Causes and Consequences of Shrinking Stock Markets

Nov. 27, 2023

Trading plays a vital role in determining share values and fostering competition. But what happens when fewer companies go public, and how does this impact the broader economy?

From London to New York, stock markets around the world are getting smaller. Fewer companies are choosing to go public as more find it easier to raise funds from private markets through venture capital and private equity.  

At a Swedish House of Finance conference entitled "How to Develop Equity Capital Markets in the EU and the US," Alexander Ljungqvist, a finance professor at the Stockholm School of Economics, discussed the reasons behind this trend and what this means for stock exchanges, companies, and the wider economy.  

Why do we have stock markets? 

Stock markets serve as platforms for companies to raise equity capital. They facilitate share trading, providing liquidity for investors to buy or sell shares and diversify portfolios based on their preferences. 

Importantly, stock markets oversee listing standards that protect public interests, Ljungqvist said.  

“Trading helps to reallocate ownership in an economy and that hopefully helps in governance of capital,” he added.  

Stock markets are shrinking 

Despite the importance of stock markets, there are concerns about the health of the listing market. 

In 2018, Nasdaq sounded the alarm in the United States (US), highlighting a decline in the number of listed firms rather than their market value. This concern is not unique to the US.  

“We see the same debate on this side of the Atlantic,” Ljungqvist said.  

Analyzing historical data on US listed firms from 1841 to 2022 reveals a peak in 1997, followed by a 40% decline. Ljungqvist acknowledged that the situation in Europe, in general, seems no better and possibly worse, although Sweden is an exception with a rising trend in listed firms. 

Why are public markets becoming less popular? 

Many experts and economists argue that the costs of being a public company have risen due to increased regulations and the growing influence of shareholder activism. Simultaneously, the cost of staying private or avoiding an initial public offering has decreased with the growth of private markets, venture capital, and private equity in the past two decades. 

A prominent example of a company that chooses to remain private, Ljungqvist pointed out, is Swedish battery maker, Northvolt.  

“Northvolt has managed to raise US $7 billion since its founding in 2016 in the private market,” Ljungqvist said. “Private capital markets are much more liquid these days.” 

“A perfect storm” 

However, there is more to consider when analyzing the decline of public markets. As Ljungqvist points out, "There is also almost a perfect storm here, as several mega trends have collided." 

Besides the 20-year private equity boom, stock markets have been affected by several factors. These include a surge in algorithmic trading and High-Frequency Trading (HFT); the fragmentation of equity markets, which has increased competition for liquidity; the rise of indexing at the expense of smaller-cap firms; and the increasing importance of Intellectual Property. 

“This is less well-researched, but I think it’s worth thinking about these issues,” he said.  

What does this mean for the broader economy? 

While having fewer companies choosing to go public may allow stock exchanges, companies, and investors to make privately optimal decisions, this does not mean that it is socially optimal for the wider economy, Ljungqvist warns.  

“By not listing, companies can impose negative externalities on others,” he said. Those negative externalities, or unintended undesirable consequences for society, include reduced price discovery, reduced competition and innovation, and reduced access to investment opportunities. 

“You let yourself be acquired by an incumbent firm instead of going public and competing with the incumbent,” Ljungqvist said. “By staying private, startups would deprive the man on the street of access to investment opportunities, contributing to an increase in wealth inequality.”