Changing tides

Professor Paul Kerin considers the future of Australian public companies and the forces likely to alter the make-up of the listed sector.

Last year marked the 25th anniversary of one of the most important business articles ever written: Eclipse of the public corporation by Harvard Business School’s Michael Jensen. While his pessimistic prediction did not eventuate, Jensen helped us understand real threats and we can learn much from what followed in the quarter-century since. 

Jensen didn’t predict the complete demise of public companies, but he did predict that other business models, particularly private equity, would come to dominate. His prediction flowed from beliefs that public companies were not sufficiently focused on shareholder value and that various elements of private equity, such as high leverage and senior executive compensation incentives, drove management to focus more on shareholder value.

It’s true that many Australian companies lacked that focus in the 1980s. However, Jensen’s prediction didn’t eventuate for two reasons. First, public companies lifted their game. Second, the prediction suffered from the fallacy of composition.

In product markets, globalisation and greater domestic competition raised the bar that businesses had to jump to survive and profit. In the market for corporate control, mounting evidence of substantial shareholder value creation following changes in ownership made companies recognise that if they didn’t focus on shareholder value they would be snapped up by corporate raiders, private equity or other companies. 

Companies improved governance systems, aligned senior executive compensation with shareholder value creation, focused on managing free cash flows and returned excess cash to shareholders. That is, they adopted the very elements of the private equity model that had caused Jensen to it see as a threat. Furthermore, while private equity is a potent threat to individual companies, it is less of a threat to public companies entirely. Private equity firms generally add most value as temporary – rather than permanent – business owners; once they’ve added the value that they can, they exit – often through re-listings or sales to public companies.

Looking ahead

So what does the next quarter-century hold? Private equity will continue to be a potent threat to individual businesses, but not to public companies entirely.
A very different organisation form may pose a bigger threat: government. Jensen actually warned of this threat in 1978, long before his more famous 1989 warning. Just as management do not necessarily act in shareholders’ interests, governments don’t necessarily act in the public interest. As Jensen argued that governments had undue incentives to control resources and over-regulate and saw “no forces likely to curb the gradual encroachment of government”, he concluded that the corporate form of organisation was “likely to disappear completely”.

While prone to exaggeration, Jensen rang important bells. He was rightly concerned about the financial and regulatory burdens that governments imposed on business. Those burdens are much heavier now. The creeping hand of government may be as big a threat to companies as slow burn is to frogs in a beaker. 

But there is another, more direct, threat from government. Australian governments have privatised many business enterprises in recent decades, partly prompted by greater recognition of the advantages of private enterprise.

However, we are currently witnessing the emergence of large state-owned enterprises (SOEs) from China and elsewhere on the global stage. In product markets, competition from SOEs will make it harder to survive and grow shareholder value. In the market for corporate control, competition from SOEs will see many businesses disappear from the listed sector.

On the other hand, many SOEs are already partially listed and it is quite possible that the next quarter-century will see foreign governments list or sell SOEs to Australian public companies.

One thing’s for sure, the make-up of the listed sector will change substantially. If recent history repeats, about 30 per cent of today’s listed companies will remain listed in 25 years’ time.

Mergers and acquisitions will account for the majority of exits, but company failures and voluntary de-listings will be significant. The ambitions of SOEs and intensifying product market competition may mean the next quarter-century sees even more change than the last.