There are fewer public companies in the U.S. than there were in the nineties. Understanding the reason for the decline in the number of public companies is important to understanding whether or not the decline is a cause for concern, as well for thinking about what if anything policymakers should about it. In an interesting May 2017 paper entitled “Looking Behind the Declining Number of Public Companies: An Analysis of U.S. Capital Markets” (here), EY takes a detailed look at the drop in the number of companies listed on U.S. exchanges and examines the causes. The paper’s analysis has a number of important implications for policymakers, for investors, and for all market observers. A version of the EY paper appeared in a May 18, 2017 post on the Harvard Law School Forum of Corporate Governance and Financial Regulation blog (here).
Fewer U.S. Listed Companies: According to the paper, the number of domestically incorporated U.S.- listed companies peaked at more than 8,000 in 1996, and dropped to around 4,330 at the end of 2016, representing a decline of more than 45 percent. However, much of that decline in the number of domestically incorporated U.S.-listed companies took place prior to 2003; more than 74% of the reduction of listing for these companies during the last 20 years took place during the period 1996-2003, largely due to M&A activity and delistings. Since the 2008 financial crisis, the total number of domestic U.S.-listed companies has largely stabilized.
A sidebar in the report provides some details about these pre-2003 public company delistings. The sidebar reports that during the period 1997-2003, 2,101 companies were “delisted for cause” (that is, as unable to meet the listing standards of their exchange), whereas during the period 2003 to 2012, fewer than 100 companies per year were delisted for cause.
Increased Numbers of Non-U.S Companies with U.S. Listings: Interestingly, while the number of domestically incorporated U.S.-listed companies has been in decline, the number of foreign incorporated companies listed on U.S. exchanges has increased, particularly since 2008, both in absolute numbers and as a percentage of all U.S.-listed companies. The number of foreign companies listed on U.S. exchanges increased from 809 (representing about 14.4% of all U.S.-listed companies) at the end of 2003 to 873 at the end of 2016 (representing nearly 17% of all U.S.-listed companies.
Public Companies are Larger Now: While there are fewer public companies overall than there were twenty years ago, the size of the remaining public companies is larger – “a typical domestic-listed company today has a higher market capitalization than in the 1990s, a trend that has accelerated in recent years.” As early February 2017, the average U.S. listed company has a market cap of about $7.3 billion, compare to roughly $1.3 billion in 1996. The median market cap as of February 2017 is $832 million (the report does not reflect the equivalent figure for prior periods). Much of this growth market capitalization growth is a reflection of the growth of the largest public companies. The largest 1% of U.S. public companies represents 29% of total market capitalization. About 140 of the U.S.-listed companies have market caps of over $50 billion, together representing more than half of total U.S. market capitalization.
Fewer, More Stable IPOs: One of the reason that there are fewer public companies now is that there are now fewer IPOs than there were at the peak in the 1990s. However, the profile of companies completing IPOs in the U.S. “has changed fundamentally over the past two decades.” U.S. IPOs now are “fundamentally more stable and are raising more capital.” The trend toward IPOs of higher quality, more sustainable companies is likely to benefit investors. The report shows that among IPOs completed from 1980 through 2014, issuers with annual revenues over $500 million slightly outperformed the market, whereas issuers with revenues under $100 million underperformed the market by an average of more than 27%.
There are a number of factors that help explain why there are fewer IPOs now than in the past:
Many Companies Have Capital Raising Options Other than Completing an IPO: Among other reasons why there are fewer IPO companies is that “the private capital market has grown aggressively recently, allowing emerging companies to access more capital without going public.” Venture capital firms, private equity funds, and even sovereign wealth funds are aggressively financing emerging companies. In some cases, emerging companies are being acquired by strategic and financial buyers rather than going public. Moreover, the trend toward private investment is accelerating; whereas in 2005, venture capital provided $31.2 billion for 2,888 private companies, in 2015, venture capital provided $77.3 billion in funding for 4,244 private companies. In addition, debt financing (as an alternative to an IPO) has also been an attractive option as companies are able to borrow at or near all-time interest rates.
Many Emerging Companies’ Business Models Fit Better with Private Markets: Many of the fledgling or developing companies today are pursuing business models that fit better with the private markets. Under private owners, disruptive companies are better able to take risks, sometimes in unregulated markets. While public markets seek predictability, “many of today’s new companies benefit from the ability to take risks without intense public scrutiny.”
Smaller Private Companies Remain Attractive Acquisition Targets: In 1996, as the dot-com frenzy began to build, there were only 1,953 acquisitions of private companies, compared to 4,817 in 2016. Companies with lower valuations or limited growth prospects have usually been more likely to explore an acquisition, especially if they have technologies or products that are valuable to large firms.
Congress Has Extended the IPO Runway: Emerging companies seeking private financing have benefitted from Congressional legislation and SEC regulatory action. The JOBS Act increased the increased the accredited investor limit requiring companies to register with the SEC as reporting companies, from 500 to 2000. SEC Regulation A+ expanded companies’ ability to make unregistered public offerings to a maximum of $50 million in any 12 month period.
U.S. Remains Preferred Market for Cross-Border Listings: The report shows that in general most companies completing IPOSs tend to choose to list in the home-country exchanges. A chart on the report shows that in almost every year during the period 1996-2016, over 90% of IPO companies have chosen to list on their domestic exchanges. In 2016, just six percent of IPOs were cross-border listings. But for those companies completing cross-border listings, “the U.S. remains the most attractive public equity market in the world.” From 2012 through 2016, the U.S. was home to almost twice as many foreign IPOs as its closest competitor, the United Kingdom. U.S. cross-border volume during that period was $66 billion, more than five times higher than the U.K. cross-border volume of around $12 billion.
Of the 21 companies that completed cross-border IPOs in the U.S. in 2016, 38% were from China, 14% were from Bermuda, 10% were from Switzerland and from Netherlands, respectively, and 29% were from six other countries.
Few U.S. Companies List Elsewhere: While the U.S. is a popular place for Non-U.S. companies to list, relatively few U.S. companies seek to list exclusively on Non-U.S. exchanges. From 2012 through 2016, only 18 U.S.-domiciled companies listed only on a foreign exchange, raising only $1 billion collectively. In 2016, only two U.S. IPOs listed exclusively on foreign exchanges. In general, these foreign IPOs are small. Over 15 years, 73% of the 90 U.S. companies that listed overseas raised less than $50 million.
The upshot is that while there has been a great deal of discussion and commentary about the decline in the number of publicly traded companies and about the decline in IPO activity, the U.S. capital markets are “fundamentally healthy” and “remain the preferred choice for U.S. and many foreign companies that seek to go public.”
While there are fewer public companies overall and fewer IPOs, the public companies that remain are larger and more stable than in the past, and delisting rates are much lower than immediately following the dot-com boom. The overall number of U.S.-listed companies has stabilized since the global financial crisis while U.S.-listed foreign companies, both in absolute numbers and as a percentage of all U.S. listings, has steadily increased at the same time.
In the past there was concern about conjectured U.S. markets’ loss of listings and IPOs to foreign exchanges. However, the actual experience has been that foreign companies “overwhelmingly choose the U.S. when they list outside of their home markets,” and U.S. companies rarely choose to list elsewhere.
The dynamics of the market for private capital has also completely altered the financial landscape. Today’s emerging companies have “more options than ever to find private financing for a longer term and in greater amounts.” The amount of private financing has grown immensely and takes many forms, including venture capital, private equity, and debt financing. The availability of these funds, as well recently enacted legislation, has made it easier for companies to stay private longer. It seems clear that these changes are helping to support growth, innovation, and job creation.
These trends and developments have important implications not only for the companies themselves, but also for investors, regulators, and policy makers. These changes also have implications for those of us in the D&O insurance marketplace. A financial arena characterized by fewer, larger publicly traded companies with increasing amounts of economic activity being undertaken by increasing numbers of larger, well-capitalized private companies arguably is different than the financial market that was in place when the current D&O insurance marketplace developed.
The changes in the financial marketplace post a number of challenges for the participants in the D&O insurance marketplace. Fewer, larger public companies mean fewer buyers purchasing higher limits. The reduction in the number of public companies represents a concentration of risk, meaning the possibility of higher claim frequency, while larger size translates into the possibility of increased severity. Increased numbers of larger private companies, with greater numbers of investors and a diversity of ownership structures, creates its own sets of risks.
The implication, if the current financial marketplace trends continue, is that we may be facing a shifting of the D&O insurance marketplace, with increased emphasis on the private company space. The changes among the private companies, as they become larger, more sophisticated, face a broader variety of potential risks, may militate in favor of product innovation in the private company D&O space.
The bottom line is that the changes in the financial marketplace in the last 20 years have a number of important implications, including for the D&O insurance marketplace.