Capitalism’s Quiet Revolution: How Private Equity’s Rise is Rewriting America’s Corporate Landscape.
The landscape of American capitalism is undergoing a profound transformation, veering away from publicly traded enterprises towards the cloistered realm of private equity (PE). A disconcerting narrative by Morgan Stanley unfolds as data reveals a stark decline in publicly traded companies within the United States. At its zenith in 1996, the stock exchanges boasted 7,300 entities; today, that figure has dwindled to a mere 4,300, indicative of a tectonic shift in corporate governance dynamics.
The genesis of this seismic transition finds its roots in the ascendancy of private equity juggernauts, entities endowed with the financial prowess to orchestrate the conversion of public entities into their private fiefdoms. The ethos of expeditious profit maximization permeates their modus operandi, often to the detriment of the broader market’s transparency and investor confidence.
A striking critique of this trend arises from within Corporate America, as data reveals a remarkable surge in the proliferation of private entities supported by private equity (PE) firms. According to JP Morgan, over the past two decades, the number of these covert enterprises has surged from a mere 1,900 to an astounding 11,200, signaling a dominance that surpasses public scrutiny.
The ramifications are manifold and profound. Publicly listed companies, nestled within the purview of regulatory oversight and disclosure requirements, are the bulwarks of transparency and investor trust.
The decline of publicly traded companies in the United States carries several long-term consequences:
Reduced Market Transparency.
With fewer publicly traded companies, there may be a decrease in available information for investors, leading to reduced market disclosure. This could undermine investor confidence and increase market volatility.
 clear Example is the Theranos scandal, where a company raised $ 724 billion based on promises of revolutionary blood-testing technology that later proved fraudulent, serves as a stark reminder of the risks inherent in diminished market transparency. Despite operating privately, Theranos evaded stricter disclosure requirements, limiting access to critical information for investors (who poured in $724 million at a valuation of $ 10 billion) and regulators.
The lack of strong openness mechanisms, such as independent audits and public disclosure of clinical trial data, allowed Theranos to obscure crucial details regarding the efficacy and reliability of its technology, potentially putting patients at risk of misdiagnosis due to inaccurate test results. As doubts mounted, investor's confidence wavered, contributing to heightened uncertainty and apprehension. With inadequate access to comprehensive and trustworthy information, investors became susceptible to misinformation and manipulation.
The Theranos debacle highlights the pivotal role of transparency and accountability in fostering shareholder confidence and upholding market integrity. Regardless of a company’s status, stringent regulatory oversight and transparent governance practices are imperative. In response, regulators and industry stakeholders must redouble their efforts to implement and enforce powerful disclosure measures, such as independent audits and public disclosure of clinical trial data. Upholding the highest standards of corporate governance is essential to mitigate the risks associated with information asymmetry and safeguard the interests of investors and the broader market.
Impact on Capital Formation.
Public markets historically have been a critical source of capital for companies, particularly for startups and smaller firms looking to expand. A decline in publicly listed companies could limit access to capital, potentially stifling innovation and economic growth.
An unmistakable illustration is the bankruptcy of Argo AI. This AI’s story serves as a compelling example of the importance of public markets in facilitating capital formation and fostering innovation. Founded in 2016, this leader in autonomous vehicle technology relied on substantial investments to drive its research, development, and expansion efforts.
A crucial initial investment of $1 billion from Ford in 2017 provided Argo AI with the lifeblood to accelerate technological advancements and expand operations. Subsequent funding rounds through strategic partnerships and venture capital injections continued to propel the company forward.
However, Argo AI’s decision to remain private limited its access to capital compared to publicly traded counterparts. Public companies can tap into a much broader pool of institutional and retail investors through Initial Public Offerings (IPOs). This influx of capital can be immense. Consider Tesla, a publicly traded leader in the electric vehicle (EV) space, which raised over $5 billion through a secondary offering in 2023. This war chest allows for aggressive R&D investments and rapid scaling, potentially giving them a significant edge in the competitive EV market.
While Argo AI has secured funding through private investments, including a recent $2.6 billion infusion from Volkswagen Group in 2019, remaining private might have ultimately hindered its ability to compete with well-funded public rivals. Public markets provide access to a vast pool of capital, allowing companies like Tesla to potentially outpace private competitors in terms of investment and innovation. This can be crucial in a rapidly evolving field like autonomous vehicles, where significant resources are required for testing, development, and deployment.
The recent news of Argo AI being wound down by its parent companies, Ford and Volkswagen, in October 2022 adds another layer to the conversation. While the reasons for this decision are complex, limited access to capital through public markets might have played a role.
The Argo AI case underscores the critical role public markets play in fostering innovation. A decline in publicly traded companies could limit access to capital for startups and innovative firms, potentially stifling progress in emerging industries and impacting economic growth. The ease with which companies like Tesla can raise billions through public offerings stands in stark contrast to the funding limitations faced by private companies like Argo AI in this capital-intensive field. As the landscape of public listings evolves, ensuring access to capital for innovative companies will be crucial for continued progress across various sectors.
Loss of Investor Opportunities.
Open companies offer retail investors the opportunity to participate in the growth of various industries and companies. A decline in publicly traded companies could limit investment options for individual backers, potentially concentrating wealth among institutional financiers and high-net-worth individuals.
A notable signal is Beyond Meat’s debut on the public markets. Beyond Meat Inc., a prominent player in the plant-based meat substitute industry, serves as a compelling example that emphasizes the loss of investor opportunities resulting from a decline in publicly traded companies. Following its initial public offering (IPO) in May 2019, Beyond Meat became a publicly traded company listed on the NASDAQ stock exchange.
Through its public listing, Beyond Meat provided retail investors with the opportunity to participate in the growth of the plant-based food industry and the company’s innovative products. Retail investors, with a starting IPO price of $25 per share, were able to purchase Beyond Meat shares through brokerage accounts, investment platforms, and public exchanges. This allowed them to diversify their investment portfolios and gain exposure to the rapidly evolving food industry.
Imagine the scenario if Beyond Meat had remained a privately held company. Retail investors would have been deprived of the opportunity to invest directly in its success. The company’s decision to go public democratized access to its stock, expanding investment opportunities for individual investors. This empowered them to capitalize on the growing demand for plant-based alternatives and potentially benefit from Beyond Meat’s future growth prospects.
By offering shares to the public, Beyond Meat didn’t just grant access to its stock; it allowed retail investors to share in the company’s success alongside institutional investors and high-net-worth individuals. The IPO, priced at $25 per share, made Beyond Meat accessible to a wide range of investors. This accessibility fueled significant retail investor interest, pushing the share price to a high of nearly $230 within a year — a staggering 920% increase. This demonstrates the potential rewards retail investors can reap from public listings.
Publicly traded companies like Beyond Meat provide retail investors with opportunities to participate in the growth of various industries and companies, fostering wealth creation and financial inclusion in the investment landscape. Public markets offer more than just stock purchases; they offer investment flexibility by allowing individuals to diversify their portfolios beyond traditional assets. Public listings also provide exposure to innovation, enabling retail investors to participate in groundbreaking trends like the plant-based food revolution.
The case of Beyond Meat highlights the stark contrast between public and private markets. If Beyond Meat remained private, retail investors would have been excluded from the potential gains witnessed during the IPO surge. Private companies typically offer investment opportunities only to accredited investors, concentrating investment opportunities and wealth creation among high-net-worth individuals and institutions.
Beyond Meat’s journey highlights the importance of public markets for retail investors. Public listings provide opportunities to participate in the growth of innovative sectors, diversify portfolios manage risk, and potentially achieve significant returns. A decline in publicly traded companies could restrict these benefits, potentially widening the wealth gap and hindering financial inclusion for ordinary citizens.
Regulatory Challenges.
Publicly traded companies are subject to rigorous regulatory oversight, including disclosure requirements and corporate governance standards. A decline in publicly traded companies could reduce the effectiveness of regulatory oversight, making it more challenging to detect and prevent corporate misconduct and fraud.
Publicly traded companies operate under a constant gaze, subject to rigorous regulatory oversight. Disclosure requirements and corporate governance standards are crucial safeguards against corporate misconduct and fraud. However, a decline in publicly traded companies could create a breeding ground for such issues, as exemplified by the recent downfall of FTX and its founder, Sam Bankman-Fried.
FTX, a major player in the cryptocurrency exchange market, thrived largely as a private company. This lack of public scrutiny may have been a contributing factor to the alleged financial improprieties that ultimately led to its collapse. Unlike publicly traded companies, FTX wasn’t obligated to disclose detailed financial information or adhere to stringent accounting practices. This opacity potentially concealed risky activities and questionable financial decisions. Public companies, on the other hand, face pressure from public shareholders and independent boards, fostering a culture of transparency and discouraging risky behavior. Additionally, regulators have greater oversight authority over public companies, making it easier to detect potential wrongdoing.
FTX, operating in a regulatory grey area as a private entity, might have escaped this scrutiny. The FTX fiasco serves as a stark reminder of the importance of robust regulatory oversight for protecting investors and maintaining market integrity. While regulations can be seen as a burden, they play a vital role in preventing financial scandals like FTX.
A decline in publicly traded companies, with a shift towards more private entities like FTX, could create a landscape ripe for exploitation. Weakened regulatory oversight could make it more difficult to identify and address potential misconduct, potentially leading to more FTX-like situations and eroding investor confidence in the industry. Public markets, with their emphasis on transparency and accountability, act as a shield against such dangers.
To reform the private equity sector and ensure greater transparency and accountability in corporate governance, several measures could be considered:
1. Enhanced Disclosure Requirements.
Regulators could impose stricter disclosure requirements on private equity firms, requiring them to provide more information about their investment strategies, portfolio companies, and financial performance. This would increase transparency and help investors make more informed decisions.
2. Improved Corporate Governance Practices.
Private equity firms could be encouraged or required to adopt corporate governance best practices, such as independent board oversight, executive compensation guidelines, and shareholder engagement policies. This would help mitigate conflicts of interest and ensure that the interests of investors are aligned with those of portfolio companies.
3. Increased Regulatory Oversight
Regulators could strengthen their oversight of the private equity industry, conducting regular examinations and audits to monitor compliance with securities laws and regulations. This would help detect and prevent fraudulent or abusive practices and hold private equity firms accountable for their actions.
4. Enhanced Investor Protections.
Regulators could implement measures to enhance investor protections in the private equity industry, such as requiring private equity firms to provide more robust disclosure to investors and imposing restrictions on certain high-risk investment strategies. This would help safeguard investor interests and reduce the potential for investor harm.
In addressing the rise of private equity dominance and protecting the interests of investors and the broader market, regulators play a crucial role. They have the authority to enact and enforce regulations that promote market integrity, transparency, and investor protection. By implementing measures to reform the private equity industry and enhance regulatory oversight, regulators can help mitigate the risks associated with private equity dominance and ensure a fair and orderly market for all participants.
However, as the gravitational pull of private equity intensifies, this foundation of accountability wanes, casting a pall over the very fabric of economic transparency.
Furthermore, the shadow of quarterly earnings looms large, exerting insidious pressure on boardroom dynamics. the relentless pursuit of short-term gains fosters a narrow corporate ethos, where fiduciary responsibilities yield to the pressure of quarterly performance metrics, consequently, the integrity of corporate governance is compromised, as companies resort to accounting legerdemain and short-term stratagems to appease the capricious demands of the market.
A collateral casualty in this epochal upheaval is the sanctity of shareholder activism. Once celebrated as the forefront of market oversight reform, shareholder activism now finds itself under siege by a perception of triviality, its effectiveness eroded by the discord of conflicting interests prevalent in annual shareholder gatherings and boardrooms.
Furthermore, the rise of proxy advisers as authorities on corporate governance signal a concerning convergence of interests. The dominance of Institutional Shareholder Services (ISS) and Glass Lewis, operating under foreign ownership, exerts significant influence over institutional investors, raising doubts about the integrity of American boardroom leadership.
In the realm of private equity dominance, the allure of remaining private blossoms overshadows the once-attractive option of public listing. Fueled by a history of substantial returns, private equity investments emerge as the primary destination for capital deployment, pushing public markets to the sidelines of investor preference.
As the influence of private equity strengthens, calls for reform intensify. Neglecting to address this trend undermines the fundamental principles of American capitalism, eroding transparency and accountability. Urgent action is imperative; without swift implementation of changes, the cherished institution of public markets faces oblivion, endangering the foundation of economic prosperity.
https://reports.jpmorganchase.com/investor-relations/2023/ar-ceo-letters.htm
https://www.wsj.com/articles/theranos-has-struggled-with-blood-tests-1444881901
https://www.coindesk.com/layer2/2022/11/30/ftxs-collapse-was-a-crime-not-an-accident/
https://www3.weforum.org/docs/WEF_Private_Equity_Industry_2022.pdf
https://www.glasslewis.com/the-role-of-proxy-advisory-firms/
