I read an interesting article in the economist last week about the SAS corporation (see Doing Well by Being Rather Nice). SAS is an interesting organization, and Jim Goodnight is definitely an interesting fellow. But to be honest, many of the details did not strike me as new (especially considering the 60 Minutes segment on SAS from 2003). However, there was one quote from the article that got me thinking.

In response to a question about why SAS was not a publicly listed and traded company, Jim Goodnight responded:

We don’t have to deal with Sarbanes-Oxley or minority shareholders suing us every time we turn around, or 25-year-old Wall Street analysts telling us how to run our business…There are lots of advantages.

Many of us take for granted that being a public company provides some real advantages for firms. In fact, for many new businesses, going public seems to represent some sort of triumph – the nadir of their corporate existence.

But Jim raises some really interesting questions, so let’s weigh some of the benefits with some of the costs:

Benefits of going public have traditionally included:

1. Access to risk seeking capital
2. Access to large pools of money

In the old days, banks were rather small, dispersed, and risk averse. During the industrial revolution, firms needed access to large sums of cash to invest in capital equipment (heavy machinery). On the one hand, their financing needs could easily outstrip the ability of small local banks to provide them. On the other, banks were risk averse by nature and were not willing to put large sums of their own money at risk on inherently risky ventures. Therefore, going public (tapping into a large and dispersed public market) allowed firms access to the large sums of cash they needed to fund their businesses from investors who were willing to bear the risk.

3. A means for wealthy families to exit existing businesses

Families often have a lot of their wealth tied up in the firms that they found. Over time, it becomes risky for families to have their wealth tied up in just one investment (which may be quite illiquid); therefore, families will often take their firms public in order to be able to diversify their assets and realize some private gains from their firm. Also, 2nd and 3rd generations may take family companies public for tax purposes – e.g., to offset some of their inheritance tax burdens. For these reasons, it’s no surprise therefore that many of the largest U.S. public corporations are, or were at one time, family firms.

4. Prestige

At some point it became prestigious to be a public company. I’m not exactly sure when or why, but being public conferred some sort of status, allowing public firms to better attract managerial talent, and maybe even lower their cost of capital vis-a-vis private firms.

Although these were traditional benefits to public corporations, there are some who have argued that things have changed recently to make it not so attractive to be public anymore. For instance:

1. The rise of institutional investors – Previously, firms were generally limited to banks (or public markets) to raise capital. But now, cash is abundant and available from various sources – banks, pension funds, investment banks, hedge funds, private equity firms, insurance companies, sovereign wealth funds, etc. This makes it easier for firms of any kind to attract capital. Firms now often have institutions competing for their business. So if I can raise capital without having to be public, then what’s the benefit of being public?

2. The cost of compliance – It’s not cheap to be public. Everyone at this point is familiar with Sarbanes-Oxley and its impact on the costs of regulatory compliance, …especially with respect to section 404. It’s not only that, but in order to be public I need accountants, auditors, PR firms, investor relations staff, not to mention a group of senior managers that spends a good deal of time dealing with wall street, and their nosy analysts. Who needs such hassles anymore? As a shareholder, I’d rather have my managers spending time running the business rather than waste time trying to mollify wall street analysts.

3. The reputation costs associated with public scandals – After Enron, Worldcom, and the like, it has become clear to investors that the management of public firms may not be the stewards of the firm, and may not act in the and shareholders’ best interests. Events like these can’t help the prestige effect, and although the scandals have been limited to a few firms, there are some reputational spillovers to other public firms.

Taken together, if benefits #1, #2, and #4 (listed above) seem to be decreasing for the reasons described, we have to take a long hard look at whether or not it really makes sense for many firms to be public. Also, we have to wonder about the kinds of firms that are currently going public. Are they truly the best, most innovative firms, or is there some adverse selection problem going on in which the riskiest, marginally managed firms are electing to take their firms public?

Who knows, maybe the costs associated with going private (via de-listing or selling the firm) are keeping some public firms that would otherwise prefer to be private from doing so. Let’s not even go there…

This entry was posted on Sunday, December 9th, 2007 at 6:20 pm and is filed under Corporate Strategy. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.