Publicly Traded vs Private companies

[Maarten]

One thing I have noticed over the last few years is that many businesses these days suffer from an extreme focus on shorter term profits over long-term profits. I would imagine part of that is the uncertainty that's everywhere nowadays about changing regulatory environments, but to some extent I think it is also related to the decline of long-term thinking in today's business culture. When you look back fifty or a hundred years, it seems many more companies focused their strategic goals on the very long term, and weren't afraid of making investments that'd pay off in twenty, thirty years. Nowadays in a lot of cases it seems as if a new investment has to pay for itself within a year or two for anyone to even look at it. Obviously there are exceptions to this, but I have noticed that general trend by looking at current events and topics that came up during various business classes I have taken.

One thing that struck me, however, is that this development seems far more apparent with Publicly Traded companies; investors these days are focused on the last few quarterly results to the exclusion of virtually all else. You frequently see the same when others comment on stock market developments, company results, etc. Because ultimately the stockholders of a publicly traded company are its owners, it seems that this short-term focus of many participants in the marketplace encourages companies to act in such a way as to maximize shorter-term returns and keep their owners happy. But very often this doesn't coincide with the best course for the company's (and the stock's) long-term returns.

If anything at all happens stocks can devalue overnight because people lose confidence, even when it doesn't have any real impact for the company's real value or growth potential.

In contrast, while I know there must be countless exceptions, it seems that privately held companies have much more freedom to pursue their longer-term goals, because they are less bound by the interests of many actors in the general marketplace. Because their stock is not traded it is far easier to take a short-term loss or forgo a profit that might not work out in the long term for the sake of longer-term growth, as long as the owners of the company understand this. Granted, this might not be the case if a company was owned by a VC firm that only wants to make a quick profit, but in most cases these companies are owned by long-term investors that don't mind waiting longer as long as it pays off. In my eyes it seems that this mode of operating has huge advantages in today's climate; not to mention that they're not as subject to the scores of regulations publicly traded companies are.

Granted, it does give a company a huge boost in capital if they go public and sell their stock for a good amount of money; but at the same time I have to wonder if it really is worth that when you consider the autonomy they lose?

Unless I am missing something it seems as if a private company would far outperform a publicly traded company in the longer-term because they don't have to sacrifice long-term gains for short term gains. That might be an oversimplification in many cases, but has anyone else noticed this particular trend?

[Capitalism Forever]

Unless I am missing something it seems as if a private company would far outperform a publicly traded company in the longer-term because they don't have to sacrifice long-term gains for short term gains.

If we assume that they have the same amount of capital, then probably yes. But it should be noted that going public makes it much easier to raise capital.

[gags]

Granted, it does give a company a huge boost in capital if they go public and sell their stock for a good amount of money; but at the same time I have to wonder if it really is worth that when you consider the autonomy they lose?

Unless I am missing something it seems as if a private company would far outperform a publicly traded company in the longer-term because they don't have to sacrifice long-term gains for short term gains. That might be an oversimplification in many cases, but has anyone else noticed this particular trend?

One of the primary advantages of going public is that it reduces the company's cost of capital. Investors are willing to accept a lower return on investments that are liquid, i.e. easily traded. Studies have shown that lack of marketability for a period as short as two years or less can result in discounts of 30% or 40%. Of course, the increasing cost of complying with government regulations detracts from the advantages of being a public company. In recent years, taking a publc company private has become a more attractive option.

I don't think you're necessarily correct in assuming that investors in public companies are always more short-term oriented than those in private firms. It really depends more on the industry, the type of company, and its stage of development. If you have a drug development company that has some promising technology that might cure cancer, you're going to draw in a group of public investors who understand that this is a long-term project and that it requires an extended investment horizon. On the other hand, that doesn't mean that your investors are going to write you a check and ask you to tell them how things are going in 10 years. They're going to want to see indications along the way that there are real signs of success. For example, they'll want to know the outcome of your clinical trials and they'll want to be informed when you pass certain milestones for FDA approval, etc...

There is no doub that a lack of marketability requires one to have a longer investment horizon when you are choosing between investing in a public company and a private one. However, that inability to sell your investment quickly also increases your required rate of return on that investment, making the cost of capital higher for a private company compared to a public one, all other things being equal.

[Castle]

There is also the factor that a great deal of schooling is not at all focused on teaching business leaders to plan or even think that long term. To do so you have to have confidence in yourself, the world you're operating in, and cause and effect. Thats not exactly paramount in the current paradigm. This seems to be accelerating as time goes on, too.

[MichaelH]

There is also the factor that a great deal of schooling is not at all focused on teaching business leaders to plan or even think that long term. To do so you have to have confidence in yourself, the world you're operating in, and cause and effect. Thats not exactly paramount in the current paradigm. This seems to be accelerating as time goes on, too.

I can second that. I recently finished my MBA, and every course included some variant of "change happens faster than ever in the modern fast-paced global business environment". Some classes had the word "internet" stuck in there as well. The line was a bromide, used as a stock intro or closure of most of the outside articles we were required to read. Business students are absolutely encouraged to see the world as a constantly changing mysterious soup in which your best guess for the next quarter is your guide to life. There was education about long-term strategy, but it would be easy to dismiss given the prevalence of "everything's going to change!!" panic in the curriculum.

[Edit: To be fair, some of this was in contrast to the old hierarchial business model where companies expected to keep doing exactly the same thing for 40+ years. However, it seemed out of proportion to me.]

Edited October 9, 2009 by MichaelH

[Castle]

There is also the deliberate insertion of uncertainty into the market by the government. It becomes difficult to plan far into the future, even if you're motivated and skilled at it, when antitrust law has no clear declaration of what actually is illegal and you never know when your industry will be target by politicians crusading against imaginary injustices to pander for a vote.

[The Individual]

There are many successful public companies and of course, many disastrous ones.

Those who are successful often have Management who are looking after the long term interests of the company's business.

Nowadays, companies have in place a stock options benefit system to encourage Management to perform well and steadily whilst ensuring the company's long term goals are met. Performance plans, which tie management compensation to measures such as growth in earning-per-share or other ratios of rate of return are also used. These incentives are in place to motivate managers to operate in a manner consistent with the company's long term goals.

The recent spate of financial companies failing ( AIG(now called AIU), CitiGroup, etc) is due to the abuse of the Golden Parachute system. The GP system specifies compensation to managers in the event of the loss of their jobs or a change in the control of the company. The managers-in-charge knowing that even if they were sacked they will receive huge amount of money, decided to take high-risks business decisions such as CitiGroup investing billions into mortgage-backed securities and AIG insuring these mortgage-backed securities.

So, how a company performs in largely due to the kind of Management in charge and not because of whether it is public or private.

[gags]

Here's an interesting piece from Bob Pozen where he talks about the problems caused by short-term thinking:

If we want corporate America to avoid short-termism, we need to help free portfolio managers and company executives from the tyranny of quarterly results. Since I work in the investment management industry as the Chairman of MFS Investment Management, I am particularly aware of the pressures to take a short-term perspective in the financial markets--and the often unintended or unknown collateral damage they wreak. This problem is particularly pernicious in that other countries don't focus on the short term nearly as much as the US. As a result, these pressures impede the pursuit of long-term strategies by American public companies to their competitive disadvantage in the global marketplace.

http://blogs.harvardbusiness.org/hbr/resto...anny-of-qu.html

[Kaiwai Gardiner]

Here's an interesting piece from Bob Pozen where he talks about the problems caused by short-term thinking:

If we want corporate America to avoid short-termism, we need to help free portfolio managers and company executives from the tyranny of quarterly results. Since I work in the investment management industry as the Chairman of MFS Investment Management, I am particularly aware of the pressures to take a short-term perspective in the financial markets--and the often unintended or unknown collateral damage they wreak. This problem is particularly pernicious in that other countries don't focus on the short term nearly as much as the US. As a result, these pressures impede the pursuit of long-term strategies by American public companies to their competitive disadvantage in the global marketplace.

http://blogs.harvardbusiness.org/hbr/resto...anny-of-qu.html

Unfortunately many people are irrational when it comes to understanding a business; for example, take a look at Apple from 1997 where profits dipped but instead of cutting staff - the total R&D increased and hiring increased. When only looks over the 12 years since Steve Jobs return one can see that those sacrifices of short term profits for long term gain has resulted in what one sees today. Too many people want to have over night profits and if they don't get those results over night they feel as though management isn't giving them what they want - they want to be a millionaire by the age of 40 and retire at 50.

Delusions drive irrational behaviour - just as one Ayn Rand enjoyed watching shows where ordinary people did extraordinary things - one also has to look at all the hard work required to get to that point. Too much time by the media is spent on people who make it big off luck thus giving the illusion that all can have that luck - the reality is that the vast majority of people hit it big after many years of failures, a lot of hardship and sacrifice. Those who make it big over night are but a small few.

Then again, it goes back to how children are raised by their parents. Everything starts when they're young - the way people behave are the result of the values instilled at an early age.