Romneywatch: Red, blue and green

Mitt Romney’s victory over President Barack Obama in November’s election depends on a handful of highly-competitive swing states voting Republican. But if a recent study led by noted academic  Oliver Gottschalg is anything to go by, Romney’s former colleagues in private equity may be keen to see this happen too.

Gottschalg, of HEC Paris, and Aviad Pe’er, of Rutgers University, claim that private equity investments made in ‘red’ or Republican-leaning states have, in the past, outperformed investments made in ‘blue’ or Democratic states. Their findings, based on an examination of 11,000 deals from 1980 to 2003, are consistent with a similar study the duo published in 2008 – which found that private equity deals in red states outperformed those completed in blue states by an average rate of return of 9 percent.

This sounds improbable; particularly when you consider that many US private equity firms are headquartered in historically blue states like New York, Connecticut and California. However, according to the study, state support for Republican presidential candidates is often reflected by local regulatory policies, which in turn creates a more favourable environment for buyout transactions.

For instance, Republicans typically advocate smaller government and deregulation of business practices – policies that tend to be popular with GPs. Hence the study’s thesis: “the formal and informal institution context in ‘red’ states is more aligned with the principal strategies through which leveraged buyout investors create value.”

The industry appears to have taken notice. The academics say that in the period they studied, firms were more likely to acquire companies headquartered in red states. Indeed, the 2008 study found that companies headquartered in a red state were 27 percent more likely to undergo a buyout than otherwise identical companies in a blue state – just because firms focus their investments on geographies that offer a better risk/ reward profile.

Recent events seem to support Gottschlag’s theory that – generally speaking – the Republican Party is more supportive of private equity. Many of its officials have characterised Democratic attacks on Romney’s track record at Bain Capital as attacks on the entire industry (or capitalism in general), while recent efforts to curb regulations for private equity have largely been spearheaded by Republican members of the House and Senate.

No wonder, then, that the political action committee of lobby group the Private Equity Growth Capital Council has largely favoured Republicans with its financial support so far in the election campaign. Although the PAC has not made any contributions to presidential candidates, at press time it had contributed $112,500 to Republican congressional candidates or affiliated PACs – and just $47,500 to Democratic affiliates, according to a PEI study of US Federal Election Commission documents.

Friends in high places

In the US, the overlap between politics and regulation is most visible in Congress, where elected officials representing hundreds of US localities have the power to shape legislation affecting the industry.

Last year, Republican Representative Robert Hurt of Virginia sponsored legislation exempting private equity firms from registering with the US Securities and Exchange Commission. The Small Business Capital Access and Job Preservation Act was later approved by a Financial Services subcommittee in May by a vote of 19 to 13 – with only one Democrat, Jim Himes of Connecticut, breaking ranks in support of the legislation. Himes received a $2,500 donation from the PEGCC PAC for his reelection campaign in October. Hurt’s reelection campaign and that of fellow Republican Spencer Bachus (the Financial Services committee chairman) were also backed by the PEGCC’s PAC, to the tune of $10,000 each.

“The Private Equity Growth Capital Council has and will continue to support candidates who understand the critical role private equity investment plays in driving economic growth by investing in promising companies in all 435 congressional districts and all 50 states,” PEGCC spokesman Noah Theran told Private Equity International recently.

The PEGCC’s individual members seem to back this strategy: professionals from 17 of the 36 member firms have contributed almost $260,000 to the political action committee’s coffers, according to FEC documents. This includes some of the industry’s most important names – KKR co-founders Henry Kravis and George Roberts pitched in a combined $7,500, while a group of managing directors at Madison Dearborn contributed almost $30,000 and the partners at TA Associates chipped in $22,750.

Shades of red

On the surface, it seems pretty uncontroversial to conclude that Republicans are generally more supportive of the industry than Democrats, and (/so) the industry is generally more supportive of Republicans.

However, drawing a causal link from state-wide voter sentiment to local policy to performance seems like more of a stretch. For one thing, defining a state as homogenously ‘red’ or ‘blue’ arguably does a disservice to the political diversity at state level. As well as presidents, voters also elect congressmen, senators, governors and local government officials – and the balance of power can be different at different levels. For example, even a decidedly Republican state like Texas – which has gone to the Republican candidate in every presidential election since 1980 – was led by Democrat governors from 1983 to 1987 and again from 1990 to 1994. Similarly, Democratic stronghold Massachusetts was governed by none other than Mitt Romney from 2003 to 2007.

Furthermore, many states alternated repeatedly between red and blue over the 23-year period examined in the study. Gottschalg and Pe’er defined an investment as red or blue based on how its home state voted in the previous election. That’s problematic in cases like Ohio, which voted for Democrat Bill Clinton in 1996 and Republican George Bush in 2000 and 2004. Under the study’s definitions, an Ohio private equity deal in 1999 would be defined as blue, even though almost the entire investment period would have happened on a Republican watch.

Similarly, virtually every deal completed in the four-year period following the 1984 election – when Ronald Reagan captured every state except Minnesota and the District of Columbia – would have counted as a red state deal. Yet Democrats held a majority in the House of Representatives during that same period.

What about more recently? Well, of the top 20 states that received the most private equity dollars of investment last year, only five voted for Republican nominee John McCain in 2008; the other 15 went to Obama.

The PEGCC’s apparent support for the Republicans may also be a red herring (to some extent). The group insists it is not affiliated with either party. In fact, one source pointed out that the PAC still has a lot of money left to distribute before to the election – and he expects the donations to Democrats to increase as a percentage over time. So far, it has largely favoured senators and representatives who by dint of their positions dictate the flow of legislation through Congress. If those positions had been occupied by Democrats – as they were in 2009, prior to the PAC’s formation – it may have been a very different story.

Perhaps the safest conclusion to draw is that professional investors will usually put pragmatism before politics…