Float like a butterfly

by The Economist 223 views0

Most people know Elon Musk for his electric vehicles and desire to colonise Mars. He inspired the portrayal of the playboy and engineering genius who is the hero of the Hollywood blockbuster, “Iron Man”.

Mr Musk is also one of the last entrepreneurs in America who seems to think that the publicly listed company can be useful. Two of his companies are listed: Tesla, a carmaker, and SolarCity, an energy firm. They have towering ambitions and valuations, and burn up cash as fast as his third company, SpaceX, burns up rocket fuel. Governance at Mr Musk’s firms is patchy and they may well fail (see article), but they are exactly the kind of exhilarating gamble that stockmarkets are meant to be good at funding.

However, such octane-rich affairs have become rare. Listed giants such as Microsoft and Johnson & Johnson are more profitable than ever. Beneath these plump incumbents, though, public firms are fading. Their number has fallen from over 7,000 in 1996 to 4,000. Startups such as Uber and Airbnb have avoided floating their shares and instead raised money through private markets and venture-capital funds. The cash raised by initial public offerings (IPOs) in America in 2016 is likely to be 50-75% less than it was a decade ago.

For mature companies, meanwhile, the private-equity industry has become the owner of choice, as our briefing explains (seeBriefing). Businesses owned by Carlyle, a buy-out firm, are together America’s second-biggest employer after Walmart, with 725,000 staff. A quarter of midsized firms are under private-equity ownership, as are a tenth of large ones. The share of corporate America that is unlisted is likely gradually to rise further, as buy-out funds invest some of their $1.3 trillion of spare cash.

Public firms are in decline for several reasons. Technological change may mean that startups are less capital-intensive, and so are less hungry for money. More worrying, managers grumble that being in the public eye has become a gigantic headache. Listed firms face ever more red tape. Then there is the treadmill of quarterly results—with the ever-present risk that Wall Street will punish even short-term slip-ups.

Politicians see public firms as easy targets. Bernie Sanders has laid into General Electric and Donald Trump has slammed Ford for being too ruthless. Staying in the shadows can lower tax bills. Without the need to report steady quarterly results, firms pile on debt to cut their taxable profits. Private-equity and venture-capital managers use a perk called “carried interest” that lets them pay a low rate of tax on some income.

Although the corporate quest for privacy is understandable, it is regrettable. At their best, stockmarkets are liquid, transparent, cheap for investors to use—so you do not have to be wealthy to own shares. At their worst, the forms of private ownership that are replacing them are illiquid, opaque, expensive and exclusively for the very rich.

Investors in private firms cannot easily sell or value their holdings. That is their choice, but it can be a problem when the economy turns sour and they need to realise cash. Companies’ books are not subject to outside scrutiny. And the pension funds (often government-run) that invest through fiddly private structures are more prone to get bamboozled by fees. There are broader costs to society, too. Chunks of the economy become off-limits for retail investors, giving people less of a stake in capitalism. Already investing in technology startups has become as democratic as owning a ski chalet in Aspen.

Public, for the public:

How can the public firm be saved? It is not up to governments to dictate how firms are owned. But they should not penalise companies for being public. That means abolishing the carried-interest perk, as Hillary Clinton and Mr Trump propose. One of the benefits of phasing out the tax advantages debt enjoys over equity would be to discourage leveraged buy-outs. The extra revenue could be used to slash the corporate-tax rate.

America’s regulators could simplify the rules public firms face, and end the bank cartel that means the fees for an IPO are typically 7%, double the level in other rich countries. Big unlisted firms should publish a basic annual report, as they are already required to in Britain and elsewhere. The cost would be low, and creditors, customers, staff and competitors could get a sense of firms’ financial condition. A competitive, open economy cannot work well if large chunks of it are secret.

Public firms also have work to do. By beefing up their boards, companies can make sure that operational managers are insulated from the short-term demands that some stockmarket investors make, as even autocrats such as Jamie Dimon at JPMorgan Chase, and Warren Buffett have recognised by backing a new code for how American boards should be run.

The public company is a vital cog of capitalism. Ringing the bell at the New York Stock Exchange must become something that entrepreneurs aspire to, not fear and dread

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