At the earliest stages of funding, small companies have become more reliant on angel investors, universities, or sector-specific investment shops.
And as these small companies find their footing, they are waiting longer than ever to go public – financing themselves instead through multiple rounds of private equity or venture capital.
The number of IPOs in the U.S., for example, has decreased during the last two decades. And even though IPOs have picked back up in the wake of the financial crisis, an increasing number of U.S. companies are going public in other countries, or even deciding to stay private and access different sources of funding.
The reaction to my piece has been illuminating. Stephen Bainbridge, of course, blames Sarbox, citing survey data, among other things. I’m unconvinced, although I do agree that it’s a boon for accountants. Derrida, in the comments on my post, reckons that a stock-market transaction tax would help. I like that idea more: liquidity can be a bad thing, and throwing sand in the wheels of the stock market would almost certain bring correlations there down, thereby reducing the diversification benefit to investing in private equity. It would also, of course, make buying and selling stocks more expensive — and that’s arguably a good thing too, if we want shareholders who act like owners rather than short-term speculators.
The most interesting pushback came from Ryan Avent. It’s worth taking his points one at a time:
Mr Salmon hasn’t managed to convince me that this recent trend is actually a threat to American capitalism. For one thing, he’s argued persuasively that private ownership is likely to be advantageous for firms that don’t need to raise money in public markets. It spares them the need to deal with pushy, impatient, litigious shareholders, allowing the firm to focus on its private goals and long-term growth. From a public policy perspective, the incentives facing firms are of some consequence.
Well yes: which is why it’s a good idea to nudge incentives more towards public markets and less against them. In America for pretty much all of the 20th Century, and in the rest of the world even today, public markets have shown themselves to be a really good thing when it comes to value creation. Before we simply come to the conclusion that we were doing it wrong all along, and that the rest of the world is still doing it wrong, it might be worth asking whether public markets shouldn’t by rights be more attractive than they are. It’s also worth asking whether pushy, impatient, and litigious shareholders are creating or destroying value. I genuinely don’t know the answer to that one.
I’m also not convinced that this trend is likely to leave private investors shut out of capital ownership. If millions of Americans want to invest their savings in equity of some sort, and if firms are out there looking for funding (and if there aren’t firms out there looking for funding, the economy has a bigger problem than stock ownership), is it really plausible that the financial system won’t find ways to match the two? There are many things to be said by way of criticism of the financial system, but its inability to exploit a profit opportunity is not one of them. And letting trillions in small investor savings trickle into low-yielding bonds would represent a massive missed profit opportunity.
I’m not for a minute saying that individual investors are going to wind up in low-yielding bonds as a result of all this. I’m saying something worse: that individual investors are going to wind up in low-yielding stocks as a result of all this. The US stock market is still worth some $17 trillion — there’s no shortage of stocks to invest in. But I worry that individuals investing in the stock market are just going to be buying and selling stocks to each other, while being gamed all the while by high-frequency traders. The more important work of capital allocation, meanwhile, is being done by private equity and venture capital shops.
The point here is that while demand for stocks to invest in might well be a profit opportunity for Wall Street, firms are smart enough now to realize that things which make lots of fee income for Wall Street aren’t necessarily good long-term ideas. So given the choice between a Wall Street investment banker who says “I can make you rich in an IPO”, and a Silicon Valley VC who says “you’re already rich, I can give you all the money you want, I can personally help you become even richer, and you won’t need to worry about being public,” the latter looks a lot more attractive. Does that VC dream of an exit-via-IPO at some vague point in the future? Maybe, maybe not. But a delayed IPO is still better than one tomorrow. Meanwhile, individual investors will continue to invest in the stocks that already exist. They just won’t make that much money from them. Which brings me to Ryan’s final point:
A different question is whether small investors will earn a lower rate of return than the big, rich, connected guys. I’m going to go ahead and ruin the suspense: they will. Now, Mr Salmon wants to make the point that defined-benefit retirement plans can earn better returns than defined-contribution plans, because managers of the big plans can play on the same field as the rich, well-connected investors who get to put money in Facebook. Perhaps that would remain the case, or perhaps that premium would disappear if a larger share of workers invested in defined-benefit plans. I can’t say. But that’s a fundamentally different question from whether falling numbers of public stock offerings threaten to end ownership of capital by the masses.
Ryan forgets, here, that a larger share of workers did invest in defined-benefit plans, for most of the stock market’s heyday. And that during those years, defined-benefit plans did pretty well, considering.
I’m not worried that falling numbers of public stock offerings threaten to end ownership of capital by the masses. What I’m worried about is that the masses will end up owning the dregs of the capital world — the overpriced stocks which nobody else wants, and which they get automatically when they buy their index funds. Meanwhile, private companies will be owned by plutocrats, and will comprise an ever-increasing share of the US economy. Which might be good for both the companies and the plutocrats. But it’s clearly not so good for those of us with 401(k)s.