The sharp decline in the number of stock market listings is troubling

June 25, 2024

An extraordinary phenomenon has been taking place in the economy since the late 1990s. Fewer and fewer companies are listed, and those that still are, are getting larger and larger. Take Figure 1 for example, it shows that a well-known all-index for US companies, the Wilshire 5000, today doesn't even come close to representing 5000 companies. At the same time as the number of listings is declining, the average market capitalization of listed companies is rising sharply, with currently the most extreme state ever: 5 megacaps now determine about 25% of the market.

Figure 1: The Wilshire Not-Quite-5000

Source: Barron’s

There are several reasons behind both trends. Let's list the four most important ones.

1) 'Private equity is devouring the economy'

One of the most frequently mentioned causes in the media is that private equity and venture capital are playing an increasingly important role in the economy. This is often presented with a negative undertone, as recently in The Atlantic under the title: 'The Secretive Industry Devouring the US Economy'. It is true that private investors are playing a more important role, but this is necessary because banks are withdrawing from financing small and medium-sized businesses.

Fortunately, these smaller companies can still finance themselves privately. Furthermore, private markets offer various advantages to investors. There are potentially higher returns due to illiquidity and complexity premiums. There is less price volatility compared to listed shares. And sustainability can potentially focus much more on the desired impact (see also below). Of course, costs must be taken into account and potentially harmful private equity must be avoided.

2) Increasing regulation deters stock exchange listings

Another reason why smaller companies prefer to seek the shelter of private financing is increased regulations. For example, listed companies must produce increasingly demanding annual reports and be careful about how and when they distribute information. At the same time, they receive less analyst coverage from the increasingly large investment banks. Until twenty years ago, investment banks also continued to follow the companies they listed as analysts. For banks, the benefits, trade, no longer outweigh the costs, thanks to Mifid 2, among others.

3) Advancing corporatocracy

Then we are also dealing with increasingly larger listed companies. Various industries are nowadays ruled by oligopolies and sometimes even monopolies, the Global Titans conquer the world. Thanks to increasingly onerous regulations and the costs of distinctive technologies, the principle of 'winner takes it all' applies, aided by far too weak anti-competition rules, extensive trade agreements, and tax benefits. This gives our society political-philosophical dilemmas, including an unequal playing field between large and small.

4) The disastrous rise of passive investing (at least for market forces and value creation)

The fourth reason why larger companies are 'helped' is passive investing. Particularly when investing in market capitalization-weighted indices, money automatically ends up in the largest companies, and as those companies continue to grow (also due to other causes), they also receive more and more money, and so on. The stock exchange is therefore becoming less and less a place in which market forces are stimulated and analysts try to determine the correct value (for smaller companies), putting pressure on the most efficient allocation of capital in the economy.

Consequences for investors

All this has several consequences for investors. Investors can use private markets to provide a headwind against the increasingly large listed companies, in order to maintain the dynamism of the economy. Furthermore, private markets make it easier to build a portfolio that meets one's own objectives, for example in the field of sustainability. For example, private ESG investing is increasing sharply, as Figure 2 shows. This largely refutes the criticism that private equity has received, namely the non-social focus on profit alone.

Figure 2: More and more private equity is ESG-proof

Source: PWC Market Research Centre, Preqin, FT.

Thirdly, listed investing nowadays has an indirect 'political' message, namely that investing in this way de facto supports larger and powerful companies, i.e. the corporatocracy. The desire for passiveness is understandable because of costs and transparency, but it fits less well with the fiduciary task of investing, at least if it also embraces issues such as diversification, impact and competition. This also means that investors increasingly have to think about what, how much, and why they do and do not do privately and publicly.

This article contains a personal opinion from Harry Geels

 

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