The U.S. listing gap

From a new NBER paper by Craig Doidge, G. Andrew Karolyi, and René M. Stulz:

The U.S. had 14% fewer exchange-listed firms in 2012 than in 1975. Relative to other countries, the U.S. now has abnormally few listed firms given its level of development and the quality of its institutions. We call this the “U.S. listing gap” and investigate possible explanations for it. We rule out industry changes, changes in listing requirements, and the reforms of the early 2000s as explanations for the gap. We show that the probability that a firm is listed has fallen since the listing peak in 1996 for all firm size categories though more so for smaller firms. From 1997 to the end of our sample period in 2012, the new list rate is low and the delist rate is high compared to U.S. history and to other countries. High delists account for roughly 46% of the listing gap and low new lists for 54%. The high delist rate is explained by an unusually high rate of acquisitions of publicly-listed firms compared to previous U.S. history and to other countries.

I do not currently see an ungated copy.

Comments

Here's an ungated copy.

Meanwhile, here's a chart showing the data, augmented with data from more recent years from Wilshire Associates (the Wilshire 5000 total stock market indiex people).

Thanks for the try, but your first link doesn't work.

But by searching on the site referenced in the notes of your second link, I found it:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2605000

Maybe the internet has helped make private equity more liquid. Wouldn't the rise of something like Second Market delay firms from going public? And if firms do hold back longer during their high growth phase, wouldn't that impact the returns of the public exchanges?

I suspect that private equity, and American tax law, have made it possible to structure deals so that the future operating profit effectively gets piped off-shore without paying American taxes.

Nah. You can't avoid US tax on effectively connected income.

The actual reason is that the private market (private equity, venture capital, industrial buyers) has paid for a while and continues to pay a premium over the public market. An IPO exit does not come to even close to maximizing the value to the seller.

So the illiquidity premium is actually a discount?

This isn't even close to true. Private valuations may appear at face value to be at a premium for the seller (billion dollar valuations for everyone!), but the way they are structured almost assuredly guarantees a premium to the *buyer*. Otherwise Venture Capital and Private Equity firms wouldn't exist.

The fact is that most interesting and high growing companies get the following advice from their bankers from this market: No point of going public, instead get financing from the private market, you'll get a better valuation. Everyone who reads these presentation decks regularly will know that this is the way the valuations and bankers' advice tilt these days. For one, it's hard to do an IPO at a price that is significantly below the last private financing round when the private market is willing to fund you at a higher valuation than the previous round.

I am saying most and on average since there are always exceptions.

The higher valuation in the private market than public market doesn't mean that private market investors get bad returns, since there's at least the potential for large selection effects. The private investors may be skimming the cream from the top at higher valuations than what the public market pays simply because the private investors are better and/or better informed.

The valuation disparity is of course not a fundamental explanation. There's the interesting question _why_ the valuations are different between public and private market. To understand that, one should search for reasons from both the public and private markets, not just the public markets.

Better informed means...less premium.

I suspect, however, your previous point was referring to a "premium" over IPO.

But, that's self-evident by that fact that one way investors make money in IPOs is through under-pricing.

Could part of the reason private sales are more lucrative be tax? I mean it's hardle news that most established companies are flush with cash. Dividend payouts would be taxed, and they all struggle to build future value through organic growth, so why not go for buying another company?

Naive question: If you use your cash flow to buy another company, is that expense tax deductible?

The fundamental reason for the rise of PE over the last 20 yrs. is the tax deductibility of debt.

The End.

Tax deductibility plus a more advantageous corporate entity structure for reducing tax gives PE a huge advantage over traditional listed C-corps.

Debt has always been deductible.

http://marginalrevolution.com/marginalrevolution/2011/12/why-not-treat-debt-and-equity-the-same.html

That may have explained some of the takeovers in the 1980's, but it's doesn't explain anything over the last 20 years.

The reason why it doesn't explain anything over the last 20 years is that after the widespread introduction of large executive stock option programs, public company CEOs and boards have not been in the least bit averse to levering their companies to the hilt. Layoff announcement, debt issuance, and share buyback is a common story told by a public company these days (and IMO usually, but not always, a good thing as it increases efficiency for many of these companies). The tax deductibility of interest payments is, to the first order, the same for public and private companies.

Furthermore, many of the interesting and fast growing companies that are being bought and sold in the private market and that would get a lower valuation in the IPO market don't have meaningful debt, or cash current cash flow to support debt. It's all equity or equity-like convertible preferreds.

Listing comes with more onerous rules? More public scrutiny?

supposedly they controlled for that and found it's not significant ("we rule out..."). But I'd think it hard to get the right spec to really rule that out in a regression, since the rules change all the time, and you don't account for which rule change is significant and which is not by just coding a dummy. Haven't read the paper, how exactly did they control for rule changes?

Precisely. In controlling anything, the devil is in the details. My prior says, increased regulation has to be a part of this. I could be wrong.

Sarbanes Oxley mainly, and yes there's really no way to totally control for that kind of thing

I'd expect regulation like SOX to slowly build up over time, not 0-1 before and after implementation. First everybody thinks it's fine, then the first CPAs get fined out of business, and then your compliance fees start to climb...

I have several clients that have gone private, and the raw cost of being a public entity, in terms of compliance costs and professional fees, was a big reason why. The other reason was one indicated above, the rise of the Internet and the ease of national business, making private valuations more favorable than previously.

They write:

".......the literature on financial development ....views the size of the stock market as a measure of financial development... Since 1996, U.S. listings per capita have fallen. By this measure the U.S. is less financially developed now than it was in 1996, or even in 1975 "

If at all, is it the number of listings the relevant measure of development or the value of the listed companies? Has the total market cap of the listed companies fallen too?

I like Epicurean Dealmaker's theory that the main reason is because smaller private companies are less likely to IPO because there is much less public demand for those companies. What has changed since 1996 that would drive this change in demand? The rise in discount stock brokerage services such as E*Trade and Schwab. Mom and Pop investors have an overwhelming large cap bias.

And with discount brokerages there is no dealer rep with an incentive to push investors into new small caps.

I like that theory. Listings do seem to have peaked when the Equity Risk Premium troughed and have been falling as ERP has risen. In the mid-1990s, a risky, small firm with high "beta" would not have called for much of a return premium, but today, it would. I don't know if this is explained by mom and pop investors, though. I think it would be a product of the complex global capital trade that has lowered real long term interest rates. Although, I guess if that was true, this would be a global trend, and not a US-centered trend.

So much for my "own the whole market" passive investing strategy. I wonder how long it will be before stakes in private equity firms is a required component of a diversified portfolio.

Pretty much now actually - and the newer rules allowing for investors to have a lower financial threshhold will exacerbate the situation.

Used to be a company like Uber or Theranos would have IPOed already in order to raise funds - but with the ease of obtaining PE funds, the "easier" means of trading PE positions AND the pita known at Sarbox, it's no wonder listings are down.

Companies are more likely to IPO now once the initial investors are looking to cash out rather than for the company to raise funds. Poster child for this is Etsy

Was the Facebook IPO similarly motivated? i.e. initial investors are looking to cash out?

To some extent, yes.

Isn't this sort of the inevitable consequence of the growth in the average size of firms and greater regulation punishing small and mid sized forms more than large ones?

A lot of good points already in this thread. But another reason might be the reduced demand for capital from new growing companies. Most firms go public when they get large enough that their demand for capital can only be satisfied on the public markets. A traditional industrial needs to raise a lot of capital to expand into a multi-billion dollar mega-corporation, Facebook did not. It only went public so that its shareholders would have a more liquid market to sell their stock, that's very different from traditional IPOs. Since 2000, and particularly in the US, the most valuable new firms have been heavily concentrated in software, where capital requirements are low.

How do you explain that non-US listings have kept on increasing? Have Capital requirements reduced only within the US?

I would put more of an emphasis on the growth of foreign marketplaces - particularly in the BRICs

Lot's of good reasons already given. Also ability of given management size to control larger scope of activities due to IT related improvements, access to better capital markets, although one would think that would obtain in other countries as well to some extent.

I read it somewhere on the internet that if we stopped taxing job creators then the job creators would stop all that speculatin and mergin and stuff and create some jobs. And I read that them unions made a fuss and them stock markets don't work no more cause of it. Don't know if it's true, but I read it on the internet.

If we stopped taxing job creators there would be practically no income taxes at all.

Rural white people are stupid. And, reducing taxes or regulatory buden is stupid too.

'least dats wut dem bois ben tll'n me, rite Ray?

Another thing to consider (maybe the paper already did, I didn't read it): institutional ownership. There seems to have been an uptick in the 70-80 period and then again in the 90s, corresponding to the chart in the paper too.

The previous point made above about the change in investors may be right, but it's not the "mom and pop" investors as much as the investment funds that "mom and pop" investors buy.

Institutional owners are going to exert a lot more pressure and control over a company, making it less attractive for young firms to go into the capital markets. (VCs even more control, but at least there's an opportunity for selection there)

Either way, given all the reasons discussed here, I can't think that this represents a decline in the "quality" of the stock markets. The raw number itself doesn't tell us anything about that.

I can't remember where I read it, but someone was making the point that the stock market used to be about creating value, but now it is all about extracting value. Because of ZIRP, CEOs have a motivation to issue bonds to buy back their stock and inflate their stock price. They win because they are compensated in options and stock. M&A activity happens most during rising stock price environments because the acquirer can use their high valued stock as currency.

One reason not considered is that public corporations can borrow at low rates or use their high priced stocks to buy firms that might have otherwise gone public in normal market conditions. There are so many more avenues of capital access during the formation period for startups that neither they nor angels nor VCs feel the same pressure to go public as quickly as possible. Combine that with the almost unlimited borrowing capability of large potential acquirers. Going public would be your last choice right now.

When I was in college in the mid 1990s, I was surprised when an accounting prof told us more stock had been withdrawn than offered over the last 30(?) years, which I found sort of amazing.

Anyways, I'm not sure why the number of companies listed would matter. Doesn't the S&P 500 generate something like 2/3 of GNP?

Actually I take that back -- there could be significant effects on competition.

I tried to read the ungated copy linked above but it doesn't seem to be an actual link as I can't click on it, at least in Chrome.

What is not controlled for is whether equity markets elsewhere are getting more competitive. The US is not the only game in town, where before a Chinese firm would come to New York to raise capital, now it may decide it could raise more capital at home. Total volatility of listings/delisting could be going up, but if other markets are snatching up the new listings we wouldn't see it unless we were looking for it.

"The number of U.S. listings fell from 8,025 in 1996 to 4,101 in 2012, whereas non-U.S. listings increased from 30,734 to 39,427."

What is the stock market for? Are there cheaper, more effective, less intrusive ways of raising capital?

Interestingly I did a search on my large clients and only one is public. The rest are privately owned. I suspect it has quite a bit to do with not having owners who don't have the faintest clue what business you are in. As well as regulators who haven't the faintest clue either. Smaller exchanges are dens of thieves, the large ones are far away. Maybe the market doesn't have smart buyers? How can an algorithm be a smart investor?

What is a "smart buyer" of stock from the point of view of a firm?

One who isn't constantly agitating for the firm to "unlock shareholder value" whatever that means (And it can mean many things to many different people)

Who does that typically? The institutional guys? The Kirk Kerkorians? The fragmented, small investors must not have the organized platform to do that, right?

Does a public listed firm have any control over its buyers?

The concentration of capital lessens the need for public stock offerings. The concentration of capital is attributable to both pooling of capital and increasing inequality. Does the concentration of capital cause greater instability in financial markets? Logic would suggest that it does, if for no other reason than there are far fewer investors to even out their irrational behavior.

Access to alternative sources of financing would explain this. More venture capitalists, more access to large business loans, ...

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