 
franchised, obviously that is the engine for our growth, and 
one of the most important attributes to our business growth.
    Mr. Bachus. So your private owner sponsors actually help 
finance these franchisees?
    Mr. Luther. No. They have aided and abetted us to work with 
outside financial firms to get better favorable rates by their 
better understanding of financial aspects, and perhaps we get 
too close to it sometimes, but for this outside influence to 
come in and educate and coach us in those areas, it has 
benefited us greatly.
    Mr. Bachus. I will ask this to anyone on the panel. Back in 
the 1980's, we had corporate raiders, and we had the LBOs. As 
to private equity investments, how are they different from 
that, or is there a difference?
    Mr. Lowenstein. I will take the first crack at that.
    I think there are a number of differences today than 20 or 
30 years ago. For one, in the early days of private equity, the 
lending typically would come from a single lender, the debt 
levels in a transaction would typically be at the 90 percent 
level, maybe even higher, and the transactions were much more 
tied to asset sales as a way to quickly repay the debt to make 
the leverage play work. Today, you have a lot of differences.
    First of all, the typical debt level in recent years in 
private equity transactions has been hovering around 40 
percent--I am sorry--equity levels are around 40 percent, so up 
considerably. There is a lot less leverage in the transactions. 
Secondly, the level of due diligence of private equity firms 
today compared to 20 years ago is quantumly farther along than 
it was then, and even the simple technology available to do 
effective analyses of the investments and so forth is far 
better. Sometimes it takes private equity firms 2 years before 
they actually make an acquisition, so they raise funds, but 
they are not investing all of their funds immediately.
    I think you also have--the other critical point is that we 
are at the point where the way today that you make money in 
private equity is not by an asset sale, because, in a sense, 
everybody knows what the assets are, and they are priced into 
the deal. These are all auctions. They are competitive 
processes. If you are going to grow a firm, you have to grow it 
with operating improvements. That is a big change from the way 
it was 20 years ago, and so the value creation comes from 
investment, from growing, from improving operations in the 
management of the company. So I think those are some of the 
major changes.
    Mr. Stern. I am not as familiar with all of the details, 
but I do want to read to you what the founder of The Carlyle 
Group says, which I know we talked a lot about value and 
decisionmaking, but he says, ``The fabulous profits that we 
have been able to generate for our limited partners are not 
solely a function of our investment genius, but have resulted, 
in large part, from a great market and the availabilities of an 
enormous amount of cheap debt. Frankly, there is so much 
liquidity in the world financial systems that lenders, even our 
lenders, are making very risky credit decisions,'' and I think 
that is a very big difference from the 1980's.
    Mr. Bachus. If they are paying top dollar, of course the 
shareholders are all benefiting from these sales, I would 
think, and then the private equity investors--I mean, if they 
pay top dollar, and they still make it work, that seems like a 
win-win situation.
    Mr. Luther. Just to weigh in, my experience is that there 
has been a lot of equity put into our deal, so it is not 
leveraged quite as it was in the 1980's. I think a significant 
difference for me in being in this industry for a while, 
meaning my industry, the restaurant industry, and watching what 
happened in the 1980's as compared to today is the fact of 
Carlyle, Bain, and Lee. During our auction process, we were 
engaged with maybe 25 of these firms that were in the auction 
process. They looked at the leadership. They looked at the 
management. They looked at organic growth as opposed to ways to 
cut their way or to save their way to success. They looked at 
all of those organic pieces--management values. What kind of 
leadership values do we have? What do you give back to the 
communities? What kind of relationships do we have with 
communities and franchisees? That was a greater part of their 
due diligence than maybe 20 years ago--I am not sure--but in 
talking with all of the potential bidders for our company, they 
all had those questions and that curiosity rather than the 5-
year plan or the numbers.
    By the way, just for the record, in our case we were able 
to put our numbers together--the management team's and the 
management projections--in the bidding process. No one told us 
to put the numbers higher or lower or whatever. They left it up 
to us, and then the auction was based on that. So there was not 
this, ``Make it better than it is. Let us take this thing 
forward in a way so we win or lose.'' It was how do we do this 
the right way, and I think that is an important distinction, 
maybe, of the perceptions of the past.
    Mr. Bachus. Thank you, Mr. Chairman.
    The Chairman. I would note that you got extra time for 
reading my ``Dear Colleague.''
    The gentlewoman from California.
    Ms. Waters. Thank you very much, Mr. Chairman.
    I want to thank our panelists for being here today to help 
us understand what has become a very, very important area as we 
look at our responsibilities here in this committee.
    I would like to know from Mr. Lowenstein, I believe it is, 
if you can help me to understand what requirements are placed 
on the fund, the private equity funds, by the investors. For 
example, CalPERS in California has a $240 billion portfolio 
there, and if they invest in one of these funds, what do they 
ask of the fund? What do they say they want you to do if they 
are investing in funds so that the fund can be involved in 
these buyouts where we are concerned about the employers in the 
community? What kind of requirements do they place on the 
people they give the money to?
    Mr. Lowenstein. Congresswoman, I think that, in all candor, 
the question is probably better put to CalPERS and the 
investors, themselves. I am not part of those negotiations. I 
will say that there are very, very intensive negotiations that 
occur between the limited partners and the private equity firms 
in putting the partnerships together. These are very, very 
intensely negotiated funds over an extended period of time, and 
certainly, in that context, limited partners are able--
    Ms. Waters. But you do not know of any standard code of 
conduct that is being required?
    Let me ask Mr. Stern.
    Mr. Stern, does the union place any requirements on its 
money that it invests in these kinds of deals?
    Mr. Stern. Well, I mean, most of the unions who are in the 
private sector are governed by fiduciary responsibilities that 
would not allow us to place particular kinds of requirements, 
you know, in terms of investment decisions other than the 
nature of the return that we would get on the investments. I 
think CalPERS' instructions, for better or worse, to the 
private equity firms are to make a lot of money.
    Ms. Waters. So public-employee pension funds and union 
funds could be investing in deals where people are going to get 
laid off?
    Mr. Stern. Yes, because, as I understand most of these 
limited partnerships, you know, they are called ``limited 
partnerships'' because they have a limited role in the 
decision-making process, and so part of the problem with some 
of the laws in our country today is that they do not allow 
investors to make what one might think are appropriate 
decisions about issues like that because it would be a breach 
of our fiduciary responsibility.
    Mr. Lowenstein. If I may just add to that, though, nobody 
is forcing any limited partner to invest in a private equity 
fund, so the best way to vote against companies that are not 
using your money in socially responsible ways that you care 
about is to not give them your money. As we said, CalPERS and 
many other limited partnerships' stakeholder pension funds are 
providing billions and billions of dollars to fuel this, in a 
sense, and then vote with their pocketbooks if they see a 
problem of how these transactions are being conducted.
    Ms. Waters. Well, let me just say this: For years, I was 
involved in a struggle in California to divest our pension 
funds from companies doing business in South Africa. We heard 
all of the fiduciary arguments, but we changed it, and we got 
involved in a divestment movement that helped to change the 
attitudes and create some social responsibilities, so it is 
something that we need to examine.
    I yield back the balance of my time.
    The Chairman. Mr. Hensarling.
    Mr. Hensarling. Thanks, Mr. Chairman.
    First, Mr. Stern, you spoke about income inequality, I 
believe, in your testimony. Does the janitor who cleans your 
office make the same income as you do?
    Mr. Stern. No, sir.
    Mr. Hensarling. So can one say that you, yourself, are 
practicing income inequality?
    Mr. Stern. No, sir.
    Mr. Hensarling. Why not?
    Mr. Stern. Because I think what we are talking about here 
in terms of income inequality is the growing gap between the 
rich and the rest of the population--that 150,000 or 300,000 
Americans now make as much as the other 150 million Americans. 
I think we are talking about a very drastic set of extreme 
circumstances that were raised in the colony of the Great 
Depression.
    Mr. Hensarling. So are you more offended by the income 
inequality of those who make less than you? It appears that 
maybe you have more concern for those who make more than you.
    Mr. Stern. I am not concerned with people getting wealthy, 
but I am concerned that people who work every day cannot own a 
home, raise a family, and live the American dream. And I am 
very concerned about a country where my kids and grandkids will 
be the first generation in American history to do worse than 
their parents. I do not think that is America.
    Mr. Hensarling. Well, I happen to agree with you there, and 
that is, for one, why I am concerned that recently the House 
passed a budget that included the largest tax increase in 
American history that will impose an approximately $2,700 tax 
increase on all of the families back in the Fifth Congressional 
District of Texas.
    Dr. Frank, in your testimony, you talked about, I believe--
I do not want to put words in your mouth--that we have been 
cutting the social safety net. Does that capture what you said 
in your testimony?
    Dr. Frank. Yes, sir.
    Mr. Hensarling. I have been reviewing figures for the 
Congressional Budget Office and the Office of Management and 
Budget, and by the figures I have seen since 2001, healthcare 
assistance has increased 40 percent at the Federal level; 
housing assistance, 27 percent; food assistance, 58 percent; 
cash and other assistance, 40 percent; and general anti-poverty 
spending at the Federal level has been 41 percent. The only 
major poverty program that I can find that has decreased is 
TANF. That is because the caseload is down about two-thirds due 
to work requirements. What have you discovered that CBO and OMB 
and everybody else who calculates these numbers haven't 
discovered?
    Dr. Frank. Well, part of what you have to understand, 
Congressman, is that the cost of a lot of the entitlement 
programs goes up for everyone, so we can provide that year by 
year. There have been cuts in the earned income tax credit 
programs. There have been cuts in the rate at which public 
transport has been supported. The public schools--
    Mr. Hensarling. I'm sorry, if I could interrupt. Where did 
you get your figures on the earned income tax credit? Because 
my figures show that it has increased at least 38 percent since 
2001.
    Dr. Frank. Relative to the cost of the middle- and low-
income family meeting basic needs, those payments have not kept 
pace, Congressman.
    Mr. Hensarling. Let me ask you another question. I think 
you spoke of the need of tax policy changes to address income 
inequality. Is that a fair assessment of your testimony?
    Dr. Frank. Yes.
    Mr. Hensarling. From my figures, we have roughly 50 percent 
of the population that for all intents and purposes pay no 
income tax at the moment. Do your figures differ from that?
    Dr. Frank. No, they don't differ from that. Most of those 
people do, however, pay payroll tax.
    Mr. Hensarling. That they do, and if we don't reform our 
entitlement programs, they will pay more as well. My figures 
show that over the last 25 years, the top 20 percent of income 
earners have seen their percentage of Federal tax paid increase 
and 80 percent of the taxpayers have seen them go down.
    Do you have some other set of figures besides the ones that 
I viewed from the U.S. Department of the Treasury.
    Dr. Frank. No, sir, that is an expected consequence of the 
change in where the pretax income has gone. The more pretax 
income that goes to the top, of course the more tax will be 
paid by people at top.
    Mr. Hensarling. I see where the top, I believe, 5 percent 
of income earners pay almost 60 percent of Federal income 
taxes. What percentage would you have the top 5 percent pay?
    Dr. Frank. A higher percentage than that because we are 
currently borrowing $800 billion a year because we are not 
collecting as much in revenue as we are incurring in expenses. 
The tax increase--
    Mr. Hensarling. Maybe we need to do something on the 
spending side as well. I see my time is up.
    The Chairman. Ms. Maloney.
    Mrs. Maloney. I would like to thank you, Mr. Chairman, for 
having this hearing, and to thank the panelists for attending. 
Many of you have touched on the widening gap between the haves 
and the have-nots in our country, which is a tremendous 
concern, I would say, of all Members of Congress. It is very 
troubling and has major ramifications. Last year, Steven 
Schwartzman, the chief executive of the private equity group 
Blackstone warned in an interview with The Financial Times that 
the widening gap between the lavish pay of executives and CEOs 
and middle America's stagnating wages may result in a backlash 
and in a political and social crisis in our country, and the 
best way to deal with this widening income inequality, 
according to Mr. Schwartzman, is for the middle class to do 
better.
    So I would like to ask Mr. Lowenstein and Mr. Stern if you 
would comment and anyone else on my question. Mr. Lowenstein, 
can you tell us how the private equity deals where Mr. 
Schwartzman and his colleagues are reaping, literally, billions 
of dollars in fees and payouts, how are their private equity 
deals helping the middle class do better?
    Are the workers sharing in the increased profits of these 
private equity firms through increased wages or benefit 
packages? How are these deals helping middle America?
    Mr. Lowenstein. Well, I think as a general proposition, as 
I said in my testimony, we believe that private equity is 
strengthening companies, and making them more competitive. And 
by definition, if that is true, people who work for those 
companies have more secure jobs. And in many cases, as I also 
said in my testimony, the few examples we use there has been 
job growth in those companies.
    And so, I think in that way that obviously supports middle 
income wage earners and so forth. As I also said, there is a 
range of indirect benefits. When you talk about private equity 
profits, 80 percent of the profit when an asset is sold goes to 
the limited partners. And those limited partners, as we 
discussed, have money that then flows back to retirees and many 
others in our community who benefit from that indirectly.
    I would also suggest to you that there is another indirect 
benefit to the extent that private equity firms are allowing 
and strengthening businesses that are part of people's everyday 
lives--Dunkin' Donuts and Domino's Pizza and J. Crew and other 
places that people shop on a regular basis. That is also 
helping people acquire the necessities of everyday life.
    So I think there are various ways that these transactions 
promote value and growth and flow through to lots of 
individuals.
    Mr. Stern. The Census Bureau reports that America has had 
its fifth straight year in a row that Americans did not get a 
raise, the longest period of economic stagnation in the history 
of our country. And it is all about that we are creating 
wealth, but it is not being distributed. I don't think private 
equity per se--maybe indirectly, but not directly, has done 
anything to help rebuild the middle class. There used to be a 
joke about when people were creating new jobs, they would say 
there are 10 million new jobs and I got 3. I think that is a 
lot of what we are seeing here.
    We are not necessarily creating the middle-class jobs that 
we saw in the plants in Massachusetts, where there were union 
jobs, and jobs where people could own a home and raise a 
family. And I am not saying that private equity is the cause of 
it. I am just saying that I don't think they are the solution 
to it either, so far.
    Mrs. Maloney. Would you like to comment, Dr. Frank, or 
anyone else, on this?
    Dr. Frank. Again, I don't think that attacking the 
competitive forces is the lever that you want to pull. I think 
the lever that you want to pull--you do have to cut spending 
where possible, but the government we elected last time 
campaigned as an opponent of government waste. You cut what you 
can. Yet one of the programs they cut was the Energy 
Department's program to round up loosely guarded nuclear 
materials in the former Soviet Union.
    We just don't have the revenue to do the things that we 
need to do, and I think that is where your focus should be.
    Mrs. Maloney. Mr. Luther?
    Mr. Luther. Yes, my experience might be a microcosm of the 
overall economy, but in our case when private equity acquired, 
the opportunity for many of our employees who worked for 
Dunkin' Brands, not our franchise organizations, we distributed 
some of that wealth to them in the form of stock and options to 
over 150 people in our organization; that is 15 percent of our 
company that now has some opportunity perhaps for their 
children to go to college without borrowing money or whatever.
    Our goal is to continue to distribute those stock options 
and equity opportunities into our organization deeper and 
deeper, so we distribute the wealth in that regard.
    Our franchise communities create the jobs and create 
management jobs within our restaurants and multi-unit jobs that 
hopefully can enable those employees to continue to grow their 
experiences and their careers so that they can compete in the 
middle-class environment, so we try hard to make sure we do 
that.
    The Chairman. We will take Mr. Castle and then we will 
break for the votes and come back immediately. There is 
apparently only one 15-minute vote. Mr. Castle. And then we 
will break and come right back.
    Mr. Castle. Thank you, Mr. Chairman. This is an interesting 
plight and tug of war going on here. Mr. Stern, let me ask you 
a question. I read your paper and listened to what you had to 
say and you are concerned, as you should be, with working 
people and the status and how they have gone. My question or 
concern here is, frankly, I am not sure how private equity has 
impacted that directly. You do have some comments in there and 
some anecdotal evidence of some things.
    But my question to you is--or to anyone else who really 
knows the answer--is there any empirical or statistical 
evidence with respect to private equity in terms of their 
investments and what has happened to the employees either in 
losing jobs or losing benefits, be it healthcare or pensions or 
whatever? And has any of that been laid up against what might 
have happened otherwise? That is, what is happening with 
corporations today in America? I am trying to get the gist of 
whether private equity has had a negative impact on that or 
not.
    Mr. Stern. I don't think there is it enough data or studies 
really yet to make those decisions. And we all can cite 
anecdotal situations and claim that they sort of represent the 
macro level, but I think we are all watching what happens. I 
think there is a huge opportunity here as private equity does 
receive, as the Congresswoman said, money from lots of public 
sources, you know, and that has helped make them incredibly 
successful, to think differently about what is their social 
responsibility as we would expect any business in America.
    And we are hoping that, given the source of their capital 
particularly, you know, from public pension funds and other 
places, that there could be a dialogue about doing as we saw 
with the deal in Texas, where environmentalists and people 
tried to work something out that was reasonable and rational 
for everybody.
    Mr. Castle. Does anybody else know if there is any real 
study or statistical evidence, and not just your conjecture on 
it.
    Mr. Lowenstein. There is data in Europe. It is not perfect 
data, but there have been studies done in Europe that show that 
private equity tends to result in net job growth and more 
investment in R&D, and other sort of measures of economic 
growth. There has been very little research here, so I think 
that is a gap that we are looking to fill.
    Mr. Stern. If you don't mind, there is one study that I 
think is important that shows that the private equity companies 
pay a lower premium to the public shareholders than other 
strategic reinvestors pay for the same companies. This is where 
Chairman Frank was asking questions about conflicts. It is not 
yet known whether that is true, but we are seeing the private 
equity pay a lower premium to shareholders in public companies 
than other strategic investors.
    Mr. Castle. This is an unanswerable question, I guess. Mr. 
Lowenstein to you, with the news of the Cerberus capital 
management takeover of DaimlerChrysler, or of Chrysler at 
least, I have a concern. I am from Delaware and we have a 
Chrysler plant there that has already been notified that they 
are going to lose a number of those jobs--not this year, but in 
the next couple of years.
    With respect to private equity type takeover, my question 
is what will happen to those employees--I am not suggesting we 
can wave a magic wand and get them reinstated--but with respect 
to their pension and healthcare plans, what has been the 
approach of private equity with respect to the rights of 
employees in circumstances such as the private equity takeover 
of a public corporation?
    Mr. Lowenstein. As I said, with respect to the Chrysler 
particulars, I am really not in a position to discuss that. As 
a general proposition, as I said in my opening statement, I am 
certainly not aware of any pattern or consistent effort on the 
part of private equity firms to raid pension funds or do a 
variety of things that are anti-worker, anti-pension, or anti-
benefit. As I said, the long-term business strategy is growth 
and you need to have a motivated and viable workforce to do 
that.
    Mr. Castle. I don't think Cerberus is under your direct 
jurisdiction, but again, on the automobile or perhaps any large 
investments--they have already made investments in the auto 
industry to a degree and my concern is that is a very capital-
intensive business. And do they have the ability to be able to 
make the investments in equipment technology, research, and 
some of the other things that are going to be needed to restore 
the American automobile industry to where it was before or is 
this a temporary investment on the way to making a profit 
someplace shortly down the road?
    Mr. Lowenstein. Let me answer that two ways: One is--I 
can't say what they will or won't do in the long run--I do 
believe that as all private equity funds the intent here is to 
grow and add value to the company. Chrysler is a difficult case 
study because obviously it has been operated as a public 
company, and it is hard to argue that it has been operated 
successfully as a public company in recent years. They 
announced 16,000 layoffs recently, as you know. I think as to 
exactly how that transaction plays out, we will just have to 
wait and see.
    But again, as an overall business proposition, there is 
nothing I have been exposed to in my conversations with private 
equity firms that suggests that they have sort of an anti-
worker or anti-growth bias in the business model, and in fact, 
quite the opposite in my experience.
    Mr. Castle. Thank you. Thank you, Mr. Chairman.
    The Chairman. I thank the gentleman. Now, Mr. Watt informed 
me that I was too optimistic. Apparently this is a motion to 
adjourn and then there is going to be 10 more minutes of debate 
and a couple of votes. We will be gone for 45 minutes. Can the 
witnesses stay? If they can, we will reconvene at 12:15 p.m.. 
We will have time to do whatever, and we will be back in 45 
minutes. So we are in recess for 45 minutes.
    [Recess]
    The Chairman. Another vote has been called. I am going to 
end the hearing. I apologize. You sat around for nothing. I 
wish--you got caught in the crossfire of a parliamentary 
dispute. It is another adjournment vote.
    I appreciate you having put up with this. I am apologetic. 
I was misinformed and I would not have held you here. I thank 
you for coming and we will not hold you here any further.
    If any of the witnesses wish to submit anything for the 
record, please feel free to do so.
    [Whereupon, at 12:45 p.m., the hearing was adjourned.]
                            A P P E N D I X



                              May 16, 2007

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