The Reason to Worry When Public Companies Disappear
(Bloomberg Opinion) -- Public corporations are an odd hybrid institution. They’re not really public in the sense of the government having a stake in them -- they’re privately owned companies that follow government standards for financial reporting. In theory, this transparency makes them suitable for the public to invest in.
Again in theory, this confers at least two benefits on a company. Financial transparency and adherence to strict government standards should raise investors’ confidence, making them more willing to invest, and thus provide businesses with capital. At the same time, exposure to public scrutiny should discipline corporate managers; if they make a bad strategic decision, their company’s stock will fall, while if they succeed, it will rise. Eugene Fama, the Nobel prize-winning financial economist, likened the horde of investors to a swarm of piranhas, just waiting to pounce on any bit of information about a company’s value, and bidding the stock price up or down appropriately.
Public markets are also supposed to be good for the public. If ownership of corporations is open to large numbers of investors, the bounty of capital income should be distributed more widely. And although it’s relatively rare, public markets theoretically allow investors to hedge their personal risks -- if you work for General Motors Co., you can buy Toyota Motor Corp.’s stock as a hedge against the possibility that Toyota outcompetes GM.
So the institution of public markets represents a complex, unwieldy compromise that serves many purposes at once, making it susceptible to break down. In fact, this seem to be happening, at least in the U.S. As economist Rene Stulz and others have noted, the number of publicly listed companies in the U.S. fell from 4,943 in 1976 to just 3,627 in 2016. Relative to population size, that’s almost a 50 percent drop.
Why is this happening? One reason is that public companies are getting much bigger -- the average market capitalization of a listed company increased by about a factor of 10 during the past four decades, even after accounting for inflation. Stulz attributes this to the rise of intangible assets -- the technology, know-how, brand recognition and other invisible secret sauce that top companies use to muscle out their less productive competitors. The fall in the number of public companies might therefore be part of the U.S. economy’s overall trend toward concentration.
Another reason is that thanks to new technology, new regulation and changes in the structure of financial markets, there is now more incentive for companies to avoid the public markets. The rise of private equity and the shift toward institutional investors like mutual funds means that companies are finding it easier than ever to raise capital without submitting to the harsh sunlight of public-market reporting requirements. Businesses like SharesPost and NASDAQ Private Market have made it a lot easier to trade privately held shares. And the Sarbanes-Oxley Act, enacted in the wake of corporate accounting scandals in the early 2000s, has increased the personal risk to corporate executives who take their companies public. And staying private can help far-sighted executives plan for the long-term, unencumbered by the pressures of public-market investors focused on the next quarterly earnings report.
Because of the increased burden of going public and the increased ease of staying private, more companies are choosing to stay out of the limelight. Behemoths like Uber Technologies Inc. have grown to enormous size without going public (though it plans to IPO in 2019). Just recently, electric car maker Tesla Motors Inc. said that it’s considering going private.
The shift to private markets is worrying, given all the functions public markets perform. But there are reasons to believe that public markets weren’t doing their job as well as they are supposed to.
The theory that public markets would steer companies toward maximum profitability has been found wanting. Statistical analysis shows that public-market investors overlook plenty of important information in companies’ public filings. Public markets are rife with inefficiencies, and are prone to bubbles and busts. That swarm of piranhas can often act more like a blundering herd of cattle.
Meanwhile, public markets haven’t been doing a great job of spreading the wealth around. Stocks are mostly owned by the rich, while the middle class has kept most of its wealth in bricks and mortar:
Of course, all of these problems may be even worse in the private markets. The difficulty of short-selling private shares means that there will be less of a check on bloated valuations. Private companies’ disclosures can be less informative than those of public companies, meaning potential investors are sometimes left blundering in the dark. And middle-class investors can only access private shares through intermediaries like private-equity firms and mutual funds, which will keep big cuts for themselves.
The best way to avoid a further deterioration in the efficiency of American capitalism is to improve the effectiveness of public markets. Policy makers should focus on finding ways to broaden stock ownership to the middle class. They should reduce onerous regulations for public companies by reforming Sarbanes-Oxley to reduce the personal risk of operating a public company, and increase reporting requirements for private companies above a certain size and age. And they should work to reduce the exorbitant fees that middle-class investors pay to own stocks. Fixing public markets is the best way to avoid a shift to even less egalitarian, less efficient private markets.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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