In 40 years through 2019, the S&P 500 Index had a total return of 11.8 percent.
We now examine three considerations that are relevant for the multi-decade shift from public to private firms, as well as the composition of the firms that remain public.
The first is the rise of intangible assets. Paul Romer, an economist who won the Nobel Prize in Economics in 2018 for his work on endogenous growth theory, poses a basic question:
“How can it be that we’re wealthier today than people were 100 years ago?”
The underlying quantity of raw materials has not changed over time.
The answer is we can now arrange resources in ways that are more valuable than before.
Traditional models of economic growth are based on inputs of capital and labor and treat technology as exogenous. Robert Solow, also a Nobel Laureate, created a model that made technology endogenous. Romer’s contribution was to make technology “partially excludable,” or a private good.
This allows firms to benefit from their investments. Romer emphasizes the importance of intangible assets, including instructions, formulas, recipes, and methods of doing things. He argues that “growth takes place when companies and individuals discover and implement these formulas and recipes.”
What’s important is that these intangible assets have characteristics that are different from physical capital or labor. Economists call them “non-rival” goods, which means that more than one person can use the good at a time. A physical book is a rival good that only one person can read at a time. A digital book is a non-rival good that can be read by many simultaneously. Under certain conditions, intangible-based companies can defy the conventional economic concept of diminishing marginal returns and in fact realize increasing returns.
This shift has a few implications for our discussion. To begin, companies need less capital because they need fewer physical assets. For example, sales per employee for Facebook, Inc. were nearly double those of Ford Motor Company in 2019. From 1956 to 1976 the number of public companies grew fivefold, as many companies needed to finance “their mass production and mass distribution.”
Today, companies simply do not require as much capital as they once did. This, along with freer access to private capital, allows private companies to remain private longer.
Second, implication is that the rate of change, which we can measure by longevity, appears to be speeding up. The idea is that if longevity is decreasing, the rate of change is increasing. About 1,500 companies went public during the 1970s, 3,000 in the 1980s, 3,900 in the 1990s, and 2,100 in the 2000s. Companies that had listed before 1970 had a 92 percent probability of surviving the next five years, and those listed in the 2000s had a probability of only 63 percent. The chance of survival has dropped in each successive decade.
Third, the main reason companies delist is that they are acquired. This contributes to the last implication. In corporate America, the strong are getting stronger. This is giving rise to “superstar” firms.
For example, the gap in return on invested capital between a U.S. company in the top 10 percent and the median has risen sharply in recent decades.52 Consolidation explains a large part of this. Measures of concentration, such as the Herfindahl-Hirschman Index, have shown a substantial increase for many industries since the mid-1990s. These include industries that rely on tangible assets.
M&A is by far the leading explanation for delisting.
First, the companies that are public now are on average much larger and older than companies in the past. Vibrant M&A has led to more concentration in most industries, and a handful of very large technology companies have attained strong market positions. As a result of where they are in the industry lifecycle and the profitability they enjoy, listed companies also have a high proclivity to
pay out capital.
Following the introduction of a safe harbor provision for buying back stock in 1982, the preferred means to return capital to shareholders has shifted from dividends to share buybacks. Second, buyout and venture capital funds have not included many Main Street investors. This could change with the Department of Labor’s instruction letter, written in 2020, that may allow private equity as an option for defined contribution plans.
Finally, there has been a large shift away from actively-managed equity funds to funds that track indexes or are rules-based.