Premature obituaries have been written for public companies before, Skeel points out. Among the most notable was a 1989 Harvard Business Review article, Eclipse of the Public Corporation, by economist Michael C. Jensen, who made many of the same arguments as Davis. Despite Jensen’s analysis, the number of listed companies in the US continued to rise for eight more years.
Many firms that have been taken private, have delayed going public or decided to never go public, are on the “borderline” – not quite big enough to easily handle the regulatory costs and shareholder hassles public firms must contend with, Skeel says. The costs of dealing with regulation did indeed rise with the passage of the 2002 Sarbanes-Oxley Act, in the wake of the Enron and WorldCom scandals, he notes.
“Certainly, the push for corporate governance [accountability] since Sarbanes-Oxley is a factor that causes some firms to stay away from the public markets,” adds Wharton finance professor Itay Goldstein. “You need to comply with all these corporate governance requirements. Everyone is looking at your stock price. Shareholder activists are breathing down the back of your neck.”
He points to Facebook, which stayed private for years after many experts felt it was time to go public. Staying private gave Facebook more freedom to do as it liked in a fast-changing market. “But to say that this is going to end up with public markets being less important, I just don’t buy that,” Goldstein adds.
The perks of going public
Academic research has shown that in recent years, young firms have tended to wait longer to go public than in the past, Geczy says. But many firms, including Facebook, do go public eventually. Facebook had no other way to raise the funds it needed to continue growing, and the public markets do offer benefits that alternatives like private equity cannot match, Geczy points out.
Federal rules, for example, prohibit most small investors and mutual funds from investing in PE firms. Many investors that can put money into PE don’t do so because of fund rules that typically bar withdrawing money for a decade or more. “So, when you finance yourself with private equity, investors cannot sell their stake very easily,” Goldstein says.
Many people and institutions with cash to invest are put off by this illiquidity, meaning that PE firms cannot match the capital-raising power of the public markets. PE funds are also very opaque, and many investors prefer the transparency offered by public corporations that have extensive disclosure requirements, Goldstein notes. While executives at public companies do chafe at the rules, even they benefit from them, Goldstein adds, because the markets provide lots of feedback to guide management. “I think one of the key advantages of public markets is that they gather information from many different people in the economy, and this can provide key information for decision makers,” he says.
“Sometimes, the managers can learn from the stock price,” Edmans adds. The shares’ rise and fall, for instance, can provide insight into whether the firm should invest in growth or hunker down.
Some experts also question whether shareholder activism is the crushing burden Davis and others claim it is. While hedge funds and some big pension funds have stepped up pressure on companies they invest in, the mutual fund industry has not followed suit, Skeel says. Passively managed funds – index-style mutual funds and exchange-traded funds – simply buy and hold shares of firms in the indexes they track, and do not typically use their voting power to pressure management, Skeel notes. In fact, the funds cannot even vote with their feet, as they must own the stocks in their benchmark index. Actively managed funds, though they do try to pick winners, are less likely to pressure management than to simply sell their holdings if they think a company is poorly run or underperforming.
For funds, which now compete by offering ever-lower fees, “one way to keep your costs down is not to engage in proxy fights,” Skeel says.
Another benefit of public ownership: A firm has more owners than if it were private. While a private equity firm may own a controlling stake in a company in which it has invested, this is not common with public companies. Hence, public ownership can muffle the cries of a minority of unhappy shareholders, making life easier for managers rather than harder. “These other [forms of ownership] don’t offer the dispersal [of ownership] you get” as a public firm, says Wharton finance professor Jessica Wachter.
Is there, then, nothing to worry about as the number of listed companies’ declines?
Wachter says that a decline in public corporations could produce unwelcome results. If the list of public corporations becomes less diversified as a result of being smaller, stock returns could become more volatile, she points out. “We don’t know for sure if it’s happening, or what the effect will be, but it’s possible that the result could be negative,” she adds. That could be harmful to investors, including those millions with retirement money in 401(k)s.
On the other hand, the decline in public-company listings may be just a passing phase – a “trend” that could reverse if Washington eases regulatory burdens, the economy picks up and the financial markets return to normal. It could be years before the verdict is in.
