The views expressed are

the personal views of

the presenter and do

not reflect those of

the PCAOB, members of

the Board, or the

PCAOB staff.

The Decline of the

Public Company Elisabeth de Fontenay

Duke University School of Law

December 7, 2017

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Changing Public Equities Characteristics of U.S. Stock Market

1976 1996 2016

Number of publicly listed companies

4,796 7,322 3,671

Average market capitalization (in 2016 USD millions)

$620 $1,683 $6,893

Average age of a listed company (years)

10.9 12.2 18.4

Average individual direct ownership

50.0% 27.2% 21.5%

Source: Credit Suisse, The Incredible Shrinking Universe of Stocks (2017)

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Explanations for the decline?

• Supply-side:

• 1) Increasing regulatory costs (e.g., Sarbanes-Oxley)

• BUT recent empirical work rejects this hypothesis…

• 2) Deregulation of private capital

• Today, private companies get the benefits of going public, without bearing any of the costs

• 3) Founder/manager preferences

• Perception of more challenging manager-investor environment in the public markets: Shareholder litigation; activism; short sellers; “short-termism,” etc.

• 4) Changes in the product market, requiring small companies to achieve scale faster (Gao, Ritter & Zhu, 2013)

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Explanations for the decline? (cont.)

• Demand-side:

• 1) Liquidity barriers for smaller public companies (decimalization, tick size, regulation of research analysts)

• 2) Mutual-fund preferences for liquidity (Bartlett et al., 2016)

• Funds have gotten larger; concentrate on larger-cap equities

• Indexing

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U.S. Securities-Law Landmarks

• Regulation:

• Securities Act of 1933; Securities Exchange Act of 1934

• 1964 amendments

• Sarbanes-Oxley (2002)

• Dodd-Frank (2010)

• …And deregulation:

• Reg. D (1982)

• Rule 144A (1990)

• 3(c)(7) of Investment Company Act of 1940 (1996)

• JOBS Act (2012)

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Costs and Benefits of Going Public

• Costs: • Regulatory costs (mandatory disclosure; proxy rules; etc.)

• Separation of ownership and control (management agency costs)

• [Shareholder litigation and shareholder activism?]

• Third-party free-riding on disclosure and trading prices

• Benefits: • Access to cheaper capital (historically)

• Liquid stock for management compensation and acquisitions

• Publicity / Reputation

• Simpler capital structure

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HISTORICALLY

• Public companies

• Access to cheap capital

• Disclosure burden

• Private companies

• Very limited access to capital

• No disclosure burden

TODAY

• Public companies

• Don’t need more equity capital

• Still bear disclosure burden

• Private companies

• Dramatically fewer restrictions on capital raising Much cheaper

• No disclosure burden

Public-Private Divide in U.S. Securities Regulation

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Explosion of Private Capital in U.S.

• Private-company financing and M&A

• PE and VC; mutual funds investing in private firms

• Increased industry concentration

• Private debt

• Secondary trading of private-company equity

• NASDAQ Private Market

• SharesPost

• Global glut of capital

• Asset-lite economy?

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The Unicorn Stampede Rank Firm Latest

Valuation

1 Uber $68 billion

2 Airbnb $30 billion

3 Palantir $20 billion

4 WeWork $20 billion

5 Meituan-Dianping $18.3 billion

6 Flipkart $15 billion

7 SpaceX $12 billion

8 Pinterest $11 billion

9 Dropbox $10 billion

10 Spotify $8.5 billion

Rank Firm Latest Valuation

11 Stemcentrx $5 billion

12 Cloudera $4.1 billion

13 Social Finance $4 billion

14 Intarcia $3.7 billion

15 Tanium $3.5 billion

16 Docusign $3 billion

17 Legendary Entertainment $3 billion

18 Moderna $3 billion

19 Oscar $2.7 billion

20 Houzz $2.3 billion

Source: Austin et al., “The Startup Stock Tracker,” WSJ, http://graphics.wsj.com/tech-startup-stocks-to-watch/ (last visited, Oct. 18, 2017)

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Convergence of public and private capital • Cost of capital

• Size of firms; number of shareholders

• Institutional ownership

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Should we be concerned about the decline in IPOs? • Growth and jobs (Weild and Kim, 2009)

• Attractiveness of U.S. capital markets

• Unequal access to investable assets

• Impact on information / price discovery

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Source: Credit Suisse, The Incredible Shrinking Universe of Stocks (2017)

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Third-Party Effects of Public-Company Disclosure • Why don’t firms voluntarily disclose the “right” amount of information?

• Management agency costs

• Managers do not want to reveal poor performance or self-dealing

• Third-party effects (externalities)

• A firm’s information is useful to competitors, other firms’ investors, regulators, and society in general, but the firm is not compensated for these uses

• Other (coordination, credibility, etc.)

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Disclosure in Private Companies

• Characteristics:

• Wide variation

• Unevenly distributed to investors

• Very rarely made public

• Exception: firm issues high-yield debt and voluntarily filing

• Contracting for information:

• Easier for debtholders than equityholders

• Rational free-riding on public-company information

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Potential solutions (and their drawbacks) • 1) Re-regulating private capital

• 2) Reducing the gap in disclosure obligations between public and private companies

• 3) Forcing more companies to go public based on size

• 4) Increasing other incentives to go public • Remember importance of managerial preferences

• Managers… • Like dual-class stock

• Dislike public-interested disclosures (pay ratio, conflict minerals, mine safety)

• Dislike shareholder litigation, etc.

Difficult tradeoffs…

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