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CAPITAL FORMATION

The Evolving Role of Public and Private Markets

CAPITAL FORMATION:
THE EVOLVING ROLE OF
PUBLIC AND PRIVATE
MARKETS

Sviatoslav Rosov, CFA

The mission of CFA Institute is to lead the investment profession globally by

promoting the highest standards of ethics, education, and professional

excellence for the ultimate benefit of society.

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profit organization that awards the Chartered Financial Analyst® (CFA) and
Certificate in Investment Performance Measurement® (CIPM) designations.
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of the trademarks owned by CFA Institute. To view a list of CFA Institute

trademarks and the Guide for the Use of CFA Institute Marks, please visit our

website at www.cfainstitute.org.

© 2018 CFA Institute. All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system, or transmitted, in any form or by

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legal advice or other expert assistance is required, the services of a

competent professional should be sought.

Contents

1.

Introduction

2. Public Markets

2.1.

The Purpose of Public Corporations and Markets

2.2.

Descriptive Statistics on Public Market Trends

2.2.1.

The Decline of Publicly Listed Firms

2.2.2.

The Decline of Small Publicly Listed Firms

2.3.

Should We Be Concerned?

3. Drivers of Trends in Public Markets

3.1. Corporate Evolution

3.1.1. Conglomeration and Reversal

3.1.2. Economies of Scope

3.1.3. The Rise of Intangible Assets

3.2. Public Market Structure

3.2.1. Regulation and the Market Ecosystem

3.2.1.1. Regulatory Expenses and Competition

3.2.1.2. The Market as a Utility

3.3. Regulatory Costs for Issuers

3.3.1. Regulatory Overreach?

3.3.2. Private Market Deregulation

3.4. Summary—The Eclipse of the Public Corporation

4. Private Markets

4.1. Private Equity

4.1.1.

Assets under Management

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. Contents

4.1.2.

Performance of Private Equity Funds

4.1.3. Dry Powder Problem and Ability to Absorb Capital

4.2. The Rise of Private Credit

5. Policy Recommendations

5.1. Avoid a Race to the Bottom

5.2. Look Out for Systemic Implications

5.3.

Improve DC Fund Access to Private Markets

6. Summary

References

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WWW.CFAINSTITUTE.ORG

Acknowledgments

We thank the members of the Capital Formation Steering Group, listed in alphabetical order
below, for their insights and advice:

James J. Angel, PhD, CFA, Associate Professor, McDonough School of Business,
Georgetown University

Frank Hatheway, CFA, Chief Economist, NASDAQ OMX

Jimmy WK Jim, CFA, CPA (Aust), Global Markets Department, Industrial and
Commercial Bank of China (Asia) Limited

John Marsland, CFA, COO Investment, Schroders

Maurice Martignier, CFA, Senior Corporate Actuary, Nestle

Nicola Ralston, FSIP, Director, PiRho Investment Consulting Ltd

Bruce Tomlinson, CFA, Manager, Hedge Funds & Alternative Strategies, Sunsuper

Pamela Yang, Managing Director, Head of Charitable Asset Management, State Street
Global Advisors

We also thank the workshop participants in Hong Kong SAR, Abu Dhabi, Dubai, London, New
York, and Washington, D.C., for their input.

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED. 1. Introduction

Public markets and public corporations are intrinsically linked. Not surprisingly, then,
changes in the nature of public markets are causing changes in corporations, and vice
versa. Public corporations have been experiencing significant changes since their defini-
tive modern form—based on dispersed equity ownership and common shareholder
rights—took hold in the early 20th century. The increased prominence of shareholder
value maximization considerations in the late 20th century caused corporations to become
more narrowly focused on maximizing profits. Today, investors and company manage-
ment are apparently shifting their attention to nonfinancial considerations, including
corporate and environmental sustainability. At the same time, pressure on public corpora-
tions is growing, due to increasing corporate disclosure requirements, listing standards,
and governance practices. Entrepreneurs often complain that being a public corporation is
increasingly or excessively onerous.

Circumstances differ today because the market power of entrepreneurs in accessing capi-
tal for their businesses has increased to the extent that avoiding public markets entirely
has become feasible. A combination of newly deregulated or largely unregulated private-
capital pools, such as Initial Coin Offerings (ICOs), with large amounts of deployable
capital searching for higher yields in a near-zero interest rate environment, as well as new
business models that require less capital to grow, provide entrepreneurs with a growing
number of options.

These new business models, most often found in highly developed markets, characteristi-
cally have high intangible asset investment. This has important implications for public
markets because companies based on intangible asset development

tend to scale very rapidly;

do not need much capital;

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prefer to deal with fewer but larger investors to retain ownership and control over eas-

ily copied intangible assets for as long as possible; and

have been enabled in doing so by changes in the regulation of private markets and the

global search for yield.

We see no obvious regulatory solution to making public markets more attractive to these
new businesses, as the nature of these businesses seems intrinsically better suited to private

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© 2018 CFA INSTITUTE. ALL RIGHTS RESERVED.