There is a puzzling contradiction at the heart of America’s economy. Investors are sinking more and more money into the stock market. Indexes are reaching record highs. But a growing number of American companies are refusing to participate in public markets at all.
Over the past 30 years, the number of companies that sell shares on markets such as the New York Stock Exchange and Nasdaq has fallen by roughly 50 percent. Fast-growing big-name companies like Anthropic, SpaceX, Databricks and Anduril — companies that in all likelihood would have gone public in the previous decade — are choosing to remain private instead.
The impact can be felt in every corner of our economy. The decline of our public markets goes hand in hand with the meteoric rise of private equity, which too often weakens companies and leaves them less committed to their employees, customers, suppliers, lenders and communities. Most everyday investors can no longer buy into some of the country’s fastest-growing businesses. The stock market’s impressive performance, on which so many retirements depend, is growing increasingly tenuous, as its returns rely on an increasingly narrow slice of the economy. Innovation is declining. Economic concentration is increasing.
I have spent more than a decade trying to understand what is going on, and I have come to believe that the culprit is public company governance, the system in which many different groups, all pursuing their own agendas, generate rules for how public companies ought to be managed. These rules, norms and regulations — which tackle such issues as who gets to be a director, how executives should be paid, in what ways companies ought to respond to climate change — are constantly accruing and building on one another until this obscure process generates towering structures that, like a great coral reef, can tear out the bottom of a boat.
These governance practices are often well intentioned, but there is no evidence that they are meeting their goals. In some cases they make no difference, and in others they make things worse, but none appear to work reliably. This coral reef provides no support for aquatic life; it exists only as a navigational hazard for shipping.
To understand what’s happening, let’s discuss a fictional, fast-growing tech company called Ontology. It’s the sort of company that every country in the world wants and America produces in relative abundance. Around five years after their initial investment, Ontology’s investors want their money back. Managers could sell Ontology to a larger competitor (often these days a large tech company) or to a private investor (often a private equity fund). The other option is to list Ontology’s shares on a public stock exchange.
Selling to Big Tech may be lucrative for Ontology’s managers and their shareholders, but for innovation and productivity as a whole, this is probably bad news. Researchers found that up to 7.4 percent of acquisitions in the pharmaceutical industry involved a company buying a rival developing a new product and then killing that product. Little wonder that the trend away from public markets has coincided with a decline in innovation and an increase in the level of concentration in more than 75 percent of U.S. industries.
The second option is to sell to a private equity fund, but like the original investors, the fund will also want to get its money out in five to seven years. The resulting damage has been well chronicled; two recent books about private equity’s track record contain “plunder” in their titles. Yet in the past five years, private equity has grown seven times as large and now manages over $3 trillion in assets. There are now globally 25 times as many companies owned by private equity and venture capital firms as exist in the public markets.
The final option is to take Ontology public. For most of the past century, this was the default decision. But companies are no longer acting as if public markets are desirable. From 2000 to 2020, only about 10 percent of a thousand successful venture-capital-backed companies chose to go public.
This decline occurred at a time when America’s population, economy and pool of venture-capital-backed companies have grown significantly. Why?
If you talk to entrepreneurs, you get a consistent response: America has made it miserable to be a public company. They say public companies are hemmed in by a welter of dysfunctional opinions and rules set by outsiders who have only a passing acquaintance with what they do.
The origins of our changes to public markets lie in the febrile atmosphere of the 1970s, a time of understandable cynicism and distrust about the traditional leaders of America’s institutions. At the time, two scholars published a paper arguing that the main goal of corporate governance should be to prevent business managers from advancing their own interests.
The result was a flood of rules, regulations, legislation and voting policies. Activists began targeting companies for any deviations from conventional wisdom. Formerly routine votes on directors could be used to impose business strategies or new board processes on companies. The movement also birthed an industry of advisory firms whose entire business is recommending to large shareholders how to vote on a growing number of matters. Empowered by shareholders, the advisory firms began creating increasingly detailed rules for running public corporations. The largest voting advisory firm, Institutional Shareholder Services, now evaluates companies based on their adherence to up to 200 managerial, strategic and compensation practices.
The trend in the growth of the rules that govern the management of public companies almost perfectly matches the decline in initial public offerings in America. Similar expansions occurred, for the same reasons and at the same time, in public markets as disparate as those of Canada, Britain, Australia and Germany. All of those countries have seen similar declines in their public markets.
If this system of rules worked, we wouldn’t necessarily care whether managers liked it. But hundreds of empirical studies found that these changes have been ineffective and occasionally counterproductive.
Take the notion that installing a board of directors from outside the company’s management team will improve corporate performance. Studies looking at the entire corpus of research on the topic have repeatedly found there is no detectable connection between the number of independent directors and corporate performance. In fact, since America began installing independent directors on boards, the list of corporate scandals has only swelled — for example, Enron, Wells Fargo and the companies behind the 2008 financial crisis. These companies had one thing in common: boards full of independent directors who didn’t know what was happening in the company except what management told them.
Or take our tragicomic experiments with executive pay. Forty years ago, boards set pay themselves. After World War II, executive compensation stayed essentially flat for 30 to 40 years. Then the S.E.C. gradually began ratcheting up pay disclosure requirements, and Congress joined in with various tax and legislative schemes. Institutional shareholders and their advisers began insisting on increasingly recondite pay rules.
The most important thing those changes to executive pay have done is lead American companies to pay their executives far more than they used to. David Zaslav, the chief executive of Warner Bros. Discovery, was paid $52 million last year, even after presiding over a stock price that declined 60 percent over the previous three years.
Congress could fix most of the mess with legislation, but the checkered history of congressional action in this area (many of the worst features of our public markets were introduced by federal legislators) suggests that the S.E.C. and private forces are the most likely sources of solutions.
The recommendations could be as detailed and as numerous as the rules themselves. But generally we need to stop imposing — and ideally start reversing — these one-size-fits-all governance practices on public companies. We need to stop trying to interfere with the managers of our country’s largest and most promising companies. Generally, these companies are embedded in tough, competitive markets that don’t afford managers with much slack to ignore the bottom line. We also need to question whether third parties that spend very little time immersed in a company’s markets and unique circumstances should be driving the boat.
Bryce C. Tingle is a business law professor at the University of Calgary and the author of “Hard Lessons in Corporate Governance.”
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