Adam Radly and Bob Bates have run a number of public companies, so this is particularly interesting:
Elon Musk recently tweeted that he intends to take Tesla private, that is, to take Tesla off U.S. stock exchanges. In a parallel development, the number of companies listed on U.S. stock exchanges has declined by almost 50% from its peak in 1996, despite dramatic increase in aggregate market capitalization. Many conjectures have been offered to explain this controversial trend. We offer a new explanation: the rising role of digital firms in the U.S. economy.
The number of listed firms can decline because of three developments: 1) bankruptcy, failure, or closure of listed firms, 2) delisting of firms going private or acquired, and 3) decrease in number of initial public offerings (IPOs). All three factors have become more common over time, which we argue stems from firms’ increasing reliance on intangible and knowledge inputs in their business models.
Emerging digital firms compete with knowledge, strategy, and expert human capital, attacking even the largest established firms. They operate as lean organizations, using cloud and internet-based infrastructure, and launch and distribute products more quickly than did firms that competed with factories, warehouses, inventories, and suppliers. The quickening pace extends to firms’ lifespan; we found that companies’ lifespans decreased substantially in each new decade of listing from the 1960s. Further analysis confirms that this trend is not just due to acquisitions; the companies are delisted sooner even when the sample is constricted only to those delisted for financial troubles. Furthermore, as production shifts to Asia and more and more U.S. firms gravitate towards digital strategies, firms have less need for elaborate finance, marketing, production, distribution, accounting, and human resource departments. These functions, to the extent they’re still required, are subcontracted using digital platforms. In sum, digital strategies and rapid technological obsolescence increases the mortality rates among existing public firms, but does not correspondingly increase the demand for IPOs. This trend, we claim, is the single largest cause for decline in listed firms. Our conclusion is supported by the fact that in each of the first three five-year intervals in the 21st century, 2001−2005, 2005−2010, and 2011−2015, the largest number of net delists, defined as the number of delisting firms minus the number of listing firms, occurred in software, electronics, and computer industry.
A trend towards digital firms also increases the pace of mergers and acquisition (M&A) activity that keeps hitting record levels each year. Digital firms are as valuable for their intangible capital as were the 20th century firms for their land, building, and factories. Hence, successful digital firms, even if incurring losses, prove attractive acquisition targets for firms that create value by mixing and matching acquired intangible assets with their own. Consider Yahoo and Whatsapp, which were acquired by Verizon and Facebook, respectively, in multi-billion-dollar deals. Such acquisitions become more lucrative with rising first-mover advantages, pace of technological development, and network externality. The dominant strategy among startup digital firms, therefore, is to grow fast and be acquired, not to purse slow and steady growth to reach profitability and then do an IPO. Increasing M&A activity naturally decreases the number of listed firms.
More than funds, today’s evolving companies need expert manpower, contacts, strategic relationships, and investors who understand their business model and can convince other investors to provide multistage funding. Their need is better met by partnerships with sophisticated, private equity investors than with passive public investors. Unlike public equity investors, private equity investors create value in their investee firms by bringing sophisticated knowledge base, obtaining direct access to managers’ private information, providing timely feedback on firm’s strategic plans, actively managing firms via board representation, creating contacts with external scientific teams, and identifying and facilitating strategic partnerships. Private investors help the evolving firms to find right suppliers of human resources, marketing, production, distribution, and accounting functions, that were previously done inhouse. Today’s firms therefore prefer to stay in private equity investors’ nurturing hands longer than did capital-hungry manufacturing corporations. For example, Uber and AirBnB remain private despite having achieved valuations of double-digit billion dollars.
Limitations of financial reporting of digital companies does not promote the cause of listing digital firms, either. Public investors are often obsessed with earning immediate profits. Chief finance officers increasingly question the ability of a day trader to value a digital company. Consider Musk’s recent comments and Dell’s going-private decision. The evolving digital companies hence seek private investors who can better understand their business models and more patiently provide multi-stage capital infusion than do public investors. Furthermore, doing IPO is not only an expensive proposition, it also consumes managerial time and energy. The rational outcome, thus, is that today’s evolving companies more likely remain private than did infrastructure-intensive companies in the middle of the 20th century.
So, what can be done to increase the number of listed companies in the U.S. exchanges — and is that even a worthwhile objective? Although we often treat the stock market as a barometer of economic activity and a healthy IPO market as the hallmark of successful entrepreneurial pursuits, there is no evidence that the recent decline in number of listed firms has adversely affected the U.S. economy. The aggregate market capitalization of listed companies keeps increasing, unemployment remains manageable, and U.S. retains its leadership in technological progress. The only change is that more deals are done with private funds and more companies come to IPO market having been initially financed by venture capitalists than ever before. Public investors do not miss out the action either. Institutional investors now channel more and more of common investors’ savings towards digital companies, by taking stakes in private equity funds. In sum, the decline in the number of listing companies is a sign of successful adaptation of organizational structures by U.S. corporations, keeping up with their changing business strategies. It should be applauded, not considered a cause for concern.