I-P-Woes

Why do companies go public?

Photo: Digby Dalton. Source: Wikipedia

Most of the biggest companies are publicly listed on a stock exchange. Exxon Mobil, Apple, and Microsoft have hundreds of billions in sales and employ hundreds of thousands of people. But there are a lot of big, nonpublic firms: Koch Industries in energy, Cargill Corporation in food, and Dell computers, among others. Private companies can hire, fire, borrow, and build things just like big public companies. And they don’t have to disclose financial and business information that might help their competitors. So why do managers put up with the hassles of public ownership?

The big reason is they need currency. They need their stock to be liquid and readily available, primarily for two purposes. The first reason is they may want to use their stock in order to acquire a related firm. Acquisitions for cash are rare among big corporations. By using their shares, the acquiring firm preserves its operating capital and doesn’t need to lever up its balance sheet.

The other reason companies need public shares is to compensate their employees. Firms can use options or restricted shares to align managers’ interests with those of the other shareholders. When employees own shares, they benefit when the stock price rises. This gives them an incentive to look for ways to improve the firm’s profitability. And public ownership allows companies to extend their equity ownership more deeply throughout the firm.

Going public doesn’t solve all of a firm’s problems, but it does provide a way for managers to put a value on their business that is widely accepted. This allows them to provide incentives to a broad range of workers, and to combine their operations with another firm at a reasonable price—without using operating cash or borrowing.

Publicly-listed companies have their disadvantages. The stock market can be a distraction. But there’s a reason why almost all of the biggest companies are public.

Douglas R. Tengdin, CFA

Chief Investment Officer

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