Where Have All the U.S. Public Companies Gone?
Preface
These days, we often hear financial pundits and media sources report on topics such as “the worrying amount of passive capital invested in the Magnificent Seven due to market-cap weighted indexes” and the “loss of the small-cap effect.” The following is an initial attempt at uncovering the forces that have shaped changes in the public markets over the past ~20 years.
The U.S. Stock Market Has Seen a Secular Decline in the Number of Publicly Traded Firms
The U.S. now has half as many publicly listed companies trading on its exchanges as it did at the peak in 1996. As the chart below shows, listed companies reached a high of 7,322. That number today is down almost by half to 3,700 (excluding the listing boom in '21 and '22) and is more than 1,000 lower than in 1975.
Research Indicates Two Major Forces are Responsible
According to the National Bureau of Economic Research, there are two major forces at work: a high number of delistings (accounting for roughly 46% of the decline) and a relatively low number of new listings (accounting for 54% of the decline).
Delistings Driven by Mergers and Acquisitions in the U.S. Have Steadily Increased...
A common post-SOX argument is that the cost and complexity of compliance incentivize more businesses (especially smaller ones) to go private; however, the number of voluntary delistings is far too small to explain the high number of delistings. Mergers and acquisitions are the main source of delistings. The U.S. experienced a high number of merger-related delistings after 1996 compared to both the U.S. historically and other countries (from 1997 to 2012, the U.S. had 8,327 delistings, of which 4,957 were due to mergers), accounting for 45% of the delistings after the 1996 peak.
Listings Driven by IPOs in the U.S. Have Steadily Decreased...
The number of U.S. listings fell from 8,025 in 1996 to 4,101 in 2012 (a 49% decrease in the U.S.), whereas non-U.S. listings increased from 30,734 to 39,427 (a 28% increase overseas). Research indicates the decrease in listings cannot be attributed to new company formation (the total number of businesses remains unchanged, and the number of startups has increased), industry (listings decreased in all but one industry after 1996), or SOX (the decrease in listings began before these regulatory changes took place). Easy access to venture, growth, and private-equity capital means that companies no longer need to pursue an initial public offering to fund growth or access liquidity.
Leading to a Large-Cap Dominated Public Equity Market
While the number of public companies has decreased, firms have grown in size. The total market value of U.S. companies listed on stock exchanges, as a percent of gross domestic product, is close to the peak reached in 1999. Scalable software and networks are winner-take-all businesses that favor incumbents (which explains the top-heavy market-weighted index funds), and new innovators now remain private for much longer due to the boom in private equity.
Companies Are Staying Private For Longer...
Companies are going public later in their lifespans. The decline in IPOs has led to a 50% increase in the average age of public companies, from 12 years in 1996 to 18 years in 2016. Jeff Bezos founded Amazon in 1994, taking the company public three years later with an enterprise value of approximately $600 million. From 1997 to 2002, public investors enjoyed a 12-fold appreciation in Amazon’s stock. Conversely, Mark Zuckerberg waited until Facebook was eight years old before taking it public. At the time of Facebook’s IPO in 2012, the social-media company had a market value of more than $100 billion. With successful startups delaying their IPOs for so long, there is little prospect for public returns like those of Amazon’s early stockholders.
Due to the Increasing Prevalence and Availability of Private Capital
The rise of private equity, which is still largely a small and mid-cap phenomenon, supports the theory that small-cap companies that might have gone public in the past are now owned by private funds. Under the purview of private equity, these businesses can remain private until they are large enough to qualify for the S&P 500 or are sold to another PE fund or company.
Publicly Traded Small-Cap U.S. Equities Have Seen a Sharp Decline in Quality...
Overall, small-cap quality has declined. As the best startups choose to stay private longer, small-cap investors now have fewer quality choices. This reflects a long-term trend. The median American small-cap in 1995 posted gross profits of about 29% over assets. Now it is 14%, even when excluding healthcare (profitless biotech and pharma stocks).
Leaving U.S. Small Caps to Underperform, But Non-U.S. Small Caps Continue to Do Well
U.S. small caps (Russell 2000) have underperformed the S&P 500 since 1978. Interestingly, the performance of small caps in Japan, Europe, and the emerging markets has been much better and has outperformed the large-cap indexes, albeit with meaningfully less data available.
Is There a Role for Active Public Small Cap Management in a Portfolio?
The S&P SmallCap 600 Index (which already strips out profitless stocks) is trading near its lowest valuations ever versus the large-cap benchmark. Is there an opportunity for meaningful mean reversion? However, note that while U.S. large caps have mostly financed themselves with bonds with long duration and fixed interest rates, smaller firms are now facing more pressure from floating rate debt coming due.
Potential Areas of Discussion and Further Analysis:
- The pools of venture capital and private equity are considerably larger today than they were in 1996. Does this account for today's tech bubble and prevalence of so-called unicorns, or startups with values of more than $1 billion?
- When companies such as Uber are well-funded through private offerings, they have little reason to go public. Is that a one-off or a broader trend?
- Are small, closely held companies looking for an exit via acquisition or merger rather than an initial public offering?
- What does the low number of publicly traded companies mean for valuations? Does it in any way suggest that stocks are now valued higher than their long-term averages?
- Company-specific outperformance has become increasingly difficult to achieve in public markets dominated by mature businesses and passive fund flows. Is it possible to assemble a portfolio with the same makeup as the stock market of 1997 without exposure to private markets?