Private Equity’s Neglected Pre-History: A Trans-Atlantic Perspective

Large-scale private equity buyouts, and the increasingly gargantuan financial firms that spearhead them, are commonly regarded as staples of today’s financialized corporate economy. However, this has not always been the case and, up until recently, private equity firms and funds were still being heralded as a novel and revolutionary force in corporate finance and governance. In a new paper, however, I argue that, far from being a modern phenomenon that emerged only a few decades ago, private equity has a considerably longer pedigree.

Many observers would regard private equity’s effective ‘year dot’ as being 1976, when the pioneering New York LBO boutique Kohlberg Kravis Roberts (‘KKR’) came into existence. Whether by coincidence or otherwise, 1976 was also the year that Michael Jensen and William Meckling published their pathbreaking ‘Theory of the Firm’ article in the Chicago-based Journal of Financial Economics, which is widely credited with inaugurating the popular ‘agency’ paradigm through which private equity’s social value to the world would come to be articulated and understood in succeeding decades. Largely due to agency theory’s narrative influence, private equity has generally come to be understood not just as a US-originated phenomenon, but also, as an inherently functional, market-driven phenomenon geared to counteracting unsustainable structural deficiencies in the United States’ mid-to-late 20th century industrial economy. In short, private equity was—and arguably still is—perceived by most commentators as a thoroughly modern, American, and organic institution, with the late-1970s and 1980s widely cast as private equity’s proverbial zeitgeist moment when it became a fundamental game-changer for corporate finance and governance both domestically and, to some extent, internationally. But to what extent were the times really, to quote Bob Dylan, ‘a changin’ during this era insofar as the growth of private equity was concerned, at least in relation to earlier periods of Anglo-American business history?

Private equity’s effective origination can, if fact, be traced back to the 1870s rather than 1970s. Indeed, in many ways, the great US investment banking pioneer John Pierpont (JP) Morgan could arguably lay claim to being America’s (if not the world’s) original private equity trailblazer in the late-nineteenth and early-20th century. Although fundamentally a transactional intermediary (rather than principal) in the orthodox investment banking sense, JP Morgan was nonetheless known to make significant personal equity investments in especially promising ventures which his banking firms underwrote. The most notable example of this was Morgan’s personal funding of Thomas Edison’s pioneering Electric Light Company, in 1878, which included providing 50 percent of the principal capital for the construction of a new power station for the company in New York. Moreover, as early as the 1880s, Morgan—via his original banking firm Drexel, Morgan & Co—was accustomed to buying significant blocks of equity in underperforming companies, which his banking firm would subsequently reorganize with a view to making a capital gain in addition to professional fees for their services. This arguably made Drexel, Morgan & Co something of a prototype for the LBO boutiques that would come to inhabit the same Manhattan streets almost a century later.

I further show how the common perception of private equity as a purely US—originated phenomenon—that only later made inroads in the UK and other jurisdictions from the 1980s onwards—is also an oversimplification, given that private equity buyouts originated much earlier than this in the UK, too, and were engendered by markedly different pressures and circumstances to those at play in the United States at the relevant times. Finally, I show how, in contrast to private equity’s typical intellectual rationalization as an organic, market-driven phenomenon, the peculiar trajectory of the UK buyout sector demonstrates that private equity is, in trans-Atlantic perspective, a heavily path-dependent institution driven at least equally by public (state) pressures as by private (market) forces.

Indeed, as regards the historical foundations of the UK’s private equity sector, the contrast with the US experience is remarkable. On the one hand, American private equity is, and always has been, an inherently private, market-driven phenomenon that originated and evolved outside direct state influence or control. This experience is consistent with prevailing intellectual rationalizations of private equity, which since the 1980s have tended to emanate from the neo-liberal, Chicago School (in short, ‘right-wing’) tradition of financial-economic theory.  On the other hand, the UK’s private equity sector contrarily emerged in large part from ‘left-wing’ public policy foundations, in the sense of being prompted by government interventionism in the pursuit of what could best be described (at least from a contemporary viewpoint) as a Keynesian or socialistic industrial policy agenda.

In the round, therefore, Anglo-American private equity has a much longer, richer, and more complex history (or, if you like, pre-history) than is typically attributed to it. As such, modern manifestations of private equity from the 1970s onwards are not nearly as unusual in the broader context of historical investment practices as is commonly believed. Accordingly, there is much to be gained from viewing the modern private equity sector against the much longer, richer, and more contextually path-dependent backdrop that I set out in my paper. Moreover, the added value to students and scholars of private equity from taking such a long (and broad) view of their subject matter is especially pertinent in the contemporary context, as the private equity sector’s rapidly increasing bureaucratic scale and functional complexity present evolving new challenges for practitioners, policymakers, and external analysts alike.

As is all too commonly the case in business and finance, as it is in sports and the arts, what at first seems like a genuinely fresh innovation has, on closer inspection, usually been done before, albeit under a different name or guise. The upside in such instances, however, is that there is consequently a much deeper and richer body of past experiences, successes, and mistakes to learn from today than might be imagined at first glance.

Private equity is no exception to this trend.

Marc Moore is Professor and Chair in Corporate and Financial law at University College London.

The paper is available here.

This post first appeared on Columbia Law School’s Blue Sky blog.