We live in an age of shareholder capitalism, or so I like to think. One in which a large part of the population has a stake in the future via its holdings in the equity markets, and, as a consequence, has a business-friendly bias. And one in which the managers of listed companies recognise the needs of the end holder of their shares and act accordingly.
This is the kind of thing that Margaret Thatcher had in mind when she came to power in 1979. She abolished dividend controls (yes, there really was a day when governments had a say in how much a company could pay in dividends); she cut the taxation on dividends from a maximum of 98% down to 40% ; she introduced the concept of tax-free investment wrappers with personal equity plans (PEPs); she deregulated the stock exchange and dragged the private investor into the market via her stunningly successful privatisation schemes and an 18-year bull market.
During the 1980s, says stockmarket historian John Littlewood in The Stock Market: 50 years of Capitalism at Work, the number of individual stock owners in the UK rose from three million to more like eight million. It was good.
However, what I like to think and what is now true are rather different things. Capitalism isn’t a static thing: it is constantly shifting in shape as the incentives around it change. We now live in an age of what the late Hyman Minsky called “money manager capitalism”, in which almost all investing is done not by individuals but by fund managers.
In 1969, 47% of the UK stockmarket was directly held by individuals, and 30% was held by institutions (unit and investment trusts plus pension funds and insurance companies). By the mid-1990s those numbers were 20% and 60% respectively. The latest numbers from the Office for National Statistics show the percentage held by individuals down to 12% .
Institutions have become the effective owners — and supposedly controllers — of listed companies. This matters enormously, particularly as it is an experience that has been replicated across the developed world. Middlemen money managers have different financial incentives from the rest of us. They compete on (and get paid depending on) short-term performance. So they are, as Mr Minsky put it in a 1996 lecture, “especially sensitive to the current stockmarket valuation of a firm”.
That means they don’t like companies to invest too much or to get into new businesses that might make them a loss. It means that they have little incentive to complain about short-term remuneration policies at big companies – if everyone is in it for the short term, what’s the problem? It also means that they are keen on companies raising debt rather than equity (it is financially “efficient”) and are addicted to mergers and acquisitions.
As Mr Minsky put it, “because of their commitment to maximising fund holders’ value these funds are constrained to accept bids that are at a premium to current market values”. That in turn has created a general bias towards two things in the stockmarkets. The first is bigger companies (the sales of the median US-listed company are now three times what they were 20 years ago in inflation-adjusted terms) and the second is fewer companies (there were about 8,000 firms listed in the US in the mid-1990s; by 2012 there were 4,000).
You might think that M&A shouldn’t end up cutting the number of firms listed. After all new initial public offerings come along all the time. They should be replacing companies that merge or delist. Sadly, it seems it isn’t so. Something else has changed in the past 20 years. Growth companies are listing later (when they are already huge) or not listing at all.
There are all sorts of reasons why this is happening. Debt is easy to come by, and cheap — it is also actively encouraged by most tax codes which allow you to write off debt interest against taxes. There are new ways to raise finance outside the big markets (private equity, hedge funds, crowdfunding and the like). As James Anderson of Scottish Mortgage regularly points out, many new business models don’t need much capital – Facebook, Alibaba and so on – so they can be huge before they bother to come to market. The rise in regulation, and hence costs, doesn’t help. Nor, for that matter, does money-manager capitalism: who wants to list if it means being harangued by a group of return-on-equity obsessed nitwits every single quarter forever? Well, quite.
All this matters for two reasons. First, letting companies get too big kills the supposedly co-operative nature of the stockmarket. Small listed companies might listen to investors, just as they have no choice but to listen to private-equity owners. Huge ones that have listed late and are still largely founder-owned don’t need to. Anyone see Google listening to the public on their tax affairs, or for that matter more than a few of the major players in money-manager capitalism having a go at them? Me neither. We can hope they will use the power they have for some kind of communal good in the end – Anderson tells me he expects them to. But it isn’t a given yet.
And second, de-equitisation brings with it all sorts of problems. People that aren’t participating in markets don’t have much sympathy for markets (I give you Google again). The same holds if they are participating passively, and, to a degree, even via an online account. And if most of the growth is happening off-market, there is an obvious wealth equality problem. It’s all bad.
Investors can deal with this in a simple way. They can get growth by participating in the unlisted economy (the growing part of the economy) via the funds that are operating in the area – Patient Capital or Scottish Mortgage, for example. And they can use Enterprise Investment Schemes or dabble in crowdfunding, something I see as a step back to the future in the way it seems to replace the 40-odd regional stockmarkets the UK had in the post-war period. But they should also mourn the replacing of old-fashioned shareholder capitalism with today’s hybrid of distance and de-equitisation. It isn’t as good.
• This article was first published in the Financial Times.