Is it a plague or a pandemic afflicting American stock exchanges, or something else decimates public companies? What are the reasons for the 50% drop in the number of public companies traded on U.S. exchanges? And, most importantly, should we worry about that? Answers below, but first several salient facts (courtesy Kathleen Kahle and Rene Stulz, “Is the Public Corporation in Trouble?”, working paper, 2017, and The Economist, “Why America Should Worry About the Shrinking Number of Listed Firms” April 22, 2017).
What’s going on here? Here are the facts:
- The major reasons for the dramatic decrease in the number of U.S. public companies are:
- Mergers and acquisitions: waves of acquisitions among public companies (e.g., Verizon recently acquired Straight Path) steadily shrinks the number of public firms.
- A dramatic fall in the number of IPOs: from 300 a year, on average, up to 2000, to about a 100 a year since then. Fewer and fewer firms wish to become public
- An increase in the number of public companies going private (e.g., Dell Computers in 2013).
- Interestingly, there is no decrease in the number of private firms in the U.S.
- The remaining public companies on U.S. exchanges are larger, older, invest much less in tangible assets and more in R&D and other intangibles, and their total capitalization (market value) as a percentage of GDP is now higher than in 1975, but lower by 24% than in 1999.
- As a result of the corporate consolidations, most industries are now more concentrated, resembling oligopolies.
- Institutional ownership of public companies increased from 17.7%, on average, in 1975 to 50.4% now.
Why are more companies deserting the public arena, and fewer joining it? Various reasons: (1) Whereas innovative startups used to venture into stock exchanges, growing organically over time, many private companies nowadays prefer to be acquired by mature public pharma, telecom, internet, or healthcare companies. Yet another aspect of lower risk-taking. (2) Plenty of venture capital and private equity funds are available to finance private companies, thereby avoiding IPOs. (3) New-age firms invest mostly in intangibles, and much less in property, plant and equipment, and accordingly need less capital provided by exchanges. But, I believe, an important reason for the vanishing allure of being a public company is:
Finally, and most importantly, should we worry about the “disappearing public company” phenomenon? Indeed, we should.
First, larger and older companies—most firms currently populating U.S. exchanges—tend to be more bureaucratic, less risk-taking, and less innovative than smaller, younger ones. Just look at the following figure showing (top, increasing line) the U.S. private-sector investment in intangibles (R&D, IT, brands, human resources, business processes) as a percentage of gross value added. Subsequent to an accelerated growth in the 1990s, the investment in intangibles, namely in innovation, flattened out recently. Less innovation, lower growth and employment. Truly worrisome.
The second reason to worry about concerns the dwindling investments opportunities open to investors. Most people invest in index funds with the idea of holding the “economy portfolio,” that is investing in the total U.S. economy. However, with a shrinking number of public companies, index investing is now restricted to the larger, older, less entrepreneurial part of the economy. Lower risk, but definitely lower returns. Moreover, as the Economist put it: “Ordinary Americans without connections are meanwhile unable directly to own shares in new companies that are active in the fastest-growing parts of the economy.” Serious concern indeed.
What can be done about the disappearing public company? I leave this to a forthcoming blog, but a good place to start is decreasing the regulatory burden on small companies. A drastic idea: eliminate quarterly reporting for companies below a certain size, usually with fewer investors. Report every six months, and disclose every three months just sales and cost of sales to keep investors updated about your performance trend. This will cut earnings calls and the futile need to meet the consensus estimate by half. Will the sky fall with six months reporting? I doubt it. U.K. companies report every six months, among other countries, and they have a thriving capital market over there.