The Disappearance Of Public Firms And The Changing Nature Of U.S. Industries
Rice University – Jesse H. Jones Graduate School of Business
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Cornell University – Samuel Curtis Johnson Graduate School of Management; Interdisciplinary Center (IDC)
May 29, 2015
There has been a systematic decline in the number of publicly-traded firms over the last two decades. Half of the U.S. industries lost over 50% of their publicly traded peers. The decline has increased industry concentration, as the void left by public firms has not been filled by an increase in the number of private businesses or by greater presence of foreign firms. Firms in industries with the largest decline in the number of firms have generated higher profit margins and abnormal stock returns, and enjoyed better investment opportunities through M&A deals. Overall, our findings suggest that the nature of US product markets has undergone a structural shift that has potentially weakened competition.
The Disappearance Of Public Firms And The Changing Nature Of U.S. Industries – Introduction
During the second half of the 20th century, several waves of tariff reductions and deregulations drastically changed the industrial landscape of many markets (e.g., Andrade, Mitchell, Stafford (2001), Irvine and Pontiff (2009), and Fresard and Valta (2014)). While these changes significantly reduced concentration levels in most industries, there is a common perception among market participants and regulators that this phenomenon has continued up to this day.
Contrary to these popular beliefs, this paper shows that U.S. industries have become more concentrated since the beginning of the 21st century due to a systematic decline in the number of publicly-traded firms. In the past twenty years U.S. has lost almost 50% of its publicly traded firms. This decline has been so dramatic, that the number of firms these days is lower than it has been in the early 1970s, when the real gross domestic product in the U.S. was one third of what it is today. This phenomenon has been a general pattern that has affected over 90% of U.S. industries.
We show that the decline in the number of public firms has not been compensated by other mechanisms that could reduce market concentration. First, private firms did not replace public firms: The aggregate number of both public and private firms in the economy has also decreased over time, so that the growth in the number of private firms did not offset the declining trend in the number of public firms.
Second, we examine whether the intensified foreign competition could provide an alternative source of rivalry to domestic firms. We find that the share of imports out of the total revenues by U.S. public firms has remained flat since 2000. This finding indicates that public firms have been expanding at a similar rate as import growth, successfully weathering foreign competition, and maintaining their concentrated presence in the U.S. markets.
Third, we show that the decrease in the number of public firms has affected the vast majority of U.S. industries. Furthermore, the decrease in the number of public firms has not been driven by distressed industries, or entire business niches that have disappeared due to technological innovations or changes in consumer preferences. Instead, it has been driven by a combination of a lower number of IPOs, documented in previous studies (Gao, Ritter, and Zhu (2013); Doidge, Karolyi, and Stulz (2013)), as well as high M&A activity.
We show that increased concentration has been associated with meaningful changes in the corporate share of profits, and the reduction in the number of firms has had implications to both corporate and asset pricing aspects of the remaining firms’ performance. Specifically, we find strong association between the reduction in the number of public firms and the remaining firms’ profitability, stock returns, and investment opportunities as captured by M&A gains.
We start by examining firm profitability, and find that the return on assets of U.S. public firms has significantly increased over the past two decades, especially in industries with a higher decline in the number of public firms. To arrive at this conclusion, we regress firm-level returns on assets (ROA) on the number of firms in the industry, including firm characteristics and firm fixed effects, and find that the number of firms in the industry is negatively correlated with profitability. When we decompose return on assets into asset utilization (or sales to assets ratio) and operating profit margins, we find that the higher return on assets are mainly driven by the firms’ ability to extract higher profit margins, while there is no relation between the number of industry incumbents and asset utilization. The abnormal profits that firms are able to extract are consistent with higher market power and potential change in the nature of the U.S. industries.
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