Are U.S. Companies Underinvesting

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Are U.S. Companies Underinvesting?In This Issue: Are U.S. Companies Underinvesting?
The State of the Public Corporation: Not So Much an Eclipse as an Evolution
8 Conrad S. Ciccotello, Georgia State University
Capital Deployment Roundtable:
A Discussion of Corporate Investment and Payout Policy
22 Panelists: John Briscoe, Bristow; Paul Clancy, Biogen Idec;
Michael Mauboussin, Credit Suisse; Paul Hilal,
Pershing Square Capital Management; Scott Ostfeld,
JANA Partners; Don Chew and John McCormack, Journal of
Applied Corporate Finance.
Moderated by Greg Milano, Fortuna Advisors.
Capital Allocation: Evidence, Analytical Methods, and Assessment Guidance
48 Michael J. Mauboussin and Dan Callahan, Credit Suisse
Bridging the Gap between Interest Rates and Investments
75 Marc Zenner, Evan Junek, and Ram Chivukula, J.P. Morgan
An Unconventional Conglomerateur: Henry Singleton and Teledyne
81 William N. Thorndike, Jr.
The Icahn Manifesto
89 Tobias Carlisle
Off Track: The Disappearance of Tracking Stocks
98 Travis Davidson, Ohio University, and Joel Harper,
Oklahoma State University
The Gap between the Theory and Practice of Corporate Valuation:
Survey of European Experts
106 Franck Bancel, ESCP Europe-Labex ReFi, and
Usha R. Mittoo, University of Manitoba
Are Certain Dividend Increases Predictable? The Effect of Repeated
Dividend Increases on Market Returns
118 David Michayluk, University of Technology, Sydney,
Karyn Neuhauser, Lamar University, and Scott Walker,
University of Technology, Sydney
VOLUME 26  | NUMBER 4  | FALL 2014
APPLIED CORPORATE FINANCE
Journal of
8 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
The State of the Public Corporation:
Not So Much an Eclipse as an Evolution
代写 Are U.S. Companies Underinvesting?
by Conrad S. Ciccotello, Georgia State University*
In addition, uncorporates are designed to satisfy a special
requirement of a growing investor clientele: current income.
The demand for tax-efficient, yield-based investments has
exploded in response to not only demographic shifts—
specifically, the increase in life expectancy for people reaching
normal retirement age—but also to macroeconomic factors
(such as the recent prolonged period of low nominal interest
rates), and shifts in the risk of retirement income provision-
ing from government and business to households (reflected,
for example, in the rise of defined contribution-type pension
plans and the decline of defined benefit plans).
In the second section of the article, I present evidence of
the decline in the number of U.S. publicly traded corpora-
tions. Using Compustat to examine ten (two-digit) Standard
Industrial Classification industries, I identified the peak
number of public companies in each of the ten industries
during the period 1966-2013 and then compared the sum of
those peak numbers to the total number for the year 2013.
On that basis, the total sample has fallen from almost 4,000
public companies to 1,652, a drop of nearly 60%.
The next part of my analysis focuses on the performance
of U.S. public companies. To analyze performance I use
a “Dupont decomposition” of the companies’ returns on
equity (ROE) during the same 48-year period. This exercise
highlights some interesting trends. In nine of the ten indus-
tries I examine, the median annual return on equity (ROE)
during the latter half of the 48-year time period (1990-
2013) was lower than the median return for the first half
(1966-1989). But while the median ROE has been falling,
the dispersion of ROEs—as reflected in a statistic called the
interquartile range—has been increasing over time in every
industry.
In addition to the trends in ROE, I also examine trends in
Tobin’s Q ratios for the same ten-industry sample of compa-
nies. Tobin’s Q is a measure of value added in that it sets
the current market value of corporate assets against either
their current “replacement value” or the historical amounts
for which they were acquired. In contrast to my findings
wenty-five years ago Harvard Business School
professor Michael Jensen wrote an article in the
Harvard Business Review called “Eclipse of the
Public Corporation.” 1 In that article, Professor
Jensen hailed the rise of leveraged buyouts as “a new orga-
nizational form,” one that promised to cause a significant
fraction of corporate America to shift from public to private
ownership. More specifically, Jensen predicted that the
private conglomerations of assets being amassed by the new
“LBO partnerships”—or what are now called private equity
firms—would end up supplanting public conglomerates and
perhaps come to dominate the more mature sectors of the
U.S. economy (those no longer requiring major infusions
of new equity). The key to the success of the LBO part-
nerships, as Jensen saw it, was the concentration of equity
ownership—much of it in the hands of management and the
board—made possible by heavy reliance on debt financing. In
Jensen’s words, “The LBO succeeded by substituting incen-
tives held out by compensation and ownership plans for the
direct monitoring and often centralized decision-making of
the typical corporate bureaucracy.”
Relying on the analytical framework presented in Jensen’s
classic article, 2 and with the benefit of a quarter-century of
hindsight since its publication, I begin this article by present-
ing some thoughts and evidence on the current state of the
public corporation. By some yardsticks, the public corpo-
ration appears to be in the midst of a pronounced secular
decline—a displacement by alternative organizational forms
that include not only the LBOs that Jensen focused on in
1989, but others that have been the focus of my own research.
In the first section of this article, I summarize evidence
of the dramatic rise during the past two decades of what
some scholars—notably, the late Larry Ribstein—have
called “uncorporate” public structures. As analyzed and
documented by Professor Ribstein and others, the growth
of “uncorporates” has been a function of several key factors,
including the demand by investors for greater transparency
and operational focus, and for more effective governance. 3
*I am grateful to Huimin Li for research assistance and to Don Chew, the editor, and
Vlado Atanasov for valuable thoughts and comments.
1. Michael Jensen, “Eclipse of the Public Corporation,” Harvard Business Review,
September-October 1989.
2. See also Michael Jensen, “Corporate Control and the Politics of Finance,” Journal
of Applied Corporate Finance, Vol. 4, No. 2, (Summer 1991), pp. 4-33.
3. See, e.g., Larry Ribstein, “Energy Infrastructure Investment and the Rise of the
Uncorporation,” Journal of Applied Corporate Finance, Vol. 23, No. 3, (Summer 2011),
pp 75-83; Conrad Ciccotello, “Why Financial Institutions Matter: The Case of Energy
Infrastructure MLPs” Journal of Applied Corporate Finance, Vol. 23, No. 3, (Summer
2011), pp 84-91.
9 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
on ROE, for nine of the ten industries, the median annual
Q ratio has actually increased over time. At the same time,
similar to the ROE findings, the interquartile range of Q
has also increased over time in every industry. Overall, the
ROE and Q findings suggest a growing separation of the best
from the rest.
In the pages that follow, I argue that these trends in ROE
and Q are associated with three main developments that have
been taking place since publication of Jensen’s article at the
end of the 1980s. First is the increasingly competitive global
marketplace for goods and services. Second is the emergence
of a deep and vigorous market for corporate control, in which
activist investors compete for the rights to influence—or, in
some cases, assume control of—corporate decision-making. 4
Third is the strengthening of internal incentives, provided by
increased equity ownership and other forms of equity-linked
compensation, to motivate the managers of public companies
to maximize the value of their firms, in some cases by selling
or otherwise divesting them. 5
During the past 25 years, the combination of these three
factors has made the surviving corporations highly efficient
while pressuring (or otherwise encouraging) poor perform-
ers to restructure. As a consequence, although the median
surviving public corporation has done a “better” job of creat-
ing value with its assets (as reflected in higher Q ratios), that
same median firm still faces a very challenging competitive
environment (as reflected in falling ROEs). Moreover, the
trends seem to have “room to run,” as the spread between
winners and losers continues to widen in terms of both profit-
ability and value creation.
Placing considerable weight on the findings of a recent
study called “Where Have All the IPOs Gone?,” I argue
that the public corporation structure has increasingly been
rewarded by the market for achieving more efficient scope and
scale, especially in a global marketplace. 6 In many industries,
rapid technological innovation, large capital requirements,
and reduced customer search costs have combined to put
pressure on the profitability of small firms. 7 Beyond the
economics of competition, large successful public corpora-
tions also have a competitive advantage at managing the
“business-government interface”—that is, at influencing
public policy decisions that affect their expected profitability
and franchise value. For example, innovative tax policies by
large multinational firms have removed much of the sting of
the corporate income tax through the use of cross-country
tax arbitrage. Together, these factors have ushered in a golden
age for the best of the best public corporations and pressure
to restructure for the rest.
Following this account of the evolution of U.S.-based
companies, I then attempt to present a more global view of the
rise of the public corporation. Since the end of the 1980s, the
world has witnessed not only the dramatic rise of dominant
multinational corporations (MNCs), but also the extraordi-
nary growth of the state-owned public corporation (typically
known as “state-owned enterprises,” or SOEs), especially in
developing countries. From the big-bang privatizations in
Eastern Europe and Russia to the gradual privatization in
China, the impact of SOEs has been profound.
Having the government as a major shareholder presents
the SOE with an array of challenges and options that are
different from those facing U.S.-domiciled MNCs. MNCs
must compete against SOEs that are likely to be heavily subsi-
dized by their governments, which are also their controlling
shareholders. But at the same time, MNCs have more freedom
代写 Are U.S. Companies Underinvesting?
Viewing the MNC and SOE as entities along a single
public corporation continuum yields an interesting insight.
Since the publication of Jensen’s “Eclipse” article in the late
’80s, the public corporation has increasingly been used by
governments as a vehicle to project economic (and politi-
cal) power on a global stage. In the case of the SOE—and
perhaps to some extent even the MNC—there is also the rise
of the power of large shareholders, and along with it a notable
increase in conflicts among different classes of shareholders
as well as the more traditional conflict between corporate
managers and their shareholders. 8
In the final section of the article, I attempt to summa-
rize the main factors influencing the evolution of the public
corporation over the past quarter century. The overall picture
is mixed. In some respects—and by some measures—the
public C-Corporation is indeed being eclipsed. Governance
and investor clientele effects are driving the extraordinary
growth of uncorporates. Intense product market competi-
tion, the need for efficient scope and scale, the rise of highly
efficient MNCs, and a well-functioning market for corpo-
rate control are significantly “thinning the herd” of public
4. For an excellent discussion of this market, and the role of private equity in forcing
public companies to become more efficient, see Karen Wruck, “Private Equity, Corporate
Governance, and the Reinvention of the Market for Corporate Control,” Journal of Ap-
plied Corporate Finance, Vol. 20, No. 3, Summer 2008, pp. 8-21.
5. See in this issue, Michael Mauboussin and Dan Callahan, “Global Capital Alloca-
tion,” Credit Suisse First Boston.
6. See Xiaohui Gao, Jay Ritter, and Zhongyan Zhao, “Where Have All the IPOs Gone?”
Journal of Financial and Quantitative Analysis, Vol. 48, No. 6 (December 2013), pp.
1663-1692.
7. Id.
8. See V. Atanasov, B. Black, and C. S. Ciccotello, “Unbundling and Measuring Tun-
neling,” University of Illinois Law Review—Issue in Tribute to Larry Ribstein. (2014), pp.
101-142; V. Atanasov, B. Black, and C. S. Ciccotello, “Law and Tunneling,” Journal of
Corporation Law 37 (1), (2011), pp. 101-151; V. Atanasov, B. Black, C. S. Ciccotello,
and S. Gyoshev, “How Does Law Affect Finance? An Examination of Equity Tunneling in
Bulgaria,” Journal of Financial Economics 96, (2010), pp. 155-173; V. Atanasov, “Is
There Shareholder Expropriation in the United States? An Analysis of Publicly-Traded
Subsidiaries,” Journal of Financial and Quantitative Analysis, 45, (2010) pp.1-26.
10 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
corporations. But in other respects, the public corporation
structure has evolved, and even thrived, over the past 25
years. Public corporation “winners” are larger, more efficient,
and arguably more influential than ever before. Moreover, the
rise of massive MNCs (and in a global context, SOEs) has
blurred the lines between business and government.
Based on the analysis of the trends discussed above, the
final section concludes with some thoughts about where the
public corporation is heading in the next 25 years.
Reasons for the Growth of Uncorporates
To help in understanding the drop in the number of public
companies, let’s begin by looking at the growth in public
uncorporate firms and the underlying reasons for that
growth. One major benefit of uncorporate structures arises
from their pass-through tax treatment; that is, similar to a
partnership, there is no income tax at the entity level. By
contrast, the C-corporation pays an entity-level tax; and if
it makes distributions in the form of dividends, the owners
owe taxes on those dividends at the applicable individual tax
rate. Pass-through tax treatment thus creates a tax incentive
to distribute cash instead of retaining it. That tax treatment
has propelled the growth of the REIT and MLP, in combi-
nation with the clientele and governance effects discussed
below.
Investor Clientele
The world’s population is aging rapidly, especially in devel-
oped nations. Birth rates have fallen below replacement levels
(approximately 2.1 children per couple) on every continent
except Africa. But even more important to the investor clien-
tele story is the increase in life expectancy contingent on
reaching normal retirement age. According to the Social
Security Administration, males who reach age 65 in the U.S.
are currently expected to live for another 19.3 years—and
for women the expectation is another 21.6 years. According
to data from the Census Bureau, the percentage of the U.S.
population over 65 will increase from 13% in 2010 to 20%
in 2050.
What do such demographics have to with the state of
the public corporation? The short answer is that shifting
demographics are creating a larger investor clientele with a
demand for current income and higher yields.
Two other widespread changes that have accompanied
demographic shifts have been accentuating these clien-
tele effects. The first is the economy-wide move away from
defined-benefit retirement plans—in the public as well private
sectors—and toward self-funded retirement in contribution
style plans. The Social Security Administration reports that
from 1980 to 2008, the proportion of private wage and salary
workers participating in defined benefit plans fell from 38
to 20 percent. Neither governments nor companies want
the burden of longevity risk, as fallout from underfunded
pensions grips a growing number of entities (think about
recent developments in the state of Illinois). Assuming the
risk of providing for their own future consumption has, at
least at the margin, altered investors’ relative preference for
income over capital appreciation.
The second is the growing difficulty of the search for yield
while avoiding significant principal risk. Thanks to a three-
decade long bull market in bonds, risk-free rates have fallen
to basically zero. Declining interest rates have triggered a
refinancing bonanza for high credit quality firms and dropped
“junk” bond rates to all-time lows, but have also brought
about an ever-increasing thirst for yield by investors. Thus,
lower interest rates and the need to fund one’s own retirement
years have increased the demand for yield products. Adding
to this demand, investors appear to have become increasingly
reluctant to convert their assets into annuities. 9
A growing stream of dividends from a high-quality
portfolio of public corporations is one possible answer to the
problem. But public corporations, as already noted, face the
burden of double taxation. While qualified dividend income
(QDI) taxation at the individual level blunts the tax burden
somewhat, the combined corporate income tax rate of 35%
and the (maximum) QDI rate of 23.8% is still quite high.
So, until quite recently, when the search for yield has become
extreme, many corporations have been relatively slow to
increase dividends.
In contrast to C corporations, uncorporate structures such
as REITs and MLPs have tax-based incentives to distribute cash
rather than retain it. Assuming they obey the tax rules, these
structures avoid the entity-level tax that corporations must pay.
Thus, the numbers of REITs and MLPs have grown markedly
in order to meet the demands of yield-oriented investors who
have been “nudged” away from fixed-income investments by
low nominal yields. This nudge is toward higher-risk products,
moving from investment grade toward “junk” debt, and even
income-producing equities. MLPs and REIT equities have
filled this demand for equity income. The assets of the typical
REIT and MLP are themselves long lived (namely, real estate
and energy infrastructure), thus matching the goal of providing
a long-lived stream of growing investment income.
In sum, demographic and retirement planning trends
suggest that the population of income-oriented investors will
continue to grow over the coming decades, which bodes well
for the popularity of uncorporate structures like the REIT
and MLP.
9. Concerns about annuities range from distrust of the strong commission-based in-
centives behind the sale of such products, product complexity, the lack of transparency
into annuity costs, and the inability to access larger sums of money when needed once
distributions have started. See Jeffrey Brown, “Understanding the Role of Annuities in
Retirement Planning.” In Annamaria Lusardi, ed., Overcoming the Savings Slump: How
to Increase the Effectiveness of Financial Education and Saving Programs. University of
Chicago Press. 2009. pp. 178- 206.
11 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
Similarly, the REIT has become an attractive structure
for corporate conversions, thanks to its tax, clientele, and
governance advantages. The traditional boundaries of this
form have also widened. Growing from its roots in multi-
family and commercial real estate, REITs have become
the structure of choice for such rapidly growing entities
as Health Care Properties and American Tower. In recent
years, the expansion of REIT status has occurred mainly
through Private Letter Rulings that have extended the
REIT qualification to other kinds of assets, notably energy
and telecommunications infrastructure. 15 Based on data
from REIT.com, in 2003 there were 171 REITs with a
market capitalization of about $224 billion. By 2013, the
number of REITs had grown to 202 with a total market cap
of $670 billion.
But even as MLPs and REITs are growing substantially
in numbers and market capitalization, they are still small
in number and size relative to publicly traded corporations.
They now comprise well less than 10% of all publicly traded
firms and about 5% of total market capitalization. And to
put size into perspective, consider that in 2013 the market
capitalization of Exxon alone, about $400 billion, repre-
sented nearly 80% of the value of the entire MLP sector.
While the size and number do look small when set
against those of public corporations, the growth of the
uncorporate forms is testimony to the importance of inves-
tor clientele, tax treatment of distributions, and governance
factors when choosing an organizational form. But these
are not the only major contributors to the decline in the
number of public companies. We now consider some other
important factors.
Decline in the Number of Public Corporations
Profitability and Valuation Trends
Having discussed the underpinnings and growth in the
number and size of uncorporates, let’s now look more closely
at the striking drop in the number of public corporations.
Near the end of 2013, Michael Santoli wrote in Barrons,
“The Wilshire 5000 is the oldest index that seeks to replicate
the entire U.S. market. It never had exactly 5,000 stocks
(that was just a marketing-driven estimate) but it often came
close. Today (December 6, 2013), it contains just over 3,600
names.” 16 Citing data from Strategas Group, Santoli states
that the number of companies traded on U.S. exchanges
peaked at 8,800 in 1997 and had fallen to 4,900 by the end
of 2012. 17
Governance
While tax and investor clientele are significant considerations
when choosing an organizational structure, I argued many
years ago—first in my Ph.D. dissertation and later in
published papers—that governance is also an important
aspect of the uncorporate restructuring. 10 Strict tax rules
and a clientele that demands distributions drive operational
focus, and the need for efficiency and transparency. 11 Firms
in the MLP structure that cut distributions tend to be
harshly treated, as the Boardwalk MLP distribution cut in
early 2014 demonstrates. 12
And as Jensen argued in “Eclipse” and elsewhere,
the C-Corporation form does not necessarily provide
effective incentives for either focus or cash distribution;
and unless acted upon by outside forces, the natural tendency
of managers of public corporations to pursue growth at the
expense of profitability and value has often led to excessive
diversification and other ways of “wasting” corporate
“free cash flow.” As Jensen defines it, “free cash flow” is
the operating cash flow that cannot be profitably
reinvested in the company; and because of the above-noted
tendency to waste such cash flow, it must be paid out to
shareholders to help ensure that the companies will maximize
their value.
Compared to the hostile takeovers and LBOs applauded
by Jensen, MLPs were a relatively “quiet restructuring” that
incentivized mature businesses to pay out cash and meet
the needs of their income-oriented clientele. 13 Qualification
rules drive distribution policy in REITs. In order to qualify
as a REIT, a company is required to pay out at least 90% of
its taxable income each year to shareholders as dividends.
Growth of Uncorporate Forms
Up to this point I have discussed trends in demographics,
investor clientele, and governance that have all contributed
to the uncorporate restructuring movement. This section
outlines the actual growth in these forms.
According to data from Wells Fargo Securities, there
were 32 MLPs in 2003 with a total market capitalization
of $45 billion. By 2013, the number of MLPs had grown to
107 and the market capitalization approached $500 billion.
This spectacular growth has been fueled in large part by the
build-out of energy infrastructure that has accompanied the
U.S. shale revolution. 14 Passage of the MLP Parity Act, which
would open the structure to alternative energy firms, could
lead to even more growth.
10. See Conrad Ciccotello and Chris.Muscarella. “Contracts between Managers and
Investors: A Study of Master Limited Partnership Agreements,” Journal of Corporate Fi-
nance 7, (2001), pp. 1-23; Conrad Ciccotello and Chris.Muscarella. Matching Organi-
zational Structure With Firm Attributes: A Study of Master Limited Partnerships, Review
of Finance, 1, (1997), pp. 169-191.
11. See Ribstein, supra note 3.
12. Boardwalk’s MLP units fell by about 50% in value in response to a distribution
cut from $0.532 to $0.10 per quarter. See http://247wallst.com/infrastruc-
ture/2014/02/10/is-boardwalk-just-the-start-of-nat-gas-mlp-woes/.
13. See John Kensinger and John Martin. “The Quiet Restructuring,” Journal of Ap-
quartile range.” This range is the difference between the 25th
and 75th percentiles, and is a simple measure of dispersion.
With the annual percentile rankings by industry as input,
I then obtained the median 25th, 50th (median), and 75th
percentile values (and interquartile ranges) from the distri-
butions of annual performance. From the median annual
values in the two (24-year) time periods (1966-1989 and
1990-2013), I observe time trends.
Figure 3 shows the results over the two 24-year time periods.
In the case of the ROEs, the pattern is striking. In nine of the
ten industries in my sample, the median (of annual medians)
for the later time period (1990-2013) turned out to be lower
than that for the earlier period (1966-1989). And some of the
differences were quite large. In the case of Oil and Gas, for
example, the median of annual median ROEs was 8.83% for
the 1966-1989 period, and 4.40% for the 1990-2013 period.
And in both Business Services and Professional Services, the
drops in median annual ROE were from above 12% (12.51 and
12.81, respectively) to roughly 7% (7.23 and 6.29).
In this section, I investigate the reasons for this decline. I
begin by examining trends in corporate performance. Using
the Compustat database, I study companies that appear in
ten different two-digit Standard Industrial Classifications
(SICs). Figure 1 shows that these ten two-digit industries
give broad representation to different sectors of the economy
as they are spread across nine different one-digit SICs. And
as also noted earlier, I look at the performance of these ten
industries over the 48-year period from 1966 through 2013.
For each of the ten industries in my study, Figure 2 shows
the beginning (1966), peak, and current (2013) number of
companies listed on Compustat. All of the industries exhibit
a common pattern of falling numbers. But the timing of
the peak year, and thus the beginning of the decline, varies
considerably among industries. The earliest peaks in terms
of numbers of companies take place in the categories of
department stores and variety retailers (SIC 53xx)—which
reached a maximum of 103 companies in 1974 (and had
fallen to 19 in 2013)—and of auto and aircraft manufacturers
(SIC 37xx), where the peak level of 175 companies in 1975
had dropped to 94 by 2013. As for the most recent industries
to peak, communications (SIC 48xx) reached a high of 310
companies in 2000, which was down by almost two thirds to
112 in 2013. And chemicals and allied products (SIC 28xx),
which had 640 companies as recently as 2006, had fallen by
almost half to 371 seven years later.
The total decline in the number of publicly traded
companies for the ten industries measured in terms of
the peak for each industry is over 2,300, representing
approximately 60%. By comparison, the growth in the
numbers of uncorporates is small. And even if we assume
that each of these new uncorporates was converted from the
public corporate form (which is clearly an exaggeration), the
g代写 Are U.S. Companies Underinvesting?
35 XX Computers & Office Equipment
37 XX Auto & Aircraft Manufacturing
48 XX Communications
53 XX Retail – Department/Variety
65 XX Real Estate
73 XX Business Services
87 XX Professional Services
Figure 2 Number of Compustat Firms by Year
in Ten Different Industries
Industry Beginning
(1966)
Peak
(Number)
Peak
(Year)
Current
(2013)
Agriculture –
Crops
9 20 1996 15
Oil and Gas 74 441 1982 210
Chemicals and
Allied Products
162 640 2006 371
Computers &
Office Equipment
234 574 1995 190
Auto & Aircraft
Manufacturing
146 175 1975 94
Communications 50 310 2000 112
Retail –
Department/
Variety.
61 103 1974 19
Real Estate 34 163 1978 45
Business
Services
64 1344 1999 524
Professional
Services
27 217 1998 72
Total 861 3987 1652
13 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
Figure 3 Dupont Decomposition of Median Annual
Return on Equity (ROE) in Ten Industries
Early Period (1966-1989) Compared to
Later Period (1990-2013)
Industry Return on
Equity (%)
Net Profit
Margin (%)
Asset
Turnover
Equity
Multiplier
Agriculture – Crops 9.37 – 5.81 5.22 – 3.46 0.88 – 0.63 2.06 – 1.93
Oil and Gas 8.83 – 4.40 9.27 – 3.57 0.33 – 0.33 1.78 – 1.83
Chemicals and
Allied Products
12.64 – -0.39 5.00 – -23.19 1.29 – 0.46 1.73 – 1.34
Computers &
Office Equipment
11.04 – 7.67 4.04 – 1.86 1.27 – 0.99 1.83 – 1.63
Auto & Aircraft
Manufacturing
11.76 – 11.82 3.50 – 2.70 1.52 – 1.15 2.11 – 2.20
Communications 12.86 – 6.21 10.98 – 2.14 0.40 – 0.49 2.49 – 2.01
Retail –
Department/Variety
10.94 – 10.39 2.38 – 1.72 2.11 – 1.95 2.28 – 2.20
Real Estate 6.13 – 4.89 6.18 – 3.41 0.23 – 0.22 2.66 – 1.91
Business Services 12.51 – 7.23 3.77 – 0.90 1.17 – 0.88 2.01 – 1.50
Professional
Services
12.81 – 6.29 2.98 – 0.56 1.49 – 1.01 2.02 – 1.68
Net profit margin is net profit/sales; asset turnover is sales/assets, and equity multi-
plier is assets/equity.
Industry Return on Equity
(25 th Percentile)
Early Later
Return on Equity
(75 th Percentile)
Inter-Quartile
Agriculture – Crops 5.19 – -2.73 15.49 – 13.37 10.30 – 15.60
Oil and Gas -0.52 – -10.46 15.94 – 14.27 16.46 – 24.73
Chemicals and
Allied Products
7.68 – -52.91 18.64 – 22.12 10.96 – 75.03
Computers &
Office Equipment
5.02 – -10.07 18.09 –19.05 13.07 – 29.12
Auto & Aircraft
Manufacturing
5.44 – -0.88 17.73 – 21.39 12.29 – 22.27
Communications 8.15 – -16.26 16.22 – 24.50 8.07 – 40.76
Retail – Depart-
ment/Variety.
7.53 – 2.67 16.42 – 17.36 8.89 – 18.03
Real Estate -2.28 – -6.74 18.39 – 18.46 20.67 – 25.20
Business Services 3.17 –-14.01 21.39 – 21.42 18.22 – 35.43
Professional
Services
2.61 – -22.29 20.01 – 18.72 17.40 – 41.01
pattern. In the latter period (1990-2013), the median annual
interquartile range of ROE was higher in all 10 industries
(relative to the 1966-1989 period). Several of the increases in
median annual interquartile range between the time periods
are strikingly large, such as those recorded for the Chemicals
and Allied Products, and Communications industries.
But even as the median ROE is tending to decline over
time, it is interesting to note that the pattern does not hold
at the 75th percentile. Figure 4 shows that ROE at the 75th
percentile does not tend to decline in the latter period (1990-
2013). This is more evidence of the growing spread between
top-quartile winners and other firms. Winners are achieving
higher levels of return on equity, even as more competitive
product and service markets continue to drag down the
median ROE.
As a measure of operating performance, ROE has the
limitation that it fails to introduce any aspect of market
valuation into the analysis. To complement the ROE
analysis, I examined trends in Tobin’s Q using the same
methods that I used when analyzing ROE. Tobin’s Q is
computed as the ratio of market value of assets to book
value of assets. Q is proxy for the market’s assessment of
management’s value added, its effectiveness in using the
firm’s assets.
The Dupont decompositions of ROE in Figure 3 show
that a significant part of the reductions were attributable
to shrinking profit margins; indeed, all ten industries
had lower median net margins in the latter period. Some
margin declines were particularly striking, especially those
experienced in the Chemicals and Allied Products and
Communications industries. But thinner margins do not
explain the entire decline in ROEs. Asset turnover also
generally declines in the latter period, and so does the equity
multiplier.
The results summarized in Figure 3 suggest that
competition in product and service markets has been
increasing over time. All else equal, lower profit margins
suggest greater competition. But that said, it’s important
to recognize that the possibility that direct comparison of
accounting metrics over long periods of time can be distorted
by a consistent bias. Many accounting rules have changed
since the 1960s. One change that might decrease reported
profitability is the trend toward the use of accelerated
depreciation methods over time. 18
Recognizing the potential problems with comparisons of
median values, I also examined trends in dispersion over time.
Figure 4 shows the median annual interquartile range over the
same two 24-year periods. Rather than declining over time
like the median, the interquartile range shows the opposite
Figure 4 Median Annual 25th and 75th Percentile
Return on Equity in Ten Industries
Early Period (1966-1989) Compared to
Later Period (1990-2013)
18. ROE results do hold across both capital-intensive and service industries, so de-
preciation bias is not a clear-cut explanation for the sample at large.
14 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
As reported in Figure 5, the median annual Q ratio, in
contrast to the ROE results, was higher in eight of the ten
industries in the later time period. But, similar to the pattern
for ROEs, the interquartile range in Q, as shown in Figure 6, is
growing over time. In nine of the ten industries I studied, the
median interquartile Q was higher in the later period than the
earlier period (and in one industry it remained unchanged).
In the study I cited earlier called “Where Have All the
IPOs Gone?,” the authors (Gao, Ritter, and Zhao) assert
that growing economies of scope are likely to be the most
important explanation for the decline in the number of public
companies. 19 The product and customer advantages possessed
by large public firms make it difficult for new entrants to
compete. The capital requirements necessary to take advantage
of scope and scale economies are vast, and the time that capital
market investors allow new public firms to show positive
results is shrinking (as discussed in the next section). In a
similar vein, a study by Brau and Fawcett relies on survey data
to argue that the most often cited reason companies go public
is to make acquisitions. 20 And consistent with this argument,
those companies that do go public seem increasingly eager to
sell themselves to larger firms when they perceive that they
are unable to compete in the medium to longer term. 21 So
the game appears to be either to go public to acquire, or to
be acquired.
The Development of the Market for
Corporate Control22
One of the main forces leading to the drop in the number
of U.S. public companies has been the operation of the U.S.
market for corporate control. Introduced by Henry Manne
as early as the 1960s, the concept of a corporate control
market was refined and documented by Michael Jensen and
his colleague Richard Ruback in the early 1980s, during the
first U.S. wave of debt-financed hostile takeovers and lever-
aged buyouts. Defined by Jensen and Ruback as “the market
in which alternative management teams compete for the right
to manage corporate resources,” the concept of a market for
corporate control was “an extension of the managerial labor
market.” 23 The basic idea is that if the current team of manag-
ers at a public firm is not employing resources efficiently, and
the company’s board fails to act, outside forces will ensure
that the management team will be replaced by another, gener-
ally more effective, team. This team could come from another
public company through a takeover or be supplied by an
“unaffiliated” group of investors.” 24 But either way, the under-
lying expectation that the new management will improve
Figure 6 Median Annual 25th and 75th Percentile
Q-Ratio in Ten Industries
Early Period (1966-1989) Compared to
Later Period (1990-2013)
19. See Gao, Ritter, and Zhao, supra at note 6.
20. Se
Chemicals and
Allied Products
1.05 – 1.54 2.74 – 4.99 1.69 – 3.55
Computers & Office
Equipment
0.94 – 1.15 1.85 –2.72 0.91 – 1.57
Auto & Aircraft
Manufacturing
0.94 – 1.08 1.41 – 1.94 0.47 – 0.86
Communications 1.01 – 1.20 1.82 – 2.39 0.81 – 1.19
Retail – Depart-
ment/Variety.
0.91 – 0.96 1.35 – 1.76 0.44 – 0.80
Real Estate 0.86 – 0.92 1.36 – 1.82 0.50 – 0.90
Business Services 1.09 – 1.34 2.46 – 3.87 1.37 – 2.53
Professional
Services
1.13 – 1.14 2.62 – 3.46 1.49 – 2.32
Figure 5 Median Annual Q-Ratio in
Ten Industries
Early Period (1966-1989) Compared to
Later Period (1990-2013)
Industry Median Annual Tobin’s Q Ratio
Agriculture – Crops 1.18 – 1.08
Oil and Gas 1.38 – 1.36
Chemicals and Allied Products 1.57 – 2.71
Computers & Office Equipment 1.23 – 1.57
Auto & Aircraft Manufacturing 1.10 – 1.33
Communications 1.29 – 1.57
Retail – Department/Variety. 1.06 – 1.24
Real Estate 1.03 – 1.15
Business Services 1.50 – 2.14
Professional Services 1.57 – 1.77
Tobin’s Q ratio is the ratio of market value of assets to book value of assets. Market
value of assets is the sum of book value of assets and market value of common stock less
the sum of book value of common stock and deferred taxes.
15 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
The Role of Private Equity. In some cases, the buyers
of public companies (or their assets or divisions) have been
other public companies. But in other cases, the buyers of
public companies—and especially their “underperforming
divisions”—have been private equity firms.
Consistent with Jensen’s prediction in 1989, during the
last 25 years, leveraged private
of 2007, the global volume of announced private equity deals
approached $400 billion, accounting for almost 30% of a $1.4
trillion global M&A market. And before the onset of the
current credit crunch in the summer of 2007, the abundance
of low-cost financing was making it very difficult for corpo-
rate buyers to compete with “financial” buyers in not just
traditional “cash-cow” industries, but areas like health care,
energy, and technology that were previously thought to be
“unleverageable.”
During the financial crisis that followed, private equity
firms were forced to undertake a massive restructuring of
many of their portfolio companies. But after working down
the mountain of maturing debt that was widely believed
to threaten its existence, the industry has rebounded with
remarkable vigor. And for the past few years, private equity
transactions are said to have accounted for about 15-20% of
total corporate M&A.
What accounts for private equity’s remarkable success
and resilience? As Ohio State professor Karen Wruck argued
in this journal, private equity addresses major conflicts
between management and shareholders over corporate size,
the efficiency and value of the acquired firm is based on the
new team’s (or their backers’) willingness to pay a significant
premium over market to acquire control.
The main actors during the leveraged takeovers and buyouts
of the 1980s were activist investors (also known as “corporate
raiders”) like Boone Pickens and Carl Icahn. But after the
combined forces of recession and regulation effectively shut
down the leveraged deals that proliferated during the second
half of the 1980s, the 1990s saw the emergence of U.S. institu-
tional investors as important players in the market for corporate
control. Addressing the “collective action” problems faced by
individual investors, control-minded institutional investors such
as Blackrock teamed up with pension funds (like CalPERS),
and hedge funds to exert pressure on companies to increase their
profitability and value. Though institutional investors clearly
exhibit very different levels of activism, it’s important to recog-
nize that, by the end of 2010, they collectively owned about
70% of the shares of U.S. non-financial public corporations,
up from about 20% ownership in 1980. 25
One of the major effects of such growing institutional
ownership has been a notable shift in the design of top
management compensation toward stock options and,
more recently, restricted stock. 26 Stock-based management
compensation has arguably created stronger incentives for
managers to increase value by selling or spinning off assets
that are clearly worth more outside than inside the firm
(“addition by subtraction”). The fact that the premiums paid
to selling companies’ shareholders are often 40 to 50 percent 27
over current market price helps explain the pressure to sell
underperforming businesses or assets now coming from the
growing number of institutions and investor activists. But in
combination with these pressures, the increase in stock-based
incentives also makes it clear why top managers have become
more receptive to such offers.
T
ake the case of Clayton & Dubilier’s buyout of lawn care
company O.M. Scott from the conglomerate ITT in
the late 1980s. After taking control of the company, C&D
set up a five-person board consisting of Scott’s top manager
under ITT, three C&D partners, and an outside director
with operating experience. The C&D partners represented
over 60% of the equity, while management and employees
held an equity stake of 17.5%. Before the buyout, Scott’s
top executive was one of many division managers in ITT’s
consumer products group who reported a few times a year
to ITT headquarters and whose “equity” consisted of stock
options in ITT (which was governed by an 11-person board
with combined stock ownership of just 0.6%). After the
buyout, Scott’s manager was the CEO and 10% owner of
a standalone company, reporting at least weekly to a board
representing 70% of the stock.
Clayton & Dubilier
25. See Roni Michaely, Jillian Popadak, and Christopher Vincent, “The Deleveraging
of U.S. Firms and Institutional Investors’ Role,” available at http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=1941902.
26. See in this issue, Michael Mauboussin and Dan Callahan, supra note 5.
27. Id.
28. Wruck, supra note 4. See also Huimin Li, The Evolution of Family Firms: The Exit
of Founding Families and the Survival of Family IPOs, Dissertation, Georgia State Uni-
versity, 2014, available at http://scholarworks.gsu.edu/finance_diss/26.
16 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
risk-taking, and payouts through three main features: high
leverage, concentrated ownership (made possible by the lever-
age), and vigorous oversight of top management by a small
and intensely interested board of directors.
What does the post-crisis resurgence of private equity
say about the future of U.S. public companies? The main
message coming out of academic research in this area is that,
although private equity has made major incursions into areas
once dominated by public equity, the economic functions of
private and public equity are better viewed as “complements”
than mutually exclusive “substitutes”—that is to say, there is
room for public as well as private companies. And perhaps
even more important, the governance and performance of
public companies are improving as a result of the success and
influence of private equity.
The future projected by Wruck and most finance schol-
ars is one in which public companies continue to prevail in
control contests involving large synergies between buyer and
seller, and where the risk-bearing benefits of public ownership
are greatest—namely, in “riskier industries with significant
economies of scale and growth opportunities requiring large,
ongoing investment and infusions of equity.” 28 But in the
meantime, private equity will continue making inroads into
mature industries (think about Dell and PCs) with “relatively
stable cash flows, limited growth opportunities, and modest
ongoing investment and capital-raising requirements.”
Wruck also notes increasing signs of collaboration or
“convergence” between private and public equity. Private equity
firms have increasingly been taking minority equity stakes
(called PIPES) in public companies, resulting in significant
improvements in such companies. And many public compa-
nies have continued, and will continue, to take pages out of the
private equity playbook, as reflected in increased payouts, stron-
ger equity incentives for managers, and smaller, more effective
boards of directors—all of which bodes well for the productivity
and competitiveness of U.S. public companies.
First, the technology boom that drove large-tech firms’ valua-
tions skyward through the mid-to-late 1990s collapsed in
2000-2002. During the run-up in stock prices, a number
of firms were serial acquirers and innovators in off-balance
sheet financing. While stock prices rise, the level of happi-
ness among investors tends to rise as well. When returns go
negative, there is considerable unrest, and the search begins
for those responsible.
Enron, WorldCom, and Tyco were the regulatory poster
children for the busting of the first bubble. Issues included
the use of aggressive merger and acquisition accounting,
off-balance sheet entities, and complex derivatives to increase
reported earnings and assets, while reporting lower expenses
and hiding liabilities. The regulatory aftermath was the
Sarbanes Oxley Act (SOX) and related stock exchange rules.
These regulations attempted to strengthen the audit function
by adding mandatory levels of independence and competence,
as well as rules surrounding conflicts of interest. 29
By the latter part of the last decade, the real estate bubble
had burst. The regulatory reaction was Dodd-Frank, another
omnibus piece of governance legislation containing an array of
requirements promoting financial stability, while addressing
governance shortfalls by provisions supporting whistleblow-
ers, and requiring votes on executive compensation. 30
Have the Federal forays into corporate law tipped the
needle against being public? Research suggests that for the
smallest public firms, the direct costs are significant. 31 While
Gao, Ritter, and Zhao argue that regulation is not the primary
reason for the decline in public corporations, they rely solely
on data they can observe. 32 But a significant proportion of the
costs of regulation for public firms may well be unobservable.
These can take the form of management time, distraction, lost
opportunity from dealing with sets of one-size-fits-all rules,
and concerns about the impact of future changes in both the
regulations and the enforcement of them.
The world of communications has also changed a great
deal since the late 1980s. First of all, modern communications
technology makes it difficult not to have a stock quote in front
of you during each moment you are awake (CNBC anyone?).
“Evaluation horizons” have clearly become shorter for not only
retail investors in stocks but for institutions who compete
in what might be described as annual (or even quarterly)
“performance tournaments.” As a consequence, the myopia
of public companies is suspected to be real and growing. In
a study of public and private U.S. companies by John Asker,
Joan Ferre-Mensa, and Alexander Ljungqvist, the authors find
that private companies invest “substantially” more than public
29. Sarbanes–Oxley Act of 2002 (Pub.L. 107–204, 116 Stat. 745, enacted July 30,
2002. For a critique, see Romano, Roberta. “The Sarbanes-Oxley Act and the Making of
Quack Corporate Governance.” Yale Law Review 114, (2005), pp. 1521-1610.
30. For a summary, see Dodd-Frank Wall Street Reform and Consumer Protection Act
(2010), available at http://www.sec.gov/about/laws/wallstreetreform-cpa.pdf.
31. See Linck, J. S., J. M. Netter, and T. Yang. “The Effects and Unintended Conse-
quences of the Sarbanes-Oxley Act on the Supply and Demand for Directors.” Review of
Financial Studies 22,(2009), pp. 3287-3328.
32. See Gao, Ritter, and Zhao, supra note.6.
33. John Asker, Joan Ferre-Mensa, and Alexander Ljungqvist, “Corporate Investment
and Stock Market Listing: A Puzzle?,” forthcoming in the Review of Financial Studies.
1
Thanks to this winnowing process, the public company selec-
tion towards winners is becoming stronger over time.
The public company U.S. market has also become
increasingly subject to global forces. Global competition is not
new to the U.S. But in the last 25 years, the world’s product
markets have become significantly more competitive. Many
of the formerly centrally planned economies have engaged
in privatization ranging from the “Big Bang” approaches
in Eastern Europe and Russia to gradual privatization
in China. At the same time, a number of countries with
market economies, such as South Korea, have developed
and refined economic models in which the business and
government sectors are very close to each other. 36 While
government controlled businesses can be very inefficient,
some government-subsidized businesses have demonstrated
their ability to become effective competitors in the global
marketplace. 37
Domestic and Multinational Leverage. What do these
two trends mean for the public C-Corporation? The growth
of MNCs (and SOEs) suggests that many public corpora-
tions now exercise degrees of power or influence that blur the
lines between private business and government. In the global
economy, comparative advantage in a number of sectors
now rests on the leverage brought about by the enormous
scale and scope of these corporations. In this section, I will
describe four aspects of this leverage that speak not of eclipse,
but of evolution toward even greater corporate global power.
companies, and that private companies are nearly four times
as responsive to perceived investment opportunities. 33
For public companies, the window to demonstrate strong
stock performance does not stay open long before restructur-
ing pressure begins. The result is an end-game strategy for
non-winners in public company tournaments. Restructure to
emphasize returns (i.e., cut costs), be acquired, or go private.
As argued above, this operation of the market for corporate
control may indeed be efficient. However, the relentless short-
term pressure in the public company world tips the needle
toward another structure.
Second, the media-saturated economy often casts the public
company “winners” in a less than favorable light. Consider the
issue of public-company CEO pay in the current environment
of high un(under)employment and stagnant overall wage
growth. Setting aside the issue of whether the “CEO is worth
it,” the populism that communications technology leverages is
a growing challenge for public firms. 34 Being privately owned
does not immunize a firm from this treatment, but it certainly
reduces the exposure to negative press.
The Rise of the Public Corporation
Having examined the evidence of a shrinking public corpo-
rate sector, let’s now turn to the growth aspect—of which
there is also impressive evidence.
While public company numbers may be down markedly
from the peak, the market capitalization of public compa-
nies is not. Based on data from the World Bank, the market
capitalization of publicly traded stocks in the U.S. in 1990
was $2.0 trillion; and by 2012, that figure had grown to $18
trillion. Thus, there is little sign of an eclipse in terms of
market capitalization.
In this section, I offer two perspectives. First, I return to
the ROE and Q analysis of the prior section and discuss the
implications of strong performance. Second, I examine how
the public corporation form can leverage “winners” in both
a domestic and multinational context.
Strong Performance. In the ROE and Q analysis
presented earlier, one common theme was the growing inter-
quartile range in performance over time. One reason that the
interquartile range can grow is that the winners are getting
stronger. As reported earlier in Figure 4, in seven of the ten
industries in my study, the median 75th percentile ROE was
higher in the later period (1990-2013) than the earlier period
(1966-1989)—even as the median ROE was falling in nine
out of ten industries. So if there is some downward bias in the
distribution of profitability over time attributable to changes
34. The challenge is similar to the one Jensen (1991) describes in reference to media
attacks on LBOs. See Jensen, supra, note 2.
35. One might argue that there is an upward time bias in Q. For example, the cost of
capital has declined in the latter half of the sample period due to declining interest rates,
thus inflating Qs. However, the increase in Q at the 75 th percentile in the latter period is
still sufficient to widen the interquartile range in nine of the ten industries over time (as
Figure 6 shows).
36. See, e.g., Bernard Black, Hasung Jang and Woochan Kim, Does Corporate Gov-
ernance Affect Firms’ Market Values? Evidence from Korea, Journal of Law, Economics
and Organization 22 (2006), pp. 366-413 (2006).
37. See Tim, Hepher, U.S. to rap European Union over compliance in Airbus subsidy
dispute, Reuters, April 16, 2013.
18 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
The first aspect of this leverage is financial, and based on
tremendous balance sheet strength. Summarizing a number
of studies showing the declining profitability of small firms
over the last few decades, Gao, Ritter, and Zhu point to
three factors: technology, globalization, and reductions in
consumer search costs. Each of these factors is a magnifier
of advantage, leading to a “winner-take-all tendency.” 38 In
this environment, MNC and SOE financial strength and size
permit them to “buy” instead of “build” and stay ahead of
rapidly changing markets. Financial strength itself has been
magnified in the environment of low nominal interest rates
that has prevailed over for much of the last two decades. In
recent years, interest rates have plummeted as central banks
have engaged in efforts to stimulate weak economic growth.
Financially strong corporations have been able to obtain
(and refinance) large amounts of debt capital at extremely
attractive rates and terms. One example is Verizon’s “record
breaking” $49 billion debt offering in 2013, which was
followed in 2014 by the sale of ten-year fixed rate debt at
1.35% annual interest. 39
Beyond the sheer magnitude of financial capital
required to compete successfully in the global marketplace,
political contacts fuel the “winner-take-all” world. For large
international projects, the political connections necessary
to gain assurances regarding a range of issues, such as
employment terms or environmental rules, typically reside in
only a very small number of firms. To cite just one example,
John Chambers of Cisco is known for negotiating with
high-level government officials when proposing overseas
operations or sales. 40
The second aspect of leverage is the global nature of the
corporate structure itself. Unlike the uncorporate structures,
the corporate form “scales” very well across international
boundaries. While there are certainly different governance,
exchange listing, and tax rules for public companies that
operate in different countries, the corporate structure is the
global standard for business. Structures like the MLP or
REIT tend to be suited only for specific tax jurisdiction, and
cannot be “transported” readily across national boundaries.
The third element of this leverage is tax. The U.S.
corporate tax rate of 35% is a massive outlier. Thus, the
“wedges” in tax rates across countries offer valuable real
options for MNCs to structure dealings so as to minimize
their U.S. corporate tax burden. For example, although
Apple is best known for its innovative products, it has
also achieved considerable notoriety for its prowess in tax
avoidance. Apple headquarters some of its operations in
Ireland, which has a 12% corporate tax rate (as compared
to 35% in the U.S.), thus taking advantage of an array of
innovative tax strategies such as “the Double Irish.” 41 More
broadly, Reuters has estimated that 37 of the top technology
firms in the U.S. pay an average tax rate of 6.8% on their
non-U.S. earnings. 42
In 2010, the Government Accountability Office
estimated that MNCs paid an average tax rate of 12.6%,
accomplished largely by “stashing” cash abroad. 43 According
to Bloomberg, MNCs have accumulated $1.95 trillion
outside of the U.S. What’s more, in one year three U.S.-based
companies—Microsoft, Apple, and IBM—accounted for
almost 20% of the increase in total U.S. corporate overseas
cash holdings. 44 Viewed in this light, the recent attempts of
U.S. companies to shift their headquarters overseas through
highly controversial “tax inversions” are just another (albeit,
extreme) form of the tax-minimizing search for lower-tax
jurisdictions. 45
More generally, the growing size and complexity of the
regulatory interface between business and government also
favors large corporations, which have the scale to make the
largest political contributions as well as employ the best
legal and accounting advisors. There is academic evidence
that these expenditures pay off handsomely. Recent studies
have shown a strong positive association between corporate
political contributions and stock returns. 46 And according
to one estimate, the return to lobbying expenditures has
exceeded $220 for every dollar spent on lobbying. 47
From 1990 to 2013, the number of pages of rules in
the Federal Register has grown from 14,179 to 26,417, an
increase of over 85%. As the number and complexity of rules
and regulations has grown over time, the ability to perform
efficiently demands access to government officials who can
(and will) make decisions. Beyond lobbying for change to
the rules, the MNC comparative advantage may also be the
preferred access to reviewers and regulators who can cut
through the red tape.
38. See Gao, Ritter, and Zhu, supra note 6.
39. See http://www.bloomberg.com/news/2014-10-22/verizon-said-to-plan-four-
part-bond-sale-to-refinance.html.
40. See Mehak Chawla, “Cisco CEO John Chambers thinks Prime Minister Narendra
Modi can ‘turnaround’ India” ECONOMICTIMES.COM Aug 14, 2014, available at http://
articles.economictimes.indiatimes.com/2014-08-14/news/52807718_1_cisco-ceo-
john-chambers-china-and-india-key-emerging-markets.
41. See “Double Irish with a Dutch Twist,” New York Times, April 28, 2012,
available at http://www.nytimes.com/interactive/2012/04/28/business/Double-Irish-
With-A-Dutch-Sandwich.html?_r=0.
42. See Tom Bergin, It’s Not Just Google, July 23, 2013, available at http://graphics.
thomsonreuters.com/13/07/BIGTECH-TAXES.pdf.
43. See Andrew Ross Sortkin, “Tax Load Lighter than It Looks,” New York Times,
August 31, 2014.
44. See Richard Rubin, Cash Abroad Rises $206 Billion as Apple to IBM Avoid Tax.
M
Second, the pressure on public companies brought about
by the combination of a competitive product market and a
vigorous market for corporate control will continue. And as a
consequence, the number of publicly traded corporations will
continue to fall. As the last two decades have witnessed, some
of this decline will be the loss of the “public” part as some of
The Evolution of the Public Corporation—
The Next 25 Years
In this final section, I will start by summarizing the argu-
ments made in the article and then close by offering my
thoughts about the next 25 years for the public corporation.
Summary. Over the past 25 years, the public corpora-
tion has been eclipsed in some respects while thriving in
others. Measured by the number of publicly traded compa-
nies, the organizational structure is in serious decline.
In each of the ten industries I examined, the number of
public firms has peaked years ago; and measured from each
industry’s peak to year end 2013, the number of public
corporations in the sample of ten representative industries
has declined by about 60%.
I offered several reasons for the decline in numbers of
public corporations. First is the growth of public uncorporates,
like MLPs and REITs, which have rules and incentives to
distribute cash instead of retaining it. These uncorporate
forms are a good match for a growing clientele of investors
who need current income, given demographic shifts and the
decline in private and public pensions. Second is the growth in
the vigor and depth of the market for corporate control, which
when coupled with the highly competitive global product and
service markets and management’s stronger equity-based-
compensation incentives (to sell out for a premium), has
led to a “thinning of the herd” of public companies. Third
is the major change in the regulatory and communications
environment of the public corporation—an environment
whose main features are (1) a dramatically expanded, one-size-
fits-all substantive federal regulatory regime, and (2) a degree
of media saturation that ensures that populist issues like
executive pay get dragged into the spotlight.
But while the number of public companies has fallen,
the market capitalization of those that remain has rocketed
upward. While the number of public companies has
dropped by roughly half over the past twenty years, the
market capitalization has increased by approximately a
factor of ten. The top public MNCs of the present day are
some of the most influential organizations not only in the
U.S., but around the globe.
In sum, the public corporation has not been eclipsed, it
has evolved. Successful MNCs have levered public corpora-
tion status in several ways. First is the economic leverage
of the public capital markets, which has helped companies
amass the balance sheets to execute large projects. Second,
MNCs have shown their ability to leverage relationships,
particularly with governments, both overseas as well as at
home. Third, MNCs have levered the ability to arbitrage tax
rules across countries.
48. Ciccotello and Muscarella, supra note 10.
49. The “Halloween Massacre” is an example of a decisive action by a government
concerned about the proliferation of uncorporate forms—in this specific case, income
trusts. Taken over a weekend in 2006, this measure effectively preempted the risk of a
large scale-migration by Canadian public corporations to the trust form in order to avoid
entity level taxation. See Barbara Balfour, “The income trusts ‘Halloween massacre’:
handling the fallout one year on,” The Lawyers Weekly, September 14, 2007, available
at http://www.lawyersweekly.ca/index.php?section=article&articleid=538.
20 Journal of Applied Corporate Finance  • Volume 26 Number 4  Fall 2014
these companies will be taken private or acquired by another
public firm. And some will be the loss of the “corporate” part
(as in a conversion from corporate to REIT structure).
Third, the market for corporate control will continue
to evolve. While the number of public corporations has
been declining over the past two decades, the number
and size of institutional investors and activist hedge funds
continue to grow. Many of these institutions practice active
management, through either a search to uncover information
that identifies mispriced securities or engagement in
actual corporate control activities. But active investment
management is under increasing pressure from ultra-low
cost index investing, as evidenced by the rapid growth of
exchange-traded funds. Active management that focuses on
the market for corporate control will remain a strategy for
a number of institutions. Since the public companies that
remain have higher Q ratios than in the past, the “lower
hanging fruit” is arguably gone. Going forward, realizing
returns to activism will thus become a more challenging
proposition as a larger number of activists chase a smaller
number of more fairly-valued targets.
For a number of institutional investors, beating their
performance benchmarks over short-term horizons is very
important. And they transmit that pressure by putting the
heat on management to perform in the short run. In the
past decade, this has meant a lot of cost cutting by public
companies to support earnings growth in a low top-line
growth environment. The effect of such pressure on the
long-run competitiveness of U.S. companies is an open
question. To the extent that institutional investors are able
to extend their investment horizons and free themselves
from a short-term focus, the pressure on public corporations
for near-term gains at the expense of longer-run value may
decline. Larry Fink’s letter to CEOs about the primacy of
long-term value creation is a marker for what could be a
dramatic evolution in the nature of investor activism in the
coming decades. 50
Fourth, the public company environment will continue to
become more challenging as growing resentment of winners
and intensifying focus on isolated anti-social corporate acts
(that are attributed to public companies as a whole) continue
to be fueled by media saturation. Some companies will find it
better to move out of the spotlight. But others will crave the
attention that media saturation brings. And another major
market correction in the U.S (triggered in whole or in part by
a suggestion of corporate malfeasance) could lead to another
omnibus regulatory package. This would raise the costs of
staying (or becoming) public, and thus accelerate the decline
in the number of public companies on the margin.
Fifth, a small number of “superstar” firms will increase
their dominant positions and lever their advantage through
political as well as economic means. Public corporations such
as Apple, Exxon, and many other highly regarded S&P 100
firms transcend political boundaries and now constitute the
most efficient (and powerful) organizations on the planet. On
a global scale, the rise of these MNCs along with the birth
of publicly traded SOEs from formerly centrally planned
economies have put the public corporation squarely at the
intersection of government and business. Consider the recent
comment by George Washington University law professor
Jeffrey Rosen: “As Facebook and Twitter have become the
public squares of the digital age, their censors now have more
power over the future of privacy than any king or president
or Supreme Court justice.” 51
The power and efficiency of the world’s largest MNCs
place them in extraordinary positions vis-à-vis government.
In industries that contract directly with the government, such
as defense, there are often only one or two viable vendors for
large purchases. On an operational basis, high-tech MNCs
now rescue government from information system challenges
that have become incredibly large and complex (e.g., health-
c
Stanford University
Amar Bhidé
Tufts University
Michael Bradley
Duke University
Richard Brealey
London Business School
Michael Brennan
University of California,
Los Angeles
Robert Bruner
University of Virginia
Christopher Culp
University of Chicago
Howard Davies
Institut d’Études Politiques
de Paris
Robert Eccles
Harvard Business School
Carl Ferenbach
Berkshire Partners
Kenneth French
Dartmouth College
Martin
Are U.S. Companies Underinvesting

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