Why It Pays to Be Private

Tired of the hassles and demands, more and more U.S. companies are abandoning the public markets - and for good reason.

By Jeffrey Pfeffer, Business 2.0 Magazine columnist

(Business 2.0 Magazine) -- At a recent conference, I listened as a CEO bemoaned how hard it was to run a public company these days. He cited endless hours meeting with analysts, attending investment conferences sponsored by banks and brokerages, and talking to major and prospective shareholders - all taking time away from running the business.

But most of all, he, like so many of his counterparts I talk to, complained about the difficulty of trying to build long-term value while struggling to meet quarterly numbers. He noted that many value-building moves, such as hiring more salespeople to enhance market coverage, take time to produce results but their costs appear immediately, thereby penalizing earnings in the short run.

This could be just management griping, except that there's data consistent with the view that being publicly traded no longer seems like such a logical goal. With the rise of hedge funds, day-traders, program trading, and incredibly rapid movement of money in and out of stocks - companies in the Nasdaq 100, for instance, saw about 20 percent of their ownership change in August alone - more companies are abandoning the public markets altogether.

According to Lehman Bros (Charts)., since mid-2003 more than 40 public companies have initiated or completed privatization deals worth $400 million or more. In August, Goldman Sachs (Charts) reported that through the first half of 2006, leveraged-buyout activity accounted for 11 percent of all announced merger and acquisition deals, the highest level since 1988 and at least a 50 percent jump in volume from 2005. According to the same report, there are 158 American private equity funds with assets greater than $500 million and another 96 with assets of more than $1 billion, with some 2,000 companies now controlled by U.S. private equity firms - a new record.

But there's more to this trend, I think, than just financial engineering.

Kevin Callaghan, a partner with leading private equity firm Berkshire Partners, believes there are three main factors pushing companies to "go private." First is what he calls the "hassle" factor of being a public company. The hassles include the costs (in both time and attention) of complying with Sarbanes-Oxley, the higher risk of shareholder lawsuits, and dealing with issues of board size and composition.

Next is the money factor. Private firms can operate a more leveraged capital structure. That helps increase the potential returns to equity investors - and to top execs, Callaghan argues, now that many are starting to chafe at new restrictions on executive compensation. When it comes to doling out options to senior management, public companies simply don't have much flexibility.

The third reason for going private is the ability to run a business more effectively. For starters, private companies needn't worry about having their every move and financial result available for rivals to analyze. And they can spend more time on long-range planning.

When I teach executive courses on why companies don't implement what they know they should be doing, executives invariably tell me that the markets won't let them do the right thing. If that's true - and private companies are starting to enjoy some inherent advantage just from being private - then natural selection will take over, and more companies will follow the same path.

That's a frightening scenario for several reasons. First, the privatization trend speaks to the competitive viability of American capital markets. There has already been lots of commentary about the number of companies going public on foreign exchanges and how this reflects on the competitiveness of U.S. capital markets.

Second, it implies that something is wrong with our markets when executives can't make the decisions necessary to raise the value of their enterprises. Perhaps most important, it suggests that entrepreneurs might want to change their goal from IPO to LBO, since that appears to be the way they can both get richer and run their businesses to build value.

Business 2.0 columnist Jeffrey Pfeffer is the Thomas D. Dee II Professor of Organizational Behavior at Stanford University's Graduate School of Business. Top of page

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