Wednesday, May 23, 2012

Going Public

The public company club is an elite group. By listing its stock on NASDAQ, Facebook is now a member. The irony is that the website, with its mammoth share flotation, has joined the party at a time when the appeal of “going public” is waning considerably. By allowing companies to raise huge amounts of capital for expansion, the public company has, since the middle of the 19th century, been a basic building block of capitalism. And, to some extent, this still holds true. The statistics on IPOs in America, however, are telling: since the late 90s, the number of companies debuting stock on a public exchange has fallen precipitously (by about 38%). There are a number of reasons for the drop, but none more important than the introduction of the Sarbanes-Oxley Act of 2002. Written and implemented in response to the scandals at Enron, Worldcom and other U.S. listed companies, Sarbanes was intended to hold officers more responsible for their actions and to ensure that public companies had an adequate internal audit system in place. But the costs to meet the mandates of Sarbanes have been a headache for small and large companies alike.

The structure of public companies has, over the last few years, become a great concern for stockholders. While shareholders are supposed to monitor management decision making, the often splintered array of owners sometimes means that management is not punished for making poor choices on strategy. The granting of stock options (which was supposed to rectify this flaw by motivating managers to act in the best interests of the company) created a situation that rewarded managers who used fraud to pump up the company’s stock price.

Before listing stock, the pressure of market insistence on short-term profitability must also be considered. It’s no secret that public companies have a hard time generating breathing room for themselves as they invest in long-term projects. It you want a concrete example of this, look no further than the battle waged over the last number of years at Amazon between Jeff Bezos and investors.

The decline in IPOs is not only due to public companies becoming less attractive, but also because other corporate forms are starting to make more and more sense. Consider one of the main benefits of corporations: limited liability. Because of industry lobbying and government action, it is now easier than ever to set up limited liability partnerships. Partnerships also benefit from the fact that income passes directly to its owners and not through the corporate/dividend tax filter. Private equity firms, like Bain Capital, have also increased in number over the last number of years as global liquidity has become more fluid. (But the inevitable rise in interest rates over the next few years might make it harder and more expensive to raise capital privately than on the open market.)

Public companies are most definitely not going to disappear. What can be said, however, is that it can no longer be taken for granted that every hot, new company will be clamoring for their own ticker symbol.
- Read more about it here: The Economist