PEGCC Chairman Ken Mehlman talks taxes, compensation proposals

What do you see as your priorities in your first year as chairman?

First of all I would say that thanks to the great work of Steve Judge (PEGCC president and CEO) and the team at the PEGCC the industry has done a very good job of engaging in dialog with policy makers about how we encourage more economic growth and also about how we make sure growth is sustainable from a financial system perspective. Our hope is to continue that dialog and make sure that where possible we can be part of the solution to how we have better economic growth and more retirement security for millions of Americans.

How is the effort going to convince Americans and their representatives that private equity is a force for economic good?

What we hope to have is a two-way dialog. We hope to listen as much as we try to persuade. What we try to do is explain some statistics. We know that in 2012, $347 billion was invested by private equity in 2083 U.S. companies. We know that if you look from the downturn five years ago to 2012 $30 billion (of private equity) was invested in American companies that had filed for bankruptcy and that employed 250,000 people. We know if we look around the country that both companies and municipalities are looking for capital to grow, to meet important needs, to ensure retirement security. In all of these areas we think we can be part of the solution. Our hope is to highlight companies that have been enhanced by our investment and by our hard work and also to point to millions of retirees who today have more security and enjoy a better time in their golden years because their pension fund decided to participate in private equity.

What regulatory issues are still a little under the radar with your members?

While Dodd-Frank wasn’t aimed at the private equity and growth capital industries there will be very important rules and regulations that impact directly our ability to operate, and to create value. One example would be rules aimed at banks that were put in place under Dodd-Frank to address swap positions. The implementation of that rule could affect entities that are not banks, including end-user companies that are owned by private equity. Making sure that rule is implemented in a way that is consistent with the legislative intent of Dodd-Frank is in our interest and something the PEGCC is actively engaged on.

Why are swaps important to portfolio companies?

Lots of industries use swaps to hedge risk. So if you’re an energy company and natural gas prices are important to you, you essentially may need to hedge natural gas prices as part of your regular operations. If you were to consolidate all the swap positions of all KKR owned companies you could limit the ability of those portfolio companies in a way that no one possibly intended. There’s an ongoing dialog with the CFTC (U.S. Commodity Futures Trading Commission) over how swap positions will be ultimately regulated. This was not a rule that was aimed at the private equity industry. But how that’s decided will have real implications for real companies in which private equity invests; a whole lot of end-user companies could be affected by this. And so members of the industry who don’t appreciate that could be surprised in a negative way that we think we can avoid because of the good work of the PEGCC.

What else is under the radar?

Another example is there are going to be rules put forward with respect to compensation. They’re also aimed at banks. Private equity has a compensation model that is very much consistent with the kinds of approach that regulators want to see, which is to say, sponsors have skin in the game, and their returns come over a longer period, not a shorter period. There are incentives for patient capital in our compensation model. That having been said, the details of that rule are very important, and something that the PEGCC is working on. There are also proposals in Europe that could have the effect of discriminating against non-European managers. The PEGCC is working on that as well.

How likely is tax reform?

My sense from what I hear from legislators is we’re unlikely to get tax reform this year. When we do get tax reform, and I believe we will, it’s important that every issue be on the table. We need to identify the goals of tax reform. I think our goals should be to have a more competitive system that encourages prudent risk-taking, more investment, and global competitiveness. And if those are your goals, then imposing additional taxes on people who want to put real dollars into real companies that employ real people for real retirees seems to me to be a really bad idea.

What are your thoughts about removing the tax deductibility of interest payments?

If you invest globally, and we do, you see that one of the reasons that this country uniquely has lots of small companies that get to be big companies is not just that we have abundant equity markets but that we have a large debt market. Obviously if you’re a new company there’s a lot more risk in somebody providing you equity than there is in providing you debt. And therefore our tax code, recognizing that, and recognizing that growing a business is a legitimate business expense, has allowed interest to be deducted. I think to lose that would seriously compromise millions of small companies that want to be big companies and potentially hurt one of the great drivers of economic growth.

And the possibility of imposing taxes at the partnership level?

You’re talking about potentially millions of companies that you’re suddenly going to impose new corporate taxes on. That strikes me as a very bad idea. What’s your goal? If your goal is more people taking risk and starting businesses, then imposing new taxes on those businesses and people that invest behind those businesses is completely counterproductive. If you tax something more you get less of it. We ought to want more investment, not less.

What’s another big priority for the council this year?

Our job is first and foremost to serve the members of the council in a way that they find value-adding. They are contributing dues, and we want to make sure there’s a good ROI on those dues. That means we provide them with information. That means we build a community of best practices in areas like governance. That means we provide a voice and a discussion with policy makers. There was often a debate before the financial crisis where some people would say, the private sector is the problem, and some people would say, the government is the problem. What a lot of people now realize is there needs to be collaboration between both if we’re going to improve our nation’s infrastructure, if we’re going to improve the economy and create jobs, if we’re going to enhance retirement security. We hope that our industry and its members can play a small part in accomplishing those goals.

Tell me about the work you’ve been doing on the Hill

There are 200 members of Congress that have met with portfolio company CEOs and visited portfolio companies. Just yesterday (March 19), for example, Congressman (Pat) Tibery from Columbus visited Dollar General, a company that KKR made significant investments in and helped to grow and improve. And that’s just one example of many of our bringing to light what in fact private equity is all about. Private equity is not about capital. It’s about building better companies and ensuring stronger retirements. And I think every business, whatever industry you’re in today, has to earn a license to operate. We need to demonstrate the value we create, and we need to engage with stakeholders. So if you’re in the private equity industry then you have an obligation to engage in this process, and the PEGCC helps you do that in a way that’s easy for you, that’s cost-effective for you, and that keeps you informed.

How sympathetic is Congress to private equity right now?

Members of Congress want to see jobs created in their districts and in their states and to see their retirees have good pensions, and we can help with respect to both. And it’s our obligation to have a discussion with them and a dialog with them about how we can help.

What’s the goal for expanding PEGCC membership?

We want to continue to provide a very good return on invest for private equity firms small, large and medium-sized by 1) providing those firms with information 2) protecting those firms’ licenses to operate in a way that’s cost-effective for them and 3) creating a community of best practices where we can learn from each other the best ways to grow companies, to improve governance at companies, to improve companies’ environmental footprints in some cases, to continue to make private equity a very good corporate governance model if your goal is long-term, patient and sustainable economic growth for companies. The team that does all the work is Steve (Judge) and company. My goal is to help them accomplish their mission. But certainly we hope to continue to expand membership. Not only do we think we’re offering a very good value for new members but we will learn from them and benefit from their intellectual input and advice.

Edited for clarity