The stock market is not only becoming more volatile and less valuable, it may slowly be becoming obsolete.
New research shows that the number of publicly traded companies has decreased, while their average age has increased. And because of their focus on shorter-term results, listed companies are older and slower and less likely to be a source of economic growth and wealth creation.
Stock markets formed about four centuries ago to trade shares created by companies in order to raise capital without having to borrow. Shares were ownership, and shareholders shared both risks and rewards, but with no contractual return.
The stock market as we know it began to evolve at the end of the 19th century, when corporations formed in order to scale up their operations as mass production demanded mass financing. The volume of capital needed necessitated public issuance and secondary trading of shares on organized exchanges, to make shares liquid and their risk tolerable; it was the original crowd-funding scheme.
The last century showed a happy trend, with a few interruptions, of wealth creation and reinvestment. Corporate market capitalizations grew as did market participation. But over the last couple of decades, the primary role of public markets has shifted from being a place for companies to raise capital to being a place for investors to earn returns. To succeed, a market needs to be both.
It used to be a milestone, a rite of passage, for a corporation to go public through an initial public offering and to have its shares listed on an exchange, giving the company access to enough capital to scale its operations and its profits. Size mattered, and the post-war conglomeration boom went on until the 1980s, when the wave of mergers that it inspired turned growth inward. It was the era of takeovers and leveraged buyouts, and some of the biggest deals of that decade were financed by debt funneled through private companies.
That trend to private capitalization was interrupted by the internet boom, when anyone with an idea and an app could go public, and did. The founding entrepreneurs were enriched beyond dreams, as were their investment bankers and deal makers. The 1990s saw the creation of hundreds of public companies, and investors rushed in.
But the stock bubble didn’t last, and in the wake of the consequent increase in investor protections and reporting requirements, companies began to turn to private capital once again. This time it was private equity and venture capital, and every consulting firm and investment bank began its own venture fund. Entrepreneurs could become just as wealthy, but without the compliance and scrutiny of a public corporation. The goal was not to go public, but to be bought.
There are now practical reasons to avoid the public markets as well. The nature of the corporate assets has changed: in the information economy, they are more likely intangible ideas or strings of code than machines and factories. Management has incentive to be less public about operations to protect intellectual property, and thus less likely to court investors in the public markets given the level of public disclosure that is required.
Disrupters will argue that a new business model needs time as well as secrecy to incubate, and that the quarterly performance measures required of public markets discourage long-term thinking and long-term growth.
And the sea change that technology created also created vast wealth. Private capital markets grew as private wealth and institutional endowments grew, because private investing promises greater return, given its earlier stage investment. Private markets are riskier precisely because they are private and lack the disclosure and public valuations required in public markets. But great concentrations of wealth can afford to take the risk and seek the greater return.
Over the last century or so, as the corporate need for capital grew, markets were created to funnel capital to them, first privately, then publicly. And it worked, and great wealth was created. Now, as that wealth becomes more concentrated, capital has gone private again: the “public” is no longer a necessary source of capital, and having public shareholders just doesn’t pay.
When corporate capital formation becomes a private market activity, without benefit of the wisdom of crowds, does it become less efficient? We can see the effect on the development of private wealth, but the effect on corporate formation and growth—how and which ideas and products are developed, scaled, and ultimately distributed—is harder to discern.
To be continued…