Tuesday, 7 October 2008

The hidden cost of equity

What’s all the noise about being a public company anyway? I recently asked the CEO of a FTSE 250 company “what’s the advantage of being listed?” She shrugged and said “I don’t know; it can give you access to some capital I guess but, apart from that…”.

Of course it is rather “sexy” and exciting. Many CEOs don’t just want to be a CEO; they want to be the CEO of a public company. But what really are the advantages of having your company listed on the stock exchange? Naturally, selling equity is a source of money, but of course there are other sources of capital which could suffice for your investment plans. But, alright, I’ll give you that; it’s one potential source of money.

Yet, I would say this source comes at a cost. Investment bankers will be able to spell out to you – in much much, much detail... – what the advantages and disadvantages are of the various sources of capital, including equity. However, I think they’re forgetting one.

I recently spoke to Bill Allan; CEO of THUS (the former Scottish Telecom). Some years back, they all of a sudden were elevated into the FTSE 100. He admitted that, at once, he found himself having to spend the majority of his time dealing with fund managers, analysts, investors, the business press, etc. Of course this was a relatively unusual and extreme situation; the telecom bubble launched THUS into the FTSE 100 when they weren’t quite ready for it. However, all the CEOs of public companies that I have talked to, in private, will admit that they spend about 30 percent of their time dealing with “the stock market” (i.e. fund managers, analysts, institutional investors and the wider public). Simply put, they wouldn’t have to do this if they weren’t listed.

Think about it: that’s quite a cost. If you have a good company and you decide to float it (starting to sell equity on the stock market), all of a sudden, you lose 30 percent of your top management capacity!

Are you sure that’s worth it? That’s 30 percent which they could have spent on cultivating the organisation, motivating employees, thinking through opportunities for future growth, integrating acquisitions, etc.

Moreover, many CEOs end up not particularly liking the 30 percent… It is a lot of hassle, pressure and a bit of a pain, having to tell (and defend) your “story” over and over again, to people who really don’t have much in-depth knowledge about the company and its business, often haven’t received any training in developing or even understanding strategy, and occasionally may not have much talent for or affinity with it anyway!

How do you quantify this cost of being listed? I don’t know; it is difficult to put a number on such a thing (which is probably why we don’t pay much attention to it in the first place!). But I will assure you that many CEOs will privately tell you – be it while whispering behind the palm of their hand – that being listed isn’t so sexy and exciting after all. And, if they still had a choice, they would do without it.


Anonymous said...

I guess this is one of the reasons PE houses give for their supernormal returns: CEOs and top management don't have to deal with the stockmarket (the PE house does have to deal with their investors, though), plus they can think longer term than the usual end-of-quarter horizons of the analysts...

On the other hand, being listed gives you a very quick assessment of the value created/destroyed by management decisions. In theory, at least, and when there are no bubbles...

Nick said...

I actually just finished writing a paper on this very topic for class. I came to the conclusion that for some companies it may be advantageous to go public, for many they are much better off staying private. Something you didnt mention, but I think are implied, are all of the costs associated with an IPO. In the US Sar-box has made it even more difficult/expensive to list on an exchange. Anymore there just arent enough pros to outweigh the cons of an IPO.