For all the arguments about the risks versus benefits of President Bush’s plan for private accounts in Social Security, one not frequently mentioned is that private accounts might be good for the economy since it would add a lot of activity to the stock market. For every person who opts for a private account, there are more investors in the market. Increasing investor participation is one of the factors that could stem the tide of public companies going private.
The relevance of the move toward private ownership is examined in a recent study conducted by Anjan Thakor, the John E. Simon professor of finance at the Olin School of Business at Washington University in St. Louis, along with Arnoud Boot at the University of Amsterdam and Radhakrishnan Gopalan from the Ross School of Business at the University of Michigan.
However, this trend toward private ownership cannot be attributed only to strict corporate governance and Sarbanes-Oxley, especially since it started before Sarbanes-Oxley was implemented. One of the key triggers that has affected the choice to remain public or private is the condition of today’s market.
According to the researcher’s model, both the level of stock prices and the price volatility depend on the level of investor participation. When more investors trade in their stock, that actually lowers volatility and raises the stock price. Firms generally desire both higher price and lower volatility. The fewer investors who participate in the public market for a given firm’s stock, the more likely that firm is to go private.
“The other part of the equation now that wasn’t there five years ago is that the cost of going private is relatively low, which is attractive to most companies.” Thakor said. “There’s a deepening of the private equity market – it’s the fastest growing segment of the financial sector. This phenomenon is not just happening in the U.S; this is the case worldwide.”
The trend toward privatization could continue unless one or more of these forces reverse themselves. Private equity is here to stay Thakor said. And we have yet to see what the real impact of Sarbanes-Oxley will be – although it is likely to become less restrictive than it is today.
“What can change is if the market takes off and stock prices rise,” Thakor said. “And that’s about the only thing out of these factors that could change any time soon.”
Enter the Bush Administration’s proposal for private accounts. According to the researcher’s theory, any increase of participation in the equity market could potentially be a factor in preventing more firms from going private.
“We all have this general belief that public ownership is good because essentially the role of the market is to spread risks out and the diversification of the investors helps firms to access capital more easily,” Thakor said. “If more investors in the market can do that, then it increases investment and growth.”
Higher investor participation could have another benefit, the researchers predict. The more investors, the more likely younger firms are to incorporate and go public. This isn’t just a theoretical proposition. Looking at the data, the researchers found that in the 1960s, the average age of a firm going public was 40 years in the US. But in the 1990s – during a period of high investor participation, the average age was five years.