I have written before about he staggering decline in the number of public companies since the late 1990s, and the concurrent growth in large, private companies. Doidge, Karolyi and Stulz published a working paper trying to explain this phenomenon. Their explanation begins with two facts:
1. The number of IPOs has slumped considerably since that period
2. The number of companies delisting from an exchange has gone up over that period.
They note that the overall number of companies has risen in that period, as well, so the loss of public companies is not a function of lower overall business formation. They also noted that it wasn’t just a drop in the number of small firms due to low IPO activity driving that reduction; de-listings were occurring across all sizes of firms. Finally, they note that voluntary de-listings are a relatively small portion of the total, with M&A being the largest driver. They conclude from this that new regulations, like SOX, could not be a significant driver of de-listings, contending that they would expect to see a regulatory effect to be reflected in voluntary de-listings. They conclude that “The number of mergers is puzzlingly high compared to both U.S. history and to other countries.”
Well, it’s not puzzling if you use a more realistic model of what would be driving those results. The model I have used for over a decade is quite simple:
A company will choose to be public when the benefits of being a public company exceed its costs, otherwise it will not join, or will exit, the public sphere.
The way it exits is of secondary importance.
So, for example, the fixed cost of being a public company for a $100 million firm (net assets) shortly before SOX was just over $1 million per year. After SOX, that number jumped up to about $3 million per year. Now, the cost versus the benefit of being public comes down to the cost of capital advantage of being public. If my cost of capital is lower as a public company versus as a private company by, say, two percent ROA per year, then if I were a $100 million company, and it cost me $1 million per year (i.e., 1 percent of net assets) to be public, then I would be ahead as a public company. If the cost of being public jumps to three percent per year, then a $100 million company with a fixed cost of $3 million per year to be public would prefer to be not public.
My one disagreement with Doidge et al. is that de-listing is not necessarily the only way to go once you have figured out that you are no longer viable as a public firm. In fact, it is easier to complete an M&A deal than to escape the public markets via a going-private route. So, the M&A spike seen by Doidge et al. should be counted as a reaction to proliferating regulations. That and the fact that private companies larger than $1 billion has grown five-fold in the period since 1996, making this phenomenon one of the more spectacular cases of capital flight ever seen.
My rough estimation is that post-SOX, it was no longer worth it for the typical $100 million company to be public. In fact, given the rising costs of being public, I estimated the a company had to be between $300 and $500 million in net assets to be viable as a public company. After Dodd-Frank, with its voluminous new regulations for public companies, I estimate that few companies under $1 billion in net assets can any longer afford to be public.
The broader question that is not being asked is: Is it good for capital formation in general, and public capital markets in particular, to no longer have the full range of companies that could be publicly available for all investors?