The changing nature of the U.S. listed market

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ritter-jayA topic that has received a lot of attention recently in many markets, especially the United States, is the fall in the number of listed companies, said Jay Ritter, the Joseph Cordell Eminent Scholar in the finance department at the University of Florida, speaking at the Canadian Investment Review‘s 2019 Investment Innovation Conference in November.

Yet, despite a fall in the number of companies listed, the total market capitalization has increased. “The average listed company has gotten bigger in terms of market cap and U.S. market cap is still about half of the world total, even though now only about 10 per cent of the listed companies in the world are U.S. companies,” Ritter said. “Another way of framing that is the average U.S. company is worth 10 times as much as the average listed company elsewhere in the world.”

The drop in U.S. listings since its peak 20 years ago has been, in part, due to a lower number of initial public offerings, Ritter said, and also due to an increased rate of acquisitions and mergers.

Although quantitatively less important, there have also been some companies that have gone private, he said. And, there have been changes in regulation in the U.S. and in technology, which are impacting IPO volume.

Yet, in Ritter’s opinion, the main factor at play is the mergers. There may be two related businesses that can combine to lower their costs or enhance their revenue, increasing economies of scope. “In many industries, there’s an increasing importance of speed and getting big fast is more important than it used to be.”

Technology and globalization have made it more difficult for smaller companies to compete against bigger companies, and in many industries on average, smaller company profitability has declined, Ritter said.

Increasingly, companies are also getting acquired before they go public.

“And that’s the main reason that I think, in a lot of industries, especially the tech industry, there aren’t as many small company IPOs as there used to be; that the successful venture-capital backed companies — instead of going public — instead, they’re selling out to a big tech company.”

Most successful venture-backed companies sell out, Ritter said, and even those that go public are more likely to grow by making acquisitions, than growing organically.

“Now this lack of public companies — the drop in IPO activity — would bother me if I thought that this reflected problems with the IPO market. But there are a couple of reasons why I’m not too concerned about this.”

This includes the reason that returns earned by limited partners on venture capital have not been extremely high. “If their returns were really high, that would lead me to believe that there was a shortage of venture capital — that a lot of start-ups were having difficulty raising money.”

Overall, this decline in IPO activity in the developed market is not a bad thing, Ritter said. “Rather than having lots of independent companies, we’ve got fewer bigger companies. And, I don’t necessarily think this is a bad thing. It could be bad. It could be too extreme, but given that, historically, the small companies have underperformed — the fact that a lot of them are selling out, rather than going public and then producing low returns for investors — doesn’t lead me to think that public market investors are losing out on things.”

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