Examining the shifting opportunity set in the U.S. from public to private markets

This quarter we would like to share some thoughts on a long‐term market trend—the continuing shift in domestic investment opportunities from public to private markets. Despite the asset growth of U.S. equity markets in the past two decades, the number of publicly traded U.S. companies has been shrinking. The Wilshire 5000 Index provides an excellent example of this. Named for the number of companies represented in the index at its launch in the 1970s, the Wilshire 5000 is a broad U.S. equities index that measures the performance of all public U.S. equity securities with readily available price data. After hitting its peak of 7,562 companies in 1998, the number of constituent companies in the index been

roughly cut in half—as of March 31, 2019, the Wilshire 5000 should technically be called the Wilshire 3,530 (though admittedly, this name is not as catchy).

And, while the number of U.S. public companies has fallen, the number of private equity‐backed U.S. companies has grown significantly and is now approximately double that of publicly listed companies (see Figure 1).

Figure 1: The number of public companies has declined as private equity‐backed companies rise. Source: The Carlyle Group.

Interestingly, this trend is unique to the

U.S. market. According to a study by

Credit Suisse, while the number of listed

companies in the U.S. fell by about 50%

from 1996 to 2016, it rose by about 50%

among the 13 non‐U.S. developed

countries with the most complete data

available. This is despite U.S. gross

domestic product (“GDP”) growth of

nearly 60% over that time. In fact, an

academic study in the Journal of Financial

Economics determined that based on GDP, GDP growth, population growth and corporate governance metrics, the U.S. should currently have more than 9,500 listed companies to be comparable to other developed countries.

So where have all the U.S. public companies gone? As a first step towards an answer, it’s important to understand the mechanics of how public companies are added and subtracted from the marketplace. Public companies are added on exchanges either when an existing public company “spins off” one of its businesses into a new standalone company (such as the spinoff of PayPal from eBay), or when a company chooses to participate in an initial public offering, or “IPO” (Uber and Lyft are recent notable examples). Companies are subtracted from public exchanges (or delisted) for three reasons: mergers and acquisitions, delisting for cause (bankruptcy, not maintaining a minimum stock price, etc.) or voluntary delisting. Mergers and acquisitions can take several forms—one public company could buy another public company (AOL buys Time Warner), a private company could buy a public company (Dell buys EMC), or a company could be taken private through its acquisition by a private equity firm (Blackstone buys Hilton).

The Journal of Financial Economics attributes the rapid fall in the number of U.S. public companies to an increase in mergers and acquisitions, combined with a substantial decrease in the number of IPOs, in roughly equal measure. Government regulation has played a part in both cases—lenient anti‐trust enforcement has allowed for an increase in the number of mergers and acquisitions, while stringent regulations mandating certain reporting and liability requirements (primarily the Sarbanes‐Oxley Act of 2002) has made the cost of being a public company rise. However, increased government regulation cannot be the only explanation, because the downward trend in public company listings began well before Sarbanes‐Oxley was enacted.

The simple explanation is that companies are now less incentivized to become public. Since many of the regulatory costs to becoming public are fixed costs, they have a bigger financial impact on small companies and are more easily absorbed by large companies. This encourages smaller companies to delay an IPO until they have grown in size. Additionally, public companies face challenges like a shortterm focus on quarterly earnings, dysfunctional board dynamics, and the potential for disruptive shareholder proxy campaigns—the relative messiness of being public may be less attractive than the controlled and streamlined environment associated with remaining private (somewhere Elon Musk is nodding in agreement). Finally, companies now have greater access to private capital as they grow and

mature, which allows them to avoid the public markets for longer. As an example, of the approximately $131 billion in total venture capital funding in 2018, nearly 50% of that was in deals of $100 million or more, compared to 12% in 2013. This means that even well‐known, later‐stage private companies (such as AirBnB) are able to attract billions in funding as they continue to grow and develop, further delaying their IPOs. As a consequence, private equity investors are able to capture more of the value created by a company before it is available to public investors. To use a past example, Google was a private company for only six years before going public. Had Google stayed private for 12 years (the current average for tech startups), over $162 billion in value creation would have been inaccessible to the public markets.

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