Take the market’s money – and the hassle
First published in the Sunday Times on 14th June 2015.
Once upon a time every truly ambitious entrepreneur wanted to be the boss of a public company quoted on the stock market. Fashions change, and many chief executives no longer have that yearning. Yet every year hundreds of business people end up as directors of a plc. So what are the benefits and the burdens of the stock market?
I had a refresher course a year ago when I took Patisserie Holdings public. I hadn’t undertaken a serious float for 10 years, and the exercise served as a reminder of the stresses and strains of being in charge of a public company.
The biggest upside is obvious: access to capital. You can raise equity finance when you float, and once quoted you can sell new shares in placings and rights issues to raise more cash for investment or acquisitions. But you have to abide by the rules of the exchange and the Takeover Code, which can be expensive and onerous.
Quoted companies have a fragmented ownership base, rather than just one private equity shareholder. To an extent this permits management to retain more control than would be possible with a sole, majority institutional owner. Of course, occasionally it allows dominant shareholders to ride roughshod over minority investors. But if your business stumbles, then it is better to be private. Public markets are unforgiving. Mistakes and challenges are played out in front of the gallery in a plc. Profit warnings, boardroom departures, order cancellations — they must all be announced. These disclosures can destabilise staff, suppliers and customers. They reinforce the key mantra by which every public company should conduct its affairs: underpromise and overdeliver.
Last week, on a panel at a Quoted Companies Alliance conference, we agreed that it was barely worthwhile being public if a business has a market value of much under £100m. Any small company faces a disproportionate cost regime, and the probability of neglect from the analyst community. Unfortunately, smaller stockbrokers are facing declining commission income, so they have diminished research capacity. This discourages potential buyers.
Short-termism is a perennial problem for the quoted markets. I banned our broker from offering shares in our float to any hedge funds, which I think of as speculators rather than investors. Yet somehow a few sneaked on to the share register. And what a surprise: almost without exception they sold out rapidly once the shares had risen. By contrast, we have gained the support of several solid institutions that appear to adopt a philosophy of investing patient capital and a longer-term view. With that sort of backing, companies can make sensible expenditure plans, and commit to research and development. That is how industries really grow and create jobs.
Unfortunately, public markets are plagued by devices that exacerbate the problem of short-termism. The issue is especially acute in American stock markets. There, managers have announced $500bn (£323bn) of stock buybacks per annum since 2012: together with dividends, buybacks now absorb more of the S&P 500’s spending than capital expenditure. This must be a key reason why productivity growth has been so weak. Executives undertake buybacks because it boosts their stock price, which boosts their stock incentives. But this form of corporate cannibalism diverts resources that should be used to expand capacity and increase innovation.
The amount the chief executives of large American public corporations are paid can only be described as bonkers. I think it has been one of the most corrosive trends in capitalism in recent times. In 2013 the average compensation among S&P 500 chief executives was almost $12m — roughly 330 times the amount they paid their workers. These bosses are ultimately employees, not founders or risk-takers. Unfortunately, many public company directors game the system, and the major institutional investors are supine in the face of such greed. It discredits the American stock market, and to an extent countries such as Britain mimic their bad habits.
Another American disease is the system of quarterly reporting. God forbid we should ever adopt it in Britain. A cycle of publishing results every three months means that business leaders are forever meeting, worrying about the next set of numbers, and neurotically obsessed over analyst expectations. It acts as a huge distraction from the principal activity of managing the firm.
Despite these issues, the stock market remains perhaps the best method for investing consumer savings in industry. The public understand capitalism much better if they are actual part-owners of quoted companies. In theory, quoted companies receive permanent capital when floated, unlike private equity, which seeks an exit after five years or so. Meanwhile, investing in AIM benefits from tax breaks, such as relief from inheritance tax; it is the best growth company exchange in the world apart from Nasdaq. And if costs were cut, analyst coverage improved and regulations relaxed, it would be even better. Long may it flourish.