The Dread of Compulsory Stock Market Floatation

The current debate in Nigeria about the House of Representative’s plan to enact a law forcing some big corporations to go public on the Capital Market is full of fallacies and assumptions that shield the promoter’s true intentions. The problems identified about the parlous state of our Capital Market are true; but the medication proposed would create new illness that will need subsequent medication. The desire to revive the capital market and the accompany sector of the nation’s economy is commendable; but the current proposals will create more problem that it will solve. Entrepreneurship is a risky business, and nobody like the rules being changed in the middle of the game. One of the main criticism and concern from foreign investors into Nigeria (for many years) has always been lack of stable political, fiscal and legal framework within which to plan long-term; as well as poor infrastructural development of course. Just when we seem to be overcoming these imponderables; we are now seeking to set ourselves back as a nation of stable investments and regulatory climate. Companies should consider the many dangers before running to the stock market for public listing. Many have given up trying to work out what is happening with the Nation’s stock market over the past few years; because the harder you try and examine the facts, the less sense they make.

For the past decade in the Global financial markets; everywhere you look, across sectors and sizes of companies, the name of the game is IPO and going public. Facebook was the biggest so far when it went public (at least partly) few weeks ago. But is it always such a good idea? At first glance, yes. A respectable track record, profitability and increasing revenues are sufficient reason. There is no better way to expand the business than putting it on the stock market, many experts will assert.

Allow investors get a share of the action, while gaining literally hundreds of millions of naira for expansion. With the capital market in Nigeria recovering from its burst of a few years ago, there is no enduring sign of robust regulatory reengineering and enforcement of global standards that will drive lots of new regular investors into the market. Also many politicians and their cronies awash with plenty of stolen public funds are looking for ways to legitimately transform the loot into traceable legitimate financial transactions. So a listing by many of the large profitable private enterprises in the country will be just what the doctors ordered.

That said, entrepreneurs and our established business investors who took the risks and now oversee hugely successful private businesses should think long and hard before giving up their companies to the gods of capital market.

For every success story, the IPO or public listing road is littered with cases of chaos all over the world. As many entrepreneurs have found to their cost, once you go down the stock market highway, your company is run by shareholders and its future often depends on the mood of faceless analysts. Short-term growth becomes everything, usually at the cost of long-term viability. The market analysts either love or hate you and your market valuation follows that mood. That is why you see a company like Facebook (who has no tangible product to showcase) is being valued a thousand times more than many traditional companies that produce the world’s favourite tangible household and industrial products and goods.

As a simple rule of thumb, the more creative and innovative you or your businesses are, the less likely you are to be successful in the stock market in my view. Remember what happened to Sir Richard Branson and Tommy Hilfiger? These are two of the business world’s most creative geniuses, but as they have said many times before, they would never go near the capital market again. They were badly burned, and ultimately let down by investors pursuing immediate share price gains.

Even if a company meets the many stringent requirements of statues and market regulators on floatation; should it do it? That is the million-naira question. And based on the current economic circumstances in Nigeria, I will strongly advise against it. Clearly if a company is terribly short of cash and sees no other way; then go ahead. But if the company is making money and not starved of investment funds; my advise will be stay clear of the Capital Market and remain private for the foreseeable future. After all; there are lots of ways available to raise investment capital that does not involve taking your company public.

It is necessary to note that even when a business is suited to being listed, it may not be the right choice. Admittedly, being a public company can present a range of benefits. The advantages of stock market flotation could include; the giving of businesses access to new capital to develop; allowing the company to offer employees extra incentives by granting share options – this could encourage and motivate employees to work towards long-term goals. Floatation can also increase the public profile of the company, thus providing added reassurance to customers and suppliers. Public listing can allow the organization to do new business – e.g. acquisitions – by using quoted shares as currency. But many of these advantages are in my view, Floatation Fallacies. Histories of many floated companies have shown these benefits are not automatic and do not always last.

Despite the foregoing advantages of going Public; the dangers far outweigh these advantages for many companies.  The disadvantages of becoming a public company on the Capital Market are many and to help you understand my arguments better; I will list them as follows:

Market fluctuations – The business may become vulnerable to market fluctuations beyond your control – including market sentiment, economic conditions or developments in your sector especially given the shaky state of the Nigerian stock market.

Cost – The costs of being quoted can be substantial and there are also ongoing costs of being a public company, such as higher professional fees.

Responsibilities to shareholders – In return for their capital, you will have to consider shareholders’ interests when running the company – which may differ from the company’s objectives. The fundamentals of the company might differ from the perception of markets thus influencing management decisions and availability of funds, as investors are erratic in their perceptions.

Demands on the management team – Managers could be distracted from running the business during the flotation/listing process and through needing to deal with investors afterwards. Also, market pressure often abound for public companies thus luring some managers to adopt creative accounting methods as well as distort reports to conceal actual performance. Enron, Worldcom, Intercontinental bank plc, Oceanic bank are cases in point in recent memory.

Exposure to Hostile Takeover actions. Listed companies can be taken over through hostile actions of competitors or other venture capitalists.

Regulatory Drag. Listed companies face much more regulatory constraints and demands than private companies. This could constitute a drag on decision-making and innovation. The agency problem is often exacerbated in listed companies as a result of the significantly increased reporting requirements as well as the increasing cost of control and ensuring compliance including audit and assurance. Also from a Government standpoint; increased cost is incurred in monitoring publicly listed companies because they involve public finance and can have strategic significance to the economy depending on the sectors. Hence government and her agencies focus more searchlights on Plc’s than other private firms. While this is understandable; it can collectively constitute a drag on speed and innovation.

Loss of Agility. Private companies have the advantage of quick decision-making and fast turnaround compared to most public companies. There are also more statutory regulations to conform to. In addition, decisions, due to bureaucracy, take longer and there may be disagreements. On floatation; private entrepreneurial instincts will have to give way to a more democratic and bureaucratic way of doing things. Hence creativity would often give way to defensive ways of doing things to please markets.

Loss of Control. With loss of agility comes the loss of control by the original owners of the business. Your company is now public property, so the personal touch will be lost. Listing can lead to loss of control of the firm by the owners, as bureaucracy replaces entrepreneurship, short-termism of employed managers replaces long-term concern for growth that owner managers have.

Possible Lower Risk Profile. Due to the pressure to maximize shareholders value; many listed companies tend to become less risk enthusiastic thus stifling innovation in the short term at least. Also market pressure may lead employed managers to engage in short term growth strategies at the expense of long-term survival.

Possible Loss of Competitive Advantage. Financial affairs must be disclosed publicly (this information could be used to competitorsadvantage).

Increase Operating Cost. Listed companies have more statutory related cost imposed on them than private companies. For instance; the strict requirement on published accounts that must to be prepared can be time consuming and costly. Also the initial ability to cut cost closely by owner managers is replaced with the retinue of employed professional spenders in the name of managers.

Profit Sharing. With more people sharing the profits of the company, there will be less income for the original owners to make from their business. This is a disincentive to future investors who could feel they will be denied the opportunity to enjoy the deserved reward of the risks they plan to undertake.

Guilt by Association. With the reported fraud, misrepresentations and figure tampering that took place in the Nigeria stock market few years back with regards the valuation of many companies; the public backlash to such deceit could rub off on all companies listed in the market. Once the public gets a negative impression of the Market; they do not distinguish between the good and the bad. They simply paint all companies with the same brush. This can result in a “guilt by association” scenario for the innocent companies.

The foregoing are risks that no business should be forced to take; particularly not by the government that owns no single share in the business. The current debate on compulsory listing by big private companies is full of some assumptions that I consider misleading. For example; it is not a certainty that a company growing at x% while private will continue to grow at that same pace when it goes public. So all shareholders could be the poorer for it. Also public listing could lead to easier market consolidation in a given sector due to easier share ownership and takeover framework. This could lead to less competition if there are fewer players in a particular sector.

It is also manifestly unfair to compel a successful business to float on the stock exchange while not doing so to loss making businesses (possibly competitors) that started at the same time. It looks like penalising success in my book. Clearly people will not buy shares in loss making companies; so the focus will be on the successful ones. This has the capacity to create an imbalance in every sector concerned.

Some are also making the argument that compulsory Capital Market listing by these big companies will ensure that National economic growth is engendered. This cannot be far from reality. Capital markets require people to already have money to buy shares with. So in the current economic climate; where will an average Nigerian get the money he/she must be prepared to bet on the markets; when paying essential bills is hard for many. So the capital market rides an already growing economy rather than by itself create the growth.

So the general ideas of the framers of this debate are commendable. But their goals can be better achieved, through incentives and encouragement rather than compulsion. If it makes sense to list, most companies will do so voluntarily. How will Nigerians truly trust a Capital Market that is filled with reluctant candidates; enlisted by force of law passed by the National Assembly? What happens if the next House decides to change course. After all what politics give, politics can take away. And for those who think that is not possible; just look at our educational system over the past thirty years and you will see the many reversals of policies and u-turns on practices. As it is becoming clear that this debate is as much about politics as it is economics; one cannot ignore the political context of this exercise.

On many occasions, the desire to expand greatly is one that every fledging private enterprise has to deal with. However it should be done voluntarily and without duress. Going public as we can see, has many pitfalls for lots of these private firms; so I say that the dread of compulsory capital market floatation is indeed the beginning of corporate wisdom. If you want to stay private; you should be free to do so. A government fiat that compels floatation will send the wrong signal to future investors and could reduce enthusiasm for and flow of new investment (with its attendant risks) in additional areas of the economy that need bold long-term investors; such as the power sector. And if a company must go public; let it be on their own terms, in their own time and not state imposed.

The basis of capitalist economic model is the power of market forces to determine the direction of travel with minimum state intervention. The Market is self-adaptive and will be able to attract new entrants into the capital market once it has cleaned up its act and put appropriate incentives in place. Don’t let us allow government needless intervention to distort the equilibrium of the Market. Government interference should be directed elsewhere.