As I have noted previously on this site, there are many fewer publicly traded companies in the United States now than there were within past decades. I have noted this phenomenon primarily within the context of observing that while the annual number of securities class action lawsuits has remained broadly stable within a range, the number of public companies has declined, suggesting that the average likelihood of any company getting hit with a securities suit has increased over time (as discussed here). This often-overlooked observation is important, but it doesn’t address the more fundamental question of why there are so many fewer publicly traded companies than there once were. A recent academic paper documents the decline in the number of publicly traded companies and suggests several possible reasons for the decline. I have my own thoughts, as well. As discussed further below, these decline in the number of listed companies has important implications for the economy generally and for the D&O insurance marketplace in particular.
The Academics’ Paper: “The Disappearance of Public Firms”
In a May 2015 paper entitled “The Disappearance of Public Firms and the Changing Nature of U.S. Industries” (here), Rice University Professor Gustavo Grullon, Penn State Professor Yelena Larkin, and Cornell University Professor Roni MIchaely examine what they call the “systemic decline” in the number of public companies over the last two decade. According to their analysis, in the past twenty years, the U.S. has lost almost 50% of its publicly traded firms. The number of publicly listed firms declined from 6,797 in 1997 to 3,485 in 2013. The current level of publicly traded firms in the economy is similar to levels in the mid-70s, when the real gross domestic product was one third of what it is today. Moreover, the authors note, the decline in the number of public companies has not been offset by an increase in the number of private firms.
As UCLA Law Professor Stephen Bainbridge noted in an April 25, 2016 post on his ProfessorBainbridge.com blog (here), these data raise the interesting question of what the causes of this decline may be. The academic authors have their own suggestion; they say that the trend has been driven by declining numbers of IPOs and a higher rate of M&A activity relative to the number of remaining public companies. While an increase in bankruptcies and insolvencies would seem a likely additional cause for the decline, the authors’ say their analysis shows that the decline in the number of firms is not driven by higher rates of bankruptcy or financial distress.
I have a number of observations about the authors’ conclusions:
- The Increase in the Number of IPOs During the Period 2014-15: Before considering the authors analysis, there is one important observation that I need to make, and that is that the authors’ data set for analysis cut off in 2013. As a result of increased levels in IPO activity in 2014 and 2015, the number of publicly traded companies has actually increased during the period since 2013, albeit slightly. The fact of the overall decline and the magnitude of the decline in the last 20 years remains largely unchanged notwithstanding the increase in the number of public companies during 2014-15.
- Why Has the Number of IPOs Declined?: As for the factors the authors suggest are responsible for the decline in the number of publicly traded companies, I think there is some truth to the idea that an increase in M&A combined with a decrease in IPO activity is an important explanation for the decline. While I think this explanation is accurate, I don’t think it is either sufficient or complete. Among other things, it does not explain why there has been a decline in the number of IPOs over the last 20 years.
- Of Course the Number of IPOs has Declined Since the Dot Com Era: There are of course many reasons that the number of IPOS has declined since the late 1990s. One may be that the IPO marketplace became pretty frothy during the dot com era and there may have been many companies that completed IPOs during the period that were not necessarily good candidates for a public listing. The number of companies completing IPOs really had to decline from that bubble-induced high. The collapse of the dot com bubble is itself a separate cause of decline, as it may have left many investors less interested in taking risk on start up ventures trying to sell their shares in a public offering.
- Global Competition for IPOs: There is another reason the number of U.S. IPOs have declined, and that is the rise of competition from other countries’ securities markets. The opportunities for global companies to raise funds and sell their shares on other countries securities’ markets is not necessarily new, but the attractiveness of the other markets is relatively new. While the U.S. markets remain interesting and attractive, there is no doubt that the U.S. has lost listing opportunities to other markets in London, Hong Kong, and elsewhere.
- The Regulatory Burden for U.S. Publicly Traded Companies: There is a further reason why some companies may choose to remain private, one that may be related to the decision of some companies to list their shares outside the U.S., and that is the administrative and regulatory burden that goes with a U.S. share offering. Indeed, in his blog post discussing the decline in the number of public companies, Professor Bainbridge suggests that the regulatory burden that goes along with a U.S. listing has had a “crushing effect” that has made U.S. securities markets less competitive with those of other countries.
- What Has Been the Impact of Bankruptcy?: I will say that I am surprised by the academic authors’ conclusion that bankruptcy and insolvency are not significant factors explaining the decline. I can’t substantiate my conclusion in this regard, but I believe bankruptcy and insolvency has been a significant factor, particularly during the 2007-2011 time frame. Just looking at one happened to my own portfolio of companies during that period, the economic downturn had a substantial impact in eliminating companies, both public and private.
- What Does it Mean for the Economy That There Are Fewer Public Companies?: Whatever the cause, the decline in the number of public companies (taken in combination with the fact that decline has not been fully offset by an increase in the number of private companies) has had a significant impact on the U.S. economy. The authors conclude, based on their analysis, that there is a strong association between the reduction in the number of public firms and the remaining firms’ profitability, stock returns, and investment opportunities as capture by M&A gains. Specifically, the authors conclude that the returns to investors of the public firms increase with higher market concentrations.
- What is the Significance for the D&O Marketplace from the Decline in the Number of Public Companies?: In addition to the impact on the economy, the decline in the number of public companies, and in the aggregate number of firms overall, has significant implications for the D&O insurance marketplace. Not to put too fine a point on it, but there are a lot fewer D&O insurance buyers now than there were twenty years ago. Moreover, that is true not just with regard to the public company D&O insurance marketplace, that is also true with respect to the private company D&O insurance marketplace as well. The drop off is not insignificant. As the academics demonstrate, the decline in the number of public companies is very significant, close to 50%.
- What has the D&O Insurance Marketplace Made of the Declining Number of Public Companies?: I have been aware as a general matter about this decline in the number of companies for some time, but I have often been unsure whether other D&O insurance marketplace participants are aware of the decline. Any marketplace with a declining number of buyers would not seem to be one that would attract new participants, yet there has been a steady stream of new entrants into the D&O marketplace, including the public company D&O insurance marketplace. To be sure, the reduction in the number of buyers has been somewhat offset by the fact that the remaining buyers are larger and in many instances buy more insurance than in the past, but this is not universally true and I would suggest it is not nearly enough to offset the effects in the overall decline in the number of companies.
You don’t have to be an economist to predict what would happen to pricing in any marketplace when there is a shrinking number of buyers and an increasing number of sellers, and in a general way that is what is happening in the D&O insurance marketplace. In general, competition continues to erode pricing. I know there are some readers who will object that the recent wave of M&A activity in the P&C insurance industry is in part a response to these dynamics; that may be true. However, the level of M&A activity, while not without its disruptive effects, is not nearly to the point where the concentration of insurance capital will offset the decrease in the number of insurance buyers.
There is a lot to think about when it comes to the decline in the number of public companies. Both the causes and consequences of the decline are interesting questions. I am interested in readers’ thoughts on these issues, and I hope that readers will weigh in using the blog’s comment feature.