This January, Interlink Electronics, a US technology company specialising in human-machine interface and force-sensing technologies, announced its voluntary delisting from Nasdaq. A quote by the company’s CEO, Steven Bronson, explained the reasons for the decision: “To better position Interlink to accelerate long-term profitable growth, we undertook a thorough and thoughtful review of our cost structure, including costs associated with being a Nasdaq-listed and SEC [Securities and Exchange Commission]-reporting company.”
There is nothing noteworthy about a company relinquishing the privilege of being listed on the stock market these days
It would seem that there is nothing noteworthy about a company relinquishing the privilege of being listed on the stock market these days – such a move is all too common. Since 1996, the number of public companies in the US has almost halved (see Fig 1), with delistings exponentially increasing and IPOs also dropping. The average number of listed companies per one million US citizens has also halved since 1976, according to a recent report by the National Bureau of Economic Research, a US think tank. The study found that the US has roughly 5,000 fewer listed companies than would be expected for a country of its size, population, economic development and rule of law. The picture is similar on the other side of the Atlantic: since 2000, the number of listed companies has dropped by 37 percent in Germany and by 23 percent in the UK (see Fig 2).
The research resurgence
Academics and market analysts do not agree on the causes of the crisis, or whether this is a crisis at all. A popular theory focuses on the rise of the knowledge economy. One of its main proponents, Professor René Stulz, argues that, in the technology sector, investment in research and development makes going public a risky option. As Stulz suggested in a recent paper: “If a firm invests in intangibles, it is much more difficult for its management to convince investors that it will make good use of its money. If the firms give too much detail, which they could be forced to do by disclosure laws if public, their competitors can use the information. If they give too little detail, investors will pay little for their shares. It is not surprising, therefore, that for such firms, participation in public markets with their disclosure requirements is likely to be onerous.”
The case of Interlink Electronics – a world leader in printed electronics with operations in Singapore, China, Hong Kong and Japan – corroborates this theory. The company’s delisting announcement noted: “The resulting reduction in operating expenses will allow us to invest greater amounts towards research and development and sales, which is a superior use of our limited resources.” The California-based firm had reregistered just three years ago, hoping to tap into capital markets to accelerate growth. However, things did not go as planned, as the firm’s leadership decided that “the benefits to the company and its stockholders of continued Nasdaq listing and SEC reporting did not justify the costs of maintaining that listing and continuing to publicly report”. Currently, the company asserts that it has “a strong balance sheet with no debt” and does not need to raise more capital to meet its targets.
But this case is the rule rather than the exception in the technology sector. For many companies, the obligations that accompany a listing are too costly and burdensome. John van Rossen, Managing Partner for EY’s private equity advisory business in Europe, the Middle East, India and Africa, told World Finance: “Governance and reporting requirements have strengthened in the public markets in the recent past, with a knock-on implication for the costs to maintain a listing.”
For some analysts, overregulation is the main culprit for the shrinking of stock markets
Another side effect of the increasing importance of the technology sector is the rise of the FAANG powerhouses – Facebook, Apple, Amazon, Netflix and Google – which dominate their markets and frequently acquire smaller tech companies before they become big enough to go public. This was the case with Facebook’s acquisition of Instagram. Dr Klaus-Heiner Röhl, a researcher at the German Institute for Economic Research in Berlin, said: “Investment in buildings, machinery and equipment becomes less important for companies, while investment in intangible capital, such as software and patents, is essential. The rise of intangible investment is often associated with network effects… A good or a service yields more utility to a customer when more people are using it. These network effects enable monopoly rents and thereby contribute to more concentration.”
Germany is a good example of such a market, Röhl told World Finance: “In Germany, non-financial corporations were traditionally highly interconnected to other corporations by their holdings of company shares. But German companies have decreased their holdings of listed shares and increased their direct acquisitions instead since 2000. This mirrors a new investment policy: in the knowledge economy, companies acquire the knowledge and the patents of other companies through the acquisition of the whole company.”
Some experts hope the trend may be reversed once more technology companies decide to go public. Sharing-economy powerhouses such as Airbnb, Uber and Lyft are expected to be listed this year. However, Professor Jay Ritter, an academic at the University of Florida who has been dubbed ‘Mr IPO’ for his work on the subject, is not optimistic: “It looks as though the long-awaited IPOs of some of the big tech unicorns will happen this year. But most smaller companies will not go public – they will merge instead, typically by being bought by a large company in their industry.”
Death by red tape
For some analysts, overregulation is the main culprit for the shrinking of stock markets. In the US, criticism focuses on the Sarbanes-Oxley Act, which was passed in 2002 as a response to the furore that followed the collapse of WorldCom and Enron due to illegal accounting practices. The law requires public companies to hire external auditors to scrutinise internal controls. Critics argue that this can be too onerous for smaller companies, costing them up to six times more for accounting compared with larger firms, according to the SEC. Others point to the JOBS Act, which increased the number of investors private companies are allowed to have before they need to report publicly.
Private equity firms have come under fire for their contribution to the shrinking of the stock market
Recognising the problem, SEC Chairman Jay Clayton has announced the commission’s intention to provide smaller, fast-growing companies with incentives to list. One of the proposals under consideration is the possibility of allowing these companies to hold informal talks with investors before announcing a listing so that they can test the waters for an IPO.
In the EU, one of the goals of the recently established capital markets union is to make listings easier for smaller companies. The policy enables firms with fewer than 500 employees to issue stocks under a less restrictive regulatory » framework, lowering the costs of an IPO. Markus Demary, a senior economist specialising in monetary policy and finance at the Cologne Institute for Economic Research, told World Finance: “What needs to be done additionally is to reduce the costs of being a public company through a reduction in the complexity of disclosure requirements, but without undermining investor protection.”
Market volatility in the markets may also prevent start-ups from considering an IPO. Last August, Elon Musk sent shock waves when he tweeted his intention to take Tesla, a hi-tech car manufacturer, out of the stock market. The price of the company’s shares skyrocketed, but plunged soon thereafter when the SEC launched an investigation into Musk’s behaviour. Leslie Pfrang, a partner at the IPO consultancy Class V Group who has previously led the sales team for hundreds of technology IPOs, told World Finance: “Short sellers can outsize the market in thinly traded stocks [that are] especially vulnerable post-IPO, and promulgate rumours, volatility and runs on stocks whether or not the fundamentals call for it. This is a big issue for companies looking at IPOs and access to future liquidity, because they see this kind of activity, especially around lock-up expiration and when the company has limited liquidity post-IPO, as something that creates risk.”
Double-edged equity sword
The impact of the drop in IPOs is exacerbated by the rapid increase of delistings. With the exception of one year, more companies have delisted from the US stock exchange than gone public over the past two decades. One reason is the explosion of mergers and acquisitions, driven by increasing private equity buyouts. Since 2000, around 15 percent of delistings in terms of market valuation have involved at least one private equity firm. Half of these companies are permanently delisted. Demary told World Finance: “Selling a company to another private equity firm or fund has become an alternative to an IPO. This is an attractive option for a firm, because the private market is less regulated compared to the public market.”
decline in listed companies in Germany since 2000
decline in listed companies in the UK since 2000
fewer listed companies in the us than would be expected for its size, population and economy
of stock market delistings since 2000 have involved at least one private equity firm
Private equity firms have come under fire for their contribution to the shrinking of the stock market and the dwindling participation of smaller investors. Criticism focuses on regulatory privileges that have driven the increase in buyouts, such as tax breaks and the treatment of profits as capital gains rather than income. Pfrang said: “Debt is tax-deductible, and carried interest is taxed at capital gains rates when drawn. This gives private equity firms that leverage up their equity investments and pay themselves in carried interest a big advantage, so private valuations have risen sometimes higher than public market valuations. And that private capital comes with very few strings attached and very little oversight by those investors – as we saw in Uber and a few other cases.”
For smaller companies, the exponential increase of private capital is a boon. Currently, just over half of all capital raised in the US by start-ups is coming from the private market. Staying private helps them skip the burdensome process of hiring lawyers and accountants to comply with SEC rules. Van Rossen said: “The direct governance model in private equity by the capital provider avoids the need for public-company-style reporting requirements. However, the industry and its funding sources are conscious of their role in the financial markets and their responsibility to stakeholders and have, in some cases, taken initiatives to enhance disclosures on a voluntary basis.”
The opacity of smaller markets
Smaller stock markets can have dire consequences for investors, many experts warn. Kara Stein, an SEC commissioner until January 2019, has repeatedly highlighted the importance of transparency in financial markets. Private companies are required to disclose a limited amount of data compared with public ones, although public information is necessary for investors and companies to make decisions. As Stein put it in an interview, the oversized growth of private markets at the expense of public ones could create “a deterioration in price discovery”. Less transparency also increases the risk of investors taking a major hit in the case of a crisis, given that investor protections in the private market are weaker.
In markets where private equity capital is less abundant than in the US, even start-ups may find it difficult to raise funds. Röhl told World Finance: “We observe that, at least in Germany, retail investors as well as institutional investors have decreased their holdings of company stocks, an indication that less capital is flowing into public markets. This can lead to funding shortages for potentially high-growth companies, which is mirrored in the declining number of IPOs. This is more of a problem for German high-growth companies than for their counterparts in the US and the UK, because in contrast to the US and UK, private equity is less available in Germany as an alternative to an IPO.”
Some experts go as far as linking the decline of listings with the rise of inequality and populism on both sides of the Atlantic. In an influential paper, Swedish economists Alexander Ljungqvist, Joacim Tåg and Lars Persson claimed that delistings can reduce citizens’ exposure to corporate profits and undermine support for business-friendly and free trade policies. The authors warned that “a shrinking stock market can trigger a chain of events that leads to long-term reductions in aggregate investment, productivity and employment”. By being excluded from capital markets, the average voter cannot reap the benefits of globalisation through increased share prices.
Many are worried that the shrinking of stock markets reflects a bigger crisis: the concentration of corporate earnings in a small number of companies
Fewer options on the stock market can also lead to a less diversified portfolio that can put smaller investors’ insurance and retirement plans at risk. Demary said: “The decline of IPOs could increase inequality, because it lowers the opportunities for average retail investors to put their money into high-growth companies. Instead of going public, these companies are acquired by private equity firms in which high-net-worth individuals can invest, but the average investor cannot.”
However, other experts find these concerns overblown. Ritter said: “I find the Ljungqvist et al hypothesis rather far-fetched. In the US, most stockholders own stock indirectly through mutual funds, and they have no idea whether their portfolio owns 100 or 500 or 3,000 different companies.” He added: “Total market cap has not declined, it is just split among fewer but larger companies. Investors still get the benefits of diversification. Although there are no autonomous vehicle companies that are publicly traded, investors can get exposure to this technology by owning Alphabet (with its Waymo division) or Tesla. Audi and other companies also are developing self-driving capability.”
Others believe that for most companies, the benefits of going public still outweigh the costs. Pfrang told World Finance: “A company that sells mission-critical SAAS [software as a service] or security software to large enterprises may win more customers when these see that the company they plan to rely on to run a key part of their enterprise technology has thousands of other customers who are buying more of their products every year and [has] a healthy balance sheet. We hear from CEOs all the time [who] have gone through the process that their companies become more focused and disciplined and better able to attack competitive opportunities.”
Many analysts are worried that the slow shrinking of stock markets reflects a bigger crisis: the concentration of corporate earnings in a small number of companies. Over the past few years, the earnings of the top 200 US firms have exceeded or approximated those of all other public firms combined. During the same period of time, US public firms have shown a preference for returning equity to investors rather than raising new capital, exacerbating fears that stock markets are becoming a mechanism for rewarding shareholders.
Several measures have been proposed to reinvigorate stock markets. To curb the increase in delistings, many experts have suggested that governments should strive to reduce the costs of investing in privately held firms for smaller investors, or alternatively force these companies to disclose more information on their activities. Others propose the elimination of tax breaks – or even tax hikes – for private equity buyouts. However, this is practically difficult, given the information asymmetry between retail and institutional investors. On both sides of the Atlantic, investment in private companies is almost exclusively reserved for ‘accredited investors’: funds and high-net-worth individuals. Roni Michaely, professor of finance at the Geneva Finance Research Institute, is not optimistic that things will change for the better: “The combination of increased concentration and increased profitability of the stock market will drive another wedge between people who own equity and those who make a living from their work.”