Stock Markets and Private Capital

As examined in my paper, ‘Stock Markets and Private Capital’, in Spain as well as elsewhere stock markets are experiencing an economic decline as a consequence of the progressive and apparently unstoppable reduction in the number of listed companies and their capital raising operations. Testament to this are the diminishing number of IPOs and the increased significance of delisting operations that largely take the form of public to private transactions carried out by private equity funds and financial investors. With regard to financing the operations of listed companies, it is revealing that the amount of share buyback programmes, that issuers use to refund contributions to the shareholders, exceeds the funds that issuers obtain from new capital increases. 

This circumstance has given rise to a response from legislators and regulators in the European Union and in Spain, although in the latter case the approach has been partial, contradictory and inconsistent. This response, also driven by the increasing competition to attract new listings, has led several countries to opt for policies designed to introduce greater flexibility to, and deregulate the system of, IPOs and the status of listed companies. While most of the proposed reforms affect regulatory issues, the loss of attractiveness of stock markets for many companies seems to be explained not only by certain changes in the nature of the companies in the new economy, but also and fundamentally by the colossal development that private capital and credit markets have undergone in recent years, in terms of assets managed, fundraising and number and volume of transactions. Public and private markets are not completely separate universes but have significant connecting elements, as evidenced by the numerous public to private transactions carried out by private investors and such investors’ importance on the IPO market, however much it has fallen on hard times in recent years. But the reality is that private capital, by guaranteeing ample and more flexible financing possibilities for companies and liquidity for their shareholders and founders, has largely replaced the functions traditionally performed by the stock markets.  

Private capital also offers important benefits by providing companies with a peculiar structure of ownership, control and incentives, giving rise, in general terms, to important economic and organizational advantages, in comparison with the stock markets. Private equity funds do not act as mere investors; they also contribute their investing experience, knowledge of the sector and management know-how, thus driving the development and expansion of investee companies. Unlike listed companies, which are subject to a strict, mandatory regime of corporate governance, private investors establish a wide range of statutory and contractual agreements with managers and other shareholders, which can be adapted to the specific needs and characteristics of each company, making alignment of the incentives of the different parties possible. This facilitates a more effective supervision and control of managers and directors by shareholders and helps to mitigate the problems of agency and information asymmetry that are inherent to listed companies. Companies and private investors also benefit from the possibility of encouraging more long-term investment strategies or policies, without suffering from the constraints and demands of immediacy that are so common in listed companies.  

The consequence is that the financial markets have seen, and are expected to continue experiencing, a process of displacement or migration from the public to the private markets, with the consequent formation of a new relationship framework or equilibrium between the two. This process has been driven both by companies, which increasingly and massively choose to finance themselves through private markets, and by investors, who also devote an increasing volume of resources to them. In this context, private capital has ended up providing companies with the financing and liquidity possibilities that have traditionally been associated with the IPO and listing processes.  

In this sense, the depression afflicting stock markets of late, which regulators in particular tend to see as the manifestation of a serious economic problem that should be corrected, should rather be interpreted as a sign or evidence that the market or economic system itself has taken care of developing financing instruments and finding alternative instruments to allocate resources to those provided by public markets. At least for certain types of companies, such alternative instruments appear to be more efficient. But there are still relevant legal policy arguments to try to revitalize stock markets, such as the informative function they perform or the fact that they represent an essential channel for investment and participation by small investors in economic growth. 

The author’s article can be found here.  

Javier García de Enterría is Professor of Commercial and Corporate Law at CUNEF Universidad.