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Private Equity Delivers on Job Growth and Quality, Lags on Board Diversity

2023-10-23

By Greg Fischer, Douglas Beal, Vinay Shandal, Ben Morley, Lorenna Buck, Benjamin Baxter, Supraja Haritha, Thais Esteves, and Andrew Lee

Reading time: 8 min

Key Takeaways

Private companies owned by PE firms continue to make progress in key social metrics, including diversity, job growth and safety, and employee engagement.

ESG Data Convergence Initiative data show that the longer companies are owned by PE firms, the better they perform on several social factors.
The number of women on private company boards continues to lag that of public companies, but private players have more women in the C-suite than do their public peers.
There is evidence that companies with a safer, more engaged workforce outperform financially.

Performance on key social topics has become increasingly critical for private companies in every industry, and judging from this year’s ESG Data Convergence Initiative (EDCI) findings, by and large, they are making progress.

First of all, while private companies trailed their public peers in some areas—notably gender diversity on their boards of directors—they outperformed on other metrics, such as job creation levels.

In addition, the data shows that the private equity investment model can be effective at driving positive change over the course of the investment period across a diverse set of social metrics, from worker injury rates to gender diversity at the management level.

Moreover, we found further evidence of links between social factors at private companies and financial results: in the relationship between an engaged workforce and reduced employee turnover, for example, and in the correlations between lower worker injury rates and higher revenue growth.

Here, we examine in greater detail two particularly important themes from the latest EDCI social data— the quantity and quality of jobs being created at private companies, and diversity at the board level and across top management. Taken together, the evidence shows that private companies are succeeding in pushing forward the social aspect of ESG and improving their own prospects in the process. (See Exhibit 1.)

While private companies trailed their public peers in some areas—notably gender diversity on their boards—they outperformed on other metrics, such as job creation.

On the Job

Job creation, and the quality of the jobs available, has long been a key concern of all stakeholders in the PE industry, and a considerable portion of the data collected through the EDCI effort has focused on these issues. While the results are mixed, the overall trend is positive.

Job Creation. Among the encouraging results of last year’s EDCI findings was the fact that—contrary to common perception—private companies were creating significantly higher numbers of jobs, net of attrition, than their public peers. And that finding held true this year: while employment growth at private companies slowed slightly, they still hired four more net new employees per 100 FTEs than did public companies. (See Exhibit 2.)

Job Safety. Even as PE firms are making progress on the absolute number of jobs created at their portfolio companies, they are also pushing to improve the quality of the jobs, a critical social aspect. While historically, these issues have been difficult to measure, they have become increasingly relevant to private equity’s social license to operate and a driver of commercial value creation. (See “What Makes a Job Good?”)

What Makes a Job Good?

One business that is thinking innovatively about the measurement and management of corporate job quality—and more broadly, the relationship between data-driven human capital management, social impact, and business performance—is Two Sigma Impact, a mission-driven private equity business and member of the EDCI. It has developed a framework and diagnostic tool, called the Good Job Score Assessment Tool¹, that is designed to help investors and leadership teams understand and manage how any given company is performing across the four dimensions they believe define a good job:

Leadership. Senior managers have the skills, the capabilities, and a genuine desire to engage the workforce.
Purpose. The company’s mission and values are clear to employees and connected to their work.
Growth. Workers feel they have the feedback, support, and opportunities to learn and grow in their careers.
Fairness. Employees feel they are safe in the workplace, are fairly compensated, and have sufficient flexibility to maintain work-life balance.

The framework provides a common language for talking about job quality and the business case for good jobs, while the tool builds on this by allowing companies to capture their workers’ perspective on the four dimensions in a standardized way that is designed to be broadly replicable over time and across industries. Preliminary analysis by the Two Sigma Impact team indicates that a company’s score positively correlates with certain financial metrics, helping to build our understanding of how job quality interrelates with and drives business outcomes.

Two Sigma Impact has made its framework and tool available on an open-source basis and expects to share case studies over time, in the hope that all PE funds can use these resources to enable the measurement of—and management of—this important metric.

Analyzing the EDCI data can also help to shed light on the fairness and leadership dimensions of the framework, with the work-related injury metric connecting to fairness and the employee engagement survey completion rate metric connecting to leadership. The latter is not a perfect metric for this dimension, as measuring the extent to which a company’s leadership effectively engages with its workforce is clearly difficult. But it is a reasonable proxy: when employees believe that company leaders are likely to listen to—and act on—their feedback, they are more likely to complete these surveys.

Given its focus on converging around measurable metrics that can apply to any privately backed business anywhere in the world, the EDCI doesn’t yet fully capture all the nuances of what makes a good job. Future EDCI working groups will continue to explore these issues and consider potential initiative extensions to better enable this analysis.

1. For more information, visit

https://www.goodjobscore.com

Work-related injuries are a key element of employee safety, and this year’s results show that injury rates vary considerably by sector, with higher levels in the food and beverage, resource transformation, and transportation sectors. These relatively higher injury rates may reflect the fact that these sectors have fewer desk-based employees, who typically have a lower propensity for injuries.

Furthermore, the results indicate that PE firms can be effective in driving down injury rates at their portfolio companies, although this too varies by sector. This year’s data shows that average injury rates at portfolio companies in three of the top five sectors ranked by injury rate declined the longer they were held by a PE firm. (See Exhibit 3.) This demonstrates that PE firms can succeed in encouraging their portfolio companies to improve safety standards. A 2018 study by the American Economic Association supports this conclusion; it found that PE-owned firms are better positioned to make long-term investments to improve both the safety of physical assets such as plants and equipment, and operational safety, through improved processes, procedures, and training, among other factors.

Employee Outcomes and Financial Performance. When discussing social considerations in PE, a common question is whether these initiatives can help to create financial value in addition to delivering social impact. Logically, it seems as though a happier, more engaged workforce should lead to lower attrition, while companies that create work environments where employees feel safe are also more likely to thrive. Is this borne out in the data?

The data does indeed back up this thesis. We found that higher employee survey response rates (a reasonable proxy for employee engagement) correlate with lower employee turnover. Companies with a more engaged workforce see lower employee churn rates. (See Exhibit 4.) And we know that companies with lower churn rates not only reduce the cost of recruiting and onboarding new employees but also have higher productivity rates, thanks to more experienced, motivated employees. For example, a Harvard Business Review study looking at more than 1,000 stores of a retail organization found that stores with the most experienced employees outperformed those with the least experience, generating over 50% more revenue and 40% higher profits.

A further benefit was the creation of more opportunities for upskilling and promotion among workers. The result: a positive cycle of social impact and financial outperformance. (See “Spreading the Wealth.”)

Spreading the Wealth

How else can private equity funds help to create this virtuous circle of employee engagement and financial outcomes? One mechanism for further aligning employee and company incentives is to offer ownership not just to company leadership—a common practice—but to front-line employees as well. This idea is gaining traction across private markets.

Ownership Works, a nonprofit with the goal of implementing models of broad-based employee ownership, has over 75 partners representing different members of the business community (including 24 PE firms). KKR, one of the initiative’s founding partners, has adopted broad-based ownership in its industrials deals because the firm found that this approach improved financial performance through reduced turnover and greater employee productivity.

In Europe, France Invest, France’s PE industry association, has encouraged its members to provide a profit-sharing scheme to all employees of their portfolio companies; the goal is for 85% of members to offer such schemes by 2030.

Already, many of France Invest’s members are moving forward with such initiatives. For example, one of TiLT Capital Partners’ four ESG priorities is ensuring that “every employee should benefit from a fair share of the financial value collectively created.” The firm is tying a quarter of its carried interest compensation to achieving goals related to this priority.

These firms, and the PE industry more broadly, are taking action not only because they believe it is the right thing to do to help tackle growing inequality, but also because there are tangible business benefits. As France Invest notes, “sharing value with employees [is] not a constraint [but instead] a driver of sustainable growth.”

Meanwhile, we also found a correlation in the EDCI data between a company’s injury rate and its revenue growth. Businesses with the lowest injury rates increased their revenue at a rate 7 percentage points greater than those with the highest rates—a finding that remains true across sectors. (See Exhibit 5.) While correlation, as always, does not mean causation, it is important to note that companies that invest in building a positive work environment and keeping employees safe are also experiencing high revenue growth rates.

The Diversity Challenge

Last year’s EDCI results showed that the private markets were significantly lagging the public markets in terms of board-level gender diversity. Just 54% of private companies had at least one woman on their boards, compared with 87% of public companies. These results were not entirely surprising, given that public companies have likely faced greater scrutiny and pressure, from a wider variety of stakeholders and for a longer period of time, to increase the presence of women on their boards.

This year’s results reveal relatively modest gains on this front. The number of private companies with at least one woman on their boards rose just 3 percentage points, to 57%. And they continue to lag public companies by a significant margin on this dimension. (See Exhibit 6.)

Gender diversity, however, isn’t just about increasing female representation on corporate boards. This year, the EDCI added a new metric—gender diversity in the C-suite—and here, private companies outperformed their public counterparts. Women made up 22% of the C-suite at the median private company, compared with 17% at public companies. This finding holds true across regions and sectors.

Moreover, the proportion of women in the C-suite at private companies increases over the course of ownership by a PE firm. (See Exhibit 7.) This is an encouraging finding: it shows that PE firms understand the benefits of having diverse perspectives in top management as well as the virtues of being able to identify, recruit, and nurture top management from a larger talent pool.

Finally, this year’s data also enabled us to analyze trends in board membership among underrepresented groups at companies based in the Americas. (Data on this metric is not available for companies based in the EMEA [Europe, the Middle East, and Africa] or Asia.) Here, private companies are generally in line with their public peers. According to data from Equilar, a provider of information services on corporate leadership, in the fourth quarter of 2021, 15% of board directors at Russell 3000 companies came from underrepresented communities, an increase of 1 percentage point over the first quarter of that year. Meanwhile, the number of members of underrepresented groups on private company boards grew by 1 percentage point, to 14%, from 2021 to 2022. (See “Making a Difference.”)

Making a Difference

Inspired by the strong belief that diversity can be a driver of commercial value as well as social impact, Ariel Alternatives, the private equity subsidiary of Ariel Investments, LLC, recently launched its first PE fund, Project Black. The fund closed with $1.45 billion in capital from its investors, one of the largest first-time funds in history.

Project Black plans to invest in middle-market companies with annual revenue of $100 million to $1 billion and then transform them into certified minority business enterprises (MBEs) with the scale to serve as tier one suppliers to the Fortune 500. The fund is intended to help corporations meet their commitments to increased business diversity while driving social impact initiatives at the portfolio-company level.

Project Black’s first acquisition was Sorenson, the leading US communications provider for the deaf and hard-of-hearing, at an enterprise value of $1.3 billion. Ariel Alternatives plans to transform Sorenson into a certified MBE, a designation for businesses that are at least 51% owned, operated, and controlled by diverse individuals. Under the leadership of CEO Jorge Rodriguez, Sorenson has made material efforts to expand employment access to diverse and underrepresented communities from the C-suite to rank-and-file employees, while maintaining a laser focus on augmenting the organization with seasoned and experienced leaders who can deliver on Sorenson’s growth potential. Prior to 2022, just 3% of Sorenson’s leadership and board of directors were minorities. As of February 2023, minorities make up 43% of the senior leadership and board.

Leading investors are harnessing their capabilities to lead the way toward a more sustainable and inclusive world.

In an increasingly uncertain world—rife with complex macroeconomic, environmental, and social forces—PE firms have an important role to play in building portfolio companies that deliver on their social license to operate. And as our analysis of EDCI data shows, many of them are rising to the challenge, building inclusive work environments, and creating safe, high-quality jobs. In doing so, they are also delivering outsize returns for their investors and society as a whole.

Yet this is no time for complacency. These results show that there are still many areas where PE funds can and should do better. We’re excited by the progress made so far and hope to see even greater adoption of the emerging best practices in the future.

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