Investors and companies are losing faith in public markets

There are many reasons to be a public company, from the ease of raising capital, to the ability to compensate founders and employees with share options. But there is also an increasing number of reasons not to be. That truth is reflected in new statistics showing that between 2000 and 2018, the number of private equity-backed companies in the US rose from less than 2,000 to nearly 8,000. Publicly listed companies in this period, by contrast, fell from 7,000 to about 4,000, according to the Milken Institute.

Globally, asset owners have now placed about 14 per cent of their assets in private markets (mostly private equity and real estate), up from virtually nothing a couple of decades ago, according to Willis Towers Watson, a risk management firm. It predicts this will rise to 20 per cent in 10 years.

Certainly, liquidity in global public equity and bond markets has declined since 2008 — which many regulators cite as their big financial risk concern at the moment — whereas financing for private deals has grown. To the extent that all this erodes the public market system, which is the main vehicle through which individuals can benefit from wealth creation in many modern societies, it is not only an economic worry but a political one, too.

Many leaders of public corporations cite the problems of quarterly capitalism as a key driver of these trends. Over the past decade or so, pressure from shareholder “activists” has vastly increased. This has forced some executives to take decisions to boost short-term share prices that might not be in a company’s long-term interest.

There are plenty of other downsides to being public these days. In the age of sustainable investing, populism and #metoo, CEOs and boards are under tremendous pressure to state their “values.” They must show progress on diversity (which can mean different things in different countries), embrace “stakeholder capitalism”, and of course articulate and execute smart corporate strategy in the midst of geopolitical and economic shifts.

All this must be achieved while companies make sure they are protecting the share price (it is still a fiduciary duty to keep it as high as possible). Little wonder the average public company CEO has a shelf life of about three years.

Meanwhile, there are many upsides to being private. Research some years ago, comparing the investment behaviour of private and public companies of similar sizes and types, found that private companies were able to invest about twice as much in productive capital expenditure. The key difference seemed to be the pressure public companies are under from investors in public markets.

One result has been the $1tn that US companies paid out in share buybacks last year. The traditional defence is that this is a good use of corporate funds in the absence of value-enhancing investment opportunities. But it is also telling that this cash dump was done when the market was close to its peak — a strange time to argue that a company’s stock still has room to rise.

Corporate debt has risen to record levels too, as many firms have engaged in a tax arbitrage in which profits go to offshore accounts, while debt is raised at record low rates in order to pay out investors at home. A public company debt bubble is one of the other big financial risks on the horizon.

All this speaks to perhaps the greatest economic issue of our time: how to reform capitalism and restore trust in free-market, liberal democracies. Populists are not the only ones to have lost faith in the public markets. Investors’ confidence has eroded as well. This worrying trend should be a focus for policymakers on both sides of the Atlantic.