Delisting Capitalism

The strange case of the shrinking stock markets

Source: DPA [M]

Here is one of the many ways in which Karl Marx failed to understand what he was writing about: “Capital” can be public as well as private. In his day, it was unimaginable that workers could simultaneously be owners by holding shares in their US-style 401(k)s or other pension or brokerage accounts. But that’s how capitalism developed in the late 20th century, especially in Anglo-Saxon countries.

This expansion in developed countries of stock exchanges (here measured not by market capitalization but by the number of listings) had many advantages. Public companies must disclose more, thus making industry more transparent to society. And the broad availability of stocks allows investors to diversify their portfolios (either directly or through mutual funds). Capital, in the process, is usually allocated quite productively.

That’s why it is a problem that stock markets have in recent years been shrinking (again, by listings, not by market cap). In America during the four decades to 2016, the number of exchange-listed firms dropped by 27 percent to 3,627. In Germany, where private “Mittelstand” capital is glorified, the number of listed firms fell by 41 percent during the past decade, to only 450. Listings are growing only in China and other parts of Asia which converted to capitalism only recently.

The reasons include mergers, fewer IPOs, and more buyouts by private equity. In that sense, Tesla became a sign of the times when Elon Musk, its founder, casually announced on Twitter the other day that he wants to take his firm private, presumably because he finds the costs of complying with all those modern regulations too onerous.

The flipside of this “Tesla trend” is an “Apple trend.” Apple this month became the world’s first company valued at $1 trillion. This is part of a pattern in which fewer, and generally older, companies get ever larger, more valuable and more profitable, while young and small firms get less profitable and drop off the exchanges. René Stulz, a professor at The Ohio State University, has calculated that the 3,281 listed American firms that were not in the top 200 by earnings actually made losses. Why?

His answer is another insight that Karl Marx could not have imagined: Capital does not have to be tangible, and increasingly isn’t. Capex (ie, spending on machines, factories and such) as a share of assets is steadily declining. Simultaneously, research spending on intellectual property keeps rising, and already tops capex. But our accounting systems, which largely date to the time of Karl Marx, treat these two types of capital formation unfairly.

Thus a firm that spends €1 million on a factory grows its balance sheet but does not reduce its profit. Another firm that spends €1 million on R&D must record this as an expense, thus probably (if it is a start-up) wiping out earnings, even if it has just found the Next Big Thing in its lab.

For investors, Mr. Stulz argues, official profits are thus becoming almost irrelevant, while for company founders, they seem increasingly misleading. If managers tell the markets too little about their patents, their firms will be undervalued; if they tell too much, rivals will know their secrets. Better to just find private equity and be done with it.

It is not good that capital is again becoming more private, as it was in Karl Marx’s day. Securities regulators and bean counters need to get up to date. Otherwise they will eventually become as obsolete as Karl Marx.

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