Between 1996 and 2016, the number of U.S. listed companies declined by about 50 percent. There are now fewer U.S. listed companies than there were in 1976. Some observers have raised the alarm about this decline. For example, SEC Chair Jay Clayton in a speech last summer called the decline in the number of U.S. listed companies “a serious issue for our markets and the country.” But before we can decide whether or not the lower number of public companies is a problem, much less what to do about it, we need to take a look at what is happening and why it is happening. A closer look suggests that the situation is more complex than it might appear at first glimpse.
What Has Happened?
According to a study last year by Credit Suisse (here), there were 3,671 public companies at the end of 2016, compared to 7,322 at the end of 1996, representing a decline of 50.5% during that 20-year period. By way of further comparison, there were fewer U.S. listed companies at the end of 2016 (3,671) than there were in 1976 (4,796), even though the U.S. economy as measured by GDP is three times larger now than it was then.
The shrinking pool of public companies has some interesting consequences. For example, the Wilshire 5000 Total Market Index, which was established in the mid-1970s, only has about 3,500 companies in its Index. The last time the index actually had 5,000 companies was December 29, 2005.
The nature of the companies listed has changed as well. The average company that has a U.S. listing is bigger, older, and more profitable than in the past. The average age of company as measured based on the time from the company’s initial listing has risen to about 18 years, compare to about 12 years in 1996. The mean market capitalization for U.S. listed companies is now almost $7 billion, more than ten times the market cap mean in 1976. Microcap, small-cap, and midcap stocks have just about disappeared from the U.S. exchanges.
Why Is it Happening?
Why are there so many fewer U.S. listed companies than there were twenty years ago? At one level, the decline is a reflection of basic arithmetic – for several years now, the number of delistings has increased while the number of new listings in the form of IPOs has declined. The delistings arise from a number of causes: mergers and acquisition; bankruptcy (and, more generally, a company’s failure to meet specified listing requirements); and voluntary delisting (for example, through a going private transaction).
In most of the years between 1996 and 2016, M&A activity was the most significant reason for delistings (the exceptions are the years of the dotcom crash and of the global financial crisis, when bankruptcies forced high numbers of delistings). Significantly, the dollar volume of M&A activity during the period between 1996 and 2016 rose exponentially compared to prior years. This massive level of M&A activity has not only meant fewer remaining public companies, but it also has meant that industries in general are more concentrated – perhaps explaining why the remaining listed companies are in general larger and more profitable than was the case in the past.
At the same time as mergers, and to a lesser extent bankruptcies and going private deals, have taken companies off of the U.S. exchanges, fewer companies are listing their shares through IPOs. Over the last few decades, the number of IPOs has declined steeply, from 846 in 1996 to 128 in 2016. There arguably are a lot of reasons for this change, but the most significant reason that fewer companies are going public is because they don’t have to.
As a result of what the Wall Street Journal recently called “the dramatic rise in private markets,” smaller companies and private enterprises don’t need to access the public financial marketplace to raise funds. According to the Journal, $2.4 trillion was raise privately last year, including a massive $1.6 trillion through private placements. As Jason Thomas of the Carlyle Group wrote in an opinion piece in the Journal late last year, “easy access to venture, growth and private-equity capital means that companies no longer need to pursue an initial public offering to fund growth or access liquidity.”
One obvious consequence of the availability of significant amounts of capital through private fundraising is that there are a significant number of private companies with valuations in excess of $1 billion (so-called “unicorn” companies). According to one source, there are over 200 unicorn companies; in the past, many of these companies would have listed their shares in IPOs.
The ready availability of private capital is only one reason why companies that might have gone public in the past are now declining to do so. Another reason is that it is expensive to go public and it is expensive to do business as a public company. Mandatory disclosures and periodic reporting requirements impose significant costs. As the Credit Suisse report to which I linked above noted, “many of these costs are fixed and have risen in recent decades, which means that they are more readily borne by larger firms.” Public companies also arguably face greater scrutiny and face the possibility of attracting the attention of regulators, activist investors, and shareholder plaintiffs.
Another culprit frequently identified as a possible cause for the decreased numbers of IPOs is increased regulation. The burdens imposed by the Sarbanes Oxley Act are frequently named as possible deterrents for companies that might otherwise list their shares. However, as the Credit Suisse report notes, “while regulation undoubtedly increased the cost of being public, the trend toward delisting was firmly in place prior to the implementation of Sarbanes-Oxley.”
Is it a Problem?
So the change in the number of public companies in the last 20 years is the result of a variety of factors. But should we be concerned that there are fewer public companies? Over very long stretches of time the number of U.S. listed companies has fluctuated dramatically. There were only about 1,000 listed companies in 1956. The number of U.S. listed companies shifted significantly during the next 60 years, both in increasing numbers up to 1996 and in decreasing numbers since then. Who’s to say which number of U.S. listed companies is the right number – or for that matter to say that more public companies is preferable to fewer public companies? The one thing that is clear from looking at the long term trends is that the number of U.S.-listed companies has constantly changed for a variety of economic and financial reasons.
While it may be that there is no magic “right” number of U.S.-listed companies, the decline in the number of public companies has a number of practical consequences.
For starters, the lower number of U.S.-listed companies has consequences for investors. Jason Thomas of the Carlyle Group pointed out in his op-ed piece that as equity investments in new growth companies has migrated to private portfolios “so too has the diversifying economic exposure they provide.” The “dispersion of stock returns” has declined, narrowing the gap between winners and losers. Less dispersion has “reduced the value of stock picking” and as a result “market values fluctuate in response to fund flows rather than fundamentals.” The result is a “dissonance between the market economy and the real economy.” In order for investors to gain exposure to faster-growing industry segments and companies, they must rely on “various forms of private equity.”
In addition to the impact on investors, might the reduction in the number of listed companies affect the economy as a whole? Is it possible that as the public markets increasingly are dominated by larger, better established companies that important signals about other parts of the economy are muted, leading to mistaken policy decisions?
A different but related concern about the declining number of listed companies and the impact on the larger economy is the consequent reduction in transparency. As Bloomberg noted in an April 9, 2018 editorial (here), “public companies provide a lot more information” than do privately held companies, which is “valuable in assessing their performance and that of the broader economy.” As valuable information goes into private portfolios, it means that less information is available generally, not just to investors, but to prospective employees, competitors, regulators, financial planners, and economists. Less publicly available information could mean less efficient decision-making across a wide range of activities and constituencies.
While there are reasons to be concerned about the decline in the number of public companies, I am wary of efforts by politicians or regulators to try and “fix” the situation. As the Bloomberg editorial correctly points out, earlier Congressional efforts to try to encourage companies to go public arguably have been counterproductive. The JOBS Act, which tried to ease the regulatory and disclosure burdens on companies seeking to go public, according to Bloomberg, has produced only dismal results. (For a recent post where I discuss the less than impressive results of Reg. A+, instituted by the JOBS Act, refer here.)
It may be that the economy itself will compel its own changes. One reason for the extensive private company fund raising as well as the huge volume of M&A activities has been the low interest rate environment that has prevailed now for many years. In addition, the Federal Reserve’s aggressive monetary policy of quantitative easing has driven up asset values, which in turn has driven investment and financing activities. As the Fed raises interests rates (and as the potential impact of the new tax law and the Trump administration’s trade policies both kick in), there could be massive changes for companies, the markets, and for economic activity.
One final note. The declining number of U.S. listed companies has significant implications for one particular segment of the U.S. financial market — the D&O insurance industry. The decline in the number of public companies over the past 20 years coincided with a rise in the number of insurers trying to write public company D&O insurance in the United States, meaning more and more insurance sellers chasing a shrinking pool of insurance buyers. The predictable result of this dynamic is that the cost of D&O insurance has declined substantially over time (although the declines recently have largely moderated for primary public company D&O insurance.)
There are at least a couple of factors that complicate the analysis for public company D&O insurers of the significance of the declining number of listed companies. That is, as noted above, the remaining listed companies tend to be bigger; bigger companies buy more insurance. Also, as companies have realized savings on their cost of insurance owing to declining prices, many of them have invested the savings in increased amount of insurance. These factors dilute somewhat the impact on D&O insurers from the decline in the number of D&O insurance buyers.
But just has been the case with investors, the D&O insurers’ portfolio of public companies has also changed, becoming less diverse and more concentrated. That could have significant implications, although it is probably important to keep in mind that many of the companies that might have gone public in the past but instead have chosen to remain private are also buying D&O insurance. The D&O insurance marketplace, along with the rest of the legal community, recently received a vivid reminder that these large companies, even though private, are subject to the federal securities laws. I am referring of course to the recent spate of problems at Theranos. The problems at Thernos and at other companies like Uber suggests that the along with the financial marketplace, the risks the D&O insurers are called up to undertake are changing as well.