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Why Are So Few Companies Going Public?

by Bennett Voyles

July 25, 2018

fewer public companies

Public companies aren’t dying out, but they are becoming a lot scarcer than they once were. In the US, the overall number of listed companies has fallen by almost half since 2000, according to Jay R. Ritter, a noted scholar on initial public offerings.

In this article, we’ll look at some of the reasons public companies are becoming rarer these days, examine whether their scarcity is having any impact on the economy and society, and speculate on how corporate ownership evolves from here.

Why these numbers fell so substantially over the same period of time the global economic product nearly doubled is not entirely clear, but Ritter, the Joseph B. Cordell Eminent Scholar in the Department of Finance, Insurance & Real Estate at the Warrington College of Business at the University of Florida in Gainesville, chalks a lot of the reluctance to being publicly traded to a stronger mergers and acquisitions market.

M&A is strong in part because scale matters more than ever now, according to Ritter. “In many industries, getting big fast is more important than it once was,” he explains. “Being big is more important than it used to be, and in many cases, internal growth takes too long.”

For the buyer, this time pressure means that paying a substantial premium can be worth it. For the seller too, an association with a big company can provide instant access to enormous resources that might otherwise take years to acquire.

Regulation discourages IPOs

Some experts point to Dodd-Frank and other post-financial crisis regulations as another discouragement to going public, along with the rise of activist investors. “On the ‘demand’ side there is a perception that the transaction tax of public ownership, both through compliance and the pressure exerted by shareholders, has simply gotten too high,” said Scott Anthony, Singapore-based Senior Partner at Innosight, a global consultancy focused on innovation. “On the ‘supply side’ there is such a wealth of capital that there are attractive options for firms seeking to go private.”

William J. Carney, Charles Howard Candler Professor of Law Emeritus, Emory University School of Law, in Atlanta also points to the growth in the availability of private capital. [P]rivate markets have grown enormously,” he says. “Venture capital has grown to the point that it can support unicorns,” he says, referring to the $1+ billion startups that early stage investors dream of. For sellers, this private money can be especially attractive, according to Carney “[T]hese markets are less efficient than public markets, providing a potentially larger payoff to good research.”

At the same time, young companies are also often in less need of money than they used to be. In many industries, capital needs have become less intensive. For instance, the cost of building and launching a product has dropped dramatically, from roughly $5 million in 2000 to $500,000 in 2005 to $50,000 today, according to Jerry Davis, the Gilbert and Ruth Whitaker Professor of Business Administration at the University of Michigan’s Ross School of Business and Professor of Sociology, also at the University of Michigan in Ann Arbor.

Another common impetus for an IPO, to give investors and early stage employees a payday, is also less important than it used to be. James A. Hutchinson, a partner at Goodwin Law in Washington, D.C., who advises private equity, growth equity, and venture capital funds and their portfolio companies, notes that private liquidity offerings are much more common today. Rather than waiting until the firm goes public, a number of companies have started to conduct private liquidity programs – a kind of IPO-lite – that give early investors and employees a way to sell their holdings without going through the hassle of taking the company public. Uber, Facebook, and a number of other companies have used this structure to help investors and employees liquidate their company stock holdings and exercise their options, according to Hutchinson.

These kinds of liquidity programs were once expensive to organize, but Hutchinson, a pioneer in the use of the structure, says that over the past few years, he and a group of colleagues have standardized the documentation, reducing the legal costs of organizing these programs by two thirds. “It’s easier, faster, and cheaper now, so people are doing it more,” he explains.

In his 2016 book, The Vanishing American Corporation, Davis argued that contract manufacturing and distribution and the availability of cloud services mean that many companies no longer need to be large to succeed. “A corporation was once a social institution, with a mission and members and boundaries that separated the inside from the outside. Today it is more like a Web page…a series of calls on outside resources that are brought together just in time to convey the image that you see,” he writes.

Vizio, for instance, with 200 employees, sold about as many televisions in the US in 2007 as Sony, with 150,000 employees. Soon, Davis suggests, “the public corporation may be like the aristocracy of Europe, which still hangs on in some corners but is no longer the dominant force in society.”

Does it matter if more companies stay private?

Some critics have claimed that the rise of M&A exits is leading to a situation in which major companies can force sales by threatening to crush promising upstarts if they don’t sell out. Ritter agrees that this does happen, but not all that often. “Does that go on?” asks Ritter. “Yes, but the vast majority [of deals] are motivated more by synergies where a small company finds that it’s worth more as part of a larger organization.”

As to whether a merger or going public is better for innovation, the evidence is mixed.

One recent study of mergers in the pharmaceutical industry found that patent applications fell 30% following an acquisition. (However, the study doesn’t differentiate between public and private companies.) On the other hand, another study that tracked companies pre- and post-IPO found that going public also reduced innovation by 40%.

Anthony does not believe one structure is necessarily better than another. “In terms of the impact, there is at least a perception that public ownership leads to short termism, which inhibits innovation. I say perception because certainly there are large public companies that think and act with a long-term orientation. Recent research by McKinsey validates the benefits of this approach, and key institutions like BlackRock are pushing it,” Anthony says.

Personally, however, he is not convinced. “My own personal view is that it really comes down to the owners. Some PE companies want to strip, shrink, and flip, and that doesn’t really help anything. Other private owners really do want to reconstruct and reorient for the long term, and that’s a good thing,” he says.

In terms of governance, Lawrence J. White, Robert Kavesh Professor of Economics at New York University’s Leonard N. Stern School of Business , also argues that public ownership is not necessarily better. In fact, he says, the few shareholders of a private company often have more say about the operation of the company in practice than the many shareholders of a large public company. Particularly given that many of these stockholders are pension funds and other institutional investors, White says, the trend toward private ownership is not one that concerns him much. “I don’t see it as a nefarious or all that worrisome trend,” he says.

A Post-Firm World?

However, Davis sees the trend toward private ownership as another aspect of a larger trend away from major companies that are also major employers, which he also sees as problematic. The idea that what’s good for General Motors is good for America might have made sense when many Americans worked for GM, but these days, according to Davis, the company has as many employees now as it did in 1928– back when the country’s population was about a third of what it is today.

The fact that fewer public companies today are major employers makes it more difficult for regulators to drive larger public policy goals, such as reducing workplace discrimination, which were easier to achieve when the biggest companies employed the most people, according to Davis. “We kind of demonize big corporations but you can tame them…it’s really hard to do that with an eco-system of small companies and independent contractors,” he explains.

In particular, the decline of the public company as a big employer doesn’t bode well for income equality. J. Adam Cobb, an Assistant Professor of Management at the Wharton School of Business, and Flannery Stevens, an Assistant Professor of Management at the David Eccles School of Business at the University of Utah, have found that American states where large corporations are big employers tend to have less income inequality than states with fewer large corporate employers.

Turn, turn, turn

Others argue that the current dearth of public companies may just be a cyclical occurrence.

Hutchinson says that most of his colleagues believe that the IPO market may soon become active again. “I think there is a cohort of companies that are old enough and mature enough to want to go public now,” he says.

One of those firms, Dell Technologies, is likely to be particularly well informed about the advantages and disadvantages of each kind of organization: Michael Dell, the computer baron who took his iconic company public in the 1988, then took the company private again five years ago, announced a plan in early July to take Dell Technologies public once more in the fall.

Sometimes, nothing will do but an IPO – particularly if the company has grown into a giant. “There’s nobody to buy you…you start to grow out of being a potential merger partner,” explains Hutchinson. “When you’re as big as Uber, who is going to write that check, other than the public markets?”

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