What If The Decline and Fall of the Stock The Stock Market Market - - PowerPoint PPT Presentation

The Decline and Fall of the Stock Market

Alexander Ljungqvist New York University

What If… The Stock Market Disappears?

The roles of the stock market

+ “Primary” market function: capital formation

– To enable firms to raise equity capital by issuing shares to the investing public, in part by setting and policing listing standards

+ “Secondary” market functions: trading

– To serve as a trading venue for a firm’s shares, thereby providing liquidity to the firm’s shareholders and an opportunity for diversification – To price a firm’s shares, thereby providing market feedback to the firm’s management and aid in efficient capital allocation (price discovery)

Stylized macro facts

• Most U.S. firms are not stock market listed

– Of the 5.7 million U.S. firms in 2010, 3,948 (=0.06%) were public

• This is true even for large U.S. firms

– Among firms with >500 employees, only 13.6% are public

• Privately held firms account for a large part of

economic activity

– 2/3 of jobs, 60% of sales, 50% of investment and profits

• U.S. stock market listed firms rarely raise equity

– Most listed firms never do; those that do, do so every 3-5 years – Listed firms raise more equity capital from employee option exercises than from the stock market – At macro level, the stock market is a net use (not source) of capital

• Stock market listings (and IPOs) have fallen out of

favor in many countries – dramatically so in the U.S.

Number of listed U.S. firms

1997: 7,428 2014: 3,773

Source: Author’s calculations using CRSP data (ordinary common shares only)

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 NASDAQ AMEX (no data pre 1962) NYSE

Net change in listings

• 1,000
• 500

500 1,000 1,500 2,000 2,500 3,000 1 9 2 5 1 9 3 1 9 3 5 1 9 4 1 9 4 5 1 9 5 1 9 5 5 1 9 6 1 9 6 5 1 9 7 1 9 7 5 1 9 8 1 9 8 5 1 9 9 1 9 9 5 2 2 5 2 1

Listings and delistings

• 1,000
• 500

500 1,000 1,500 2,000 2,500 3,000 1 9 2 5 1 9 3 1 9 3 5 1 9 4 1 9 4 5 1 9 5 1 9 5 5 1 9 6 1 9 6 5 1 9 7 1 9 7 5 1 9 8 1 9 8 5 1 9 9 1 9 9 5 2 2 5 2 1 Delistings New listings

Mega IPOs still happen …

• 2. FACEBOOK IPO DATE: 5/18/12 | $ 16 BILLION

Mega IPOs still happen …

• 3. ALIBABA IPO DATE: 9/19/14 | $ 21.8 BILLION

Mega IPOs still happen …

… but smaller IPOs stay away

Source: NASDAQ OMX, April 2013

… as do SMEs

0% 20% 40% 60% 80% 100% 1980-1989 (N=2,041) 1990-1998 (N=3,601) 1999-2000 (N=857) 2001-2014 (N=1,547)

$200m≤sales $100m≤sales<$200m $ 50m≤sales<$100m sales<$ 50m

Source: Author’s calculations using data from Jay Ritter

… and VC exits have shifted to M&A

100 200 300 400 500 600 700

1 9 8 1 9 8 2 1 9 8 4 1 9 8 6 1 9 8 8 1 9 9 1 9 9 2 1 9 9 4 1 9 9 6 1 9 9 8 2 2 2 2 4 2 6 2 8 2 1 2 1 2 2 1 4

Year

• No. of exits

Mergers IPOs

Source: National Venture Capital Association

The “greying” of the U.S. stock market

5 10 15 20 25 30 35 40 45 50 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

46 years 32 years Average age of U.S. listed firms

Source: Heider & Ljungqvist (JFE 2015)

Is this a “first world problem”?

Source: Author’s calculations using data from the World Federation of Exchanges and from national exchanges

UK NYSE Euronext Nasdaq Nordic Germany Italy Russia Greece Switzerland Turkey Spain Norway Cyprus Austria Slovenia Hungary Ireland Luxembourg 2 3

• r

e a r l i e s t 2 1 4

• r

l a t e s t 200 400 600 800 1,000 1,200 1,400 1,600 1,800

Asia looks healthy

Source: Author’s calculations using data from the World Federation of Exchanges and from national exchanges

I n d i a J a p a n C h i n a A u s t r a l i a K

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e a H

• n

g K

• n

g T a i w a n M a l a y s i a T h a i l a n d I n d

• n

e s i a S i n g a p

• r

e V i e t n a m S r i L a n k a P h i l i p p i n e s N e w Z e a l a n d K a z a k h s t a n 2 3

• r

e a r l i e s t 2 1 4

• r

l a t e s t 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

Causes

A shifting cost-benefit trade-off COSTS COSTS BENEFITS BENEFITS

A shifting cost-benefit trade-off

COSTS COSTS

BENEFITS BENEFITS

A shifting cost-benefit trade-off

Increased costs?

• Regulatory burdens

– Sarbanes-Oxley – Dodd-Frank – (various initiatives aimed at reducing regulatory burdens: JOBS Act, JOBS Act 2.0, MiFID II, EU’s “Capital Markets Union”)

• “Onerous” governance rules

– say on pay, pay ratios, clawbacks

• “Expensive distractions” (Ed

Knight, NASDAQ)

– proxy battles with activist shareholders

Reduced benefits?

• Less trading liquidity for

small-caps

– less analyst research – less institutional interest

• Lower risk of involuntarily

becoming “private filer”

• Increased competition from
• ther sources of capital and

trading venues

– equity: crowdfunding (?), superangels, venture capital, growth equity, hedge funds… – debt: “business development companies”, markets for “Mittelstand bonds” – alternative liquidity platforms

Consequences: What if … the stock market disappears?

Where are we headed?

Source: Author’s calculations using CRSP data (ordinary common shares only)

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

NASDAQ AMEX (no data pre 1962) NYSE

Caveat

“Prediction is very difficult, especially if it's about the future.” Nils Bohr, Nobel laureate in physics

A tongue-in-cheek prediction

Source: Author’s calculations using CRSP data (ordinary common shares only)

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

NASDAQ AMEX (no data pre 1962) NYSE

A tongue-in-cheek prediction

Source: Author’s calculations using CRSP data (ordinary common shares only) 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 NASDAQ AMEX (no data pre 1962) NYSE

Caveat

“Prophesy is a good line of business, but it is full of risks.” Mark Twain

Consequences

• If growth companies turn their backs on the public equity

markets – is that necessarily such a bad thing?

– Probably bad for the exchanges

• reduced revenue from listing fees
• if the primary market dies, can the secondary market survive?

– But innovation disrupting businesses is nothing new – What is lost to the economy?

• 1. Unlisted firms have a higher cost of capital, which impacts

investment, innovation, growth, job creation … – but the cost-of-capital gap may be shrinking

• 2. “Ordinary” investors miss out on the opportunity to participate

in the wealth created by growth companies – wealth inequality may widen – public support for shareholder capitalism could decline

Origins of shareholder capitalism

The Gilded Age 1870s-1900

At the dawn of the industrial age, the U.S. experienced

– corporate consolidation (the “trusts”) – financial volatility (frequent “panics”) – widening income and wealth inequality – surging immigration – and class conflict

The Progressive Era 1900-1917

“War Loans raised the profile of the small investor in the political landscape: Policymakers should consider investors’ interests paramount when gauging the possible economic impact of policy proposals.” J.C. Ott (2007)

A brief moment of social democracy

“At war’s end, many Americans anticipated that widespread federal bond ownership would justify greater state interventions in the economy. Neither robust securities market regulation, nationalized enterprise, nor the welfare state was understood to be fundamentally inconsistent with the ideal of a mass investment society. “The War Loans raised expectations for new institutions, laws, and policies to support and to protect citizen-investors, even in their private corporate investments.”

Capital fights back

The “New Proprietorship”

• “Corporations and financial institutions took

deliberate steps to promote … stock

• wnership. … Shares of corporate stock

would convey an economic-political stake more effectively than federal bonds.

• “Universal investment would reconcile

corporate capitalism with … democracy … under the banner of ‘investor democracy.’

• “Corporations and financial institutions ...

marketed securities to retail investors in the hopes of nurturing political affinities and shaping political culture.

• “Led by AT&T, hundreds of corporations

instituted employee and customer stock

• wnership plans in the early 1920s. ESOPs

served as a counteroffensive against unionization, while COPs sought to repel … regulatory action.

The Roaring Twenties

• These efforts didn’t quite turn “every worker

into a capitalist”, but they reduced the allure of “radical ideas” such as the welfare state

• Instead, investor democracy gave citizens a

stake in preserving and extending business- friendly policies

• By the late 1920s, more than 20 million

Americans had purchased a war bond and around 10 million owned shares in publicly traded corporations – out of a voting age population of around 70 million

What if the process goes into reverse?

1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 1 9 2 5 1 9 3 1 9 3 5 1 9 4 1 9 4 5 1 9 5 1 9 5 5 1 9 6 1 9 6 5 1 9 7 1 9 7 5 1 9 8 1 9 8 5 1 9 9 1 9 9 5 2 2 5 2 1

0.05 0.1 0.15 0.2 0.25 0.3

Stock market participation

A model of a shrinking stock market

• Consider an economy consisting of

– N firms (some public, some private) – 3 social classes

• entrepreneurs (who create and own private firms)
• the middle class (who work for wages and own

shares in public firms)

• workers (who work for wages but own no shares)

– A private equity investor who can delist firms – 2 political parties

• left-wing party (caters to workers)
• right-wing party (caters to entrepreneurs)

A model of a shrinking stock market

Timing 1.Delistings take place – PE firm and middle class bargain over buyout price 2.Elections take place – middle-class voters decide election outcome 3.The government sets policy to be more or less business friendly to suit its core constituency – e.g. making it harder or easier for unions to call strikes 4.Firms invest taking into account business policy

A model of a shrinking stock market

In equilibrium… 1.Delistings are privately optimal for the PE firm and the middle class 2.If delistings reach the point where they affect middle- class voting behavior, they impose externalities on workers (+) and entrepreneurs (-) 3.Aggregate investment, profits, and share prices in the economy then fall. The economic pie shrinks, redistribution increases. 4.These outcomes are more likely – when it’s easy to delist firms – when the benefits of remaining listed fall – when investors hold concentrated portfolios – when the stock market has shrunk

Consequences: Might something be gained as well?

Short-termism vs. patient capital

Two notable concerns (among others)

• 1. Quarterly reporting cycle may encourage excessive

focus on short term results, at the expense of long term wealth creation

– Graham, Harvey, and Rajgopal: “The majority of [US] managers would avoid initiating a positive NPV project if it meant falling short of the current quarter’s consensus earnings [forecasts].”

• 2. Disclosure requirements may hinder a firm’s ability to

build support for a change in corporate or financial strategy

– how easy is it for a public firm to cut the dividend to finance a profitable investment opportunity, without a) panicking investors and b) revealing too much sensitive information to competitors?

• Attractions of private ownership:

– more “patient” capital – more “private” dialogue with shareholders

SOURCE: “Stock market listing and corporate investment: A puzzle?”, Asker, Farre-Mensa & Ljungqvist, Review of Financial Studies 2015 McKinsey & Company | 1

Take-aways

The changing role of the stock market (in the U.S.)

• Dramatic decline in the demand for listing services:

companies increasingly don’t use the stock market to fund investment and growth

• In fact, more capital formation among private firms in

the U.S., despite their cost of capital disadvantage Does it matter?

• Stock market still the most efficient way to supply

capital to growth companies – but the gap may narrow, eroding the stock market’s competitive advantage

• A shrinking stock market may undermine hard-won

support for business-friendly policies

• Difficult for ‘ordinary’ investors to participate in wealth

created by privately held firms

• But private firms may have advantages: more patient

capital and better long-term investment incentives