“In 1976, the United States had 4,943 firms listed on exchanges. By 2016, it had only 3,627 firms. From 1976 to 2016, the U.S. population increased from 219 million to 324 million, so the U.S. went from 23 listed firms per million inhabitants to 11.” This is the opening salvo of a new report from the National Bureau of Economic Research (NBER) penned by Professor René Stulz, the Everett D. Reese Chair of Banking and Monetary Economics and director of the Dice Center for Research in Financial Economics at The Ohio State University. In the report, The Shrinking Universe of Public Firms: Facts, Causes, and Consequences, Professor Stulz looks at the shift in public stock markets and its larger impact on the economy.

The peak in the number of public listings in the stock market was in 1997; the market has seen a decrease in public companies every year since, except 2013. Stulz points out that mergers are the primary contributor to the number of companies delisting from the public stock market. In the report, Stulz takes a deeper look at the makeup of the companies comprising the public stock market, and comes up with some startling data. Not only has the public stock market been shrinking, but it has been changing substantially also.

CRSP: Center for Research in Security Prices

The companies in the public stock market have become markedly older and larger, with smaller and younger firms largely staying out of the public exchanges. A few of Stulz’ key findings include:

• The fraction of listed firms with assets of less than $100 million (in 2015 dollars) were 61.5% in 1975, down to 43.9% in 1995, and only 22.6% in 2015!
• The average market cap and median market cap (accounting for inflation) increased by a factor of 10 from 1975 to 2015.
• At the peak of listings, the average age of a listed firm was 12 years, which has increased to 20 years currently.

The real question is why has this shift occurred, and Stulz provides an interesting answer. He discusses a trend toward less tangible assets growing in importance. Whereas firms used to focus on tangible assets like factories, land, and vehicles, many companies now are focused more on intangibles such as intellectual property, technology, and brand identity. Under generally accepted accounting principles (GAAP), Stulz notes, investment in intangibles appears as expenses rather than assets on a firm’s balance sheet, ultimately hurting earnings. For a large, established firm, this is not necessarily an issue; people understand its economic value. But for a smaller, younger firm, poor earnings combined with intangible assets can make it difficult to draw general investors. Instead, these smaller firms require specialized private equity investors who understand and are able to better assess intangibles.

One of the end results of this trend is that public stock market investors may be getting less volatility – because the offerings are older, larger, and more established companies – but they are also getting less diversification, and fewer diversification opportunities, particularly in smaller companies, as innovative startups are looking to private investors for funding rather than joining the public exchanges. Additionally, one of Stulz’ most astounding findings is that public stock market earnings are concentrating at the top: “In 2015, the top 200 firms by earnings had total earnings exceeding the total earnings of all public firms combined. In other words, the total earnings of the 3,281 firms that were not in the top 200 firms by earnings were negative.”

What can investors do about it? U.S. public equity investors should be aware of the change in the market and take this into account in their portfolio construction. Investors may have to seek out diversification in alternative places, such as international equity, private equity, and alternative investments. Read more in the following additional articles on related topics or watch our video, Stand Out from the Crowd:

Overcrowding in U.S. public equity: why private equity is taking market share.

FAANG Stocks: Dominating a Concentrated Market

Read the full NBER report here: www.nber.org/reporter/2018number2/stulz.html