The simplest way to understand why this Star Tribune 100 is likely the last that will have 100 publicly held companies on it may be to consider the success of a TV pitchman known as the E-Trade baby.
“I use E-Trade, so, check it,” the baby says in one ad for the online broker E-Trade Financial. “Click. I just bought stock. You just saw me buy stock! No big deal. I mean, you know, if I can do it …”
Buying stocks used to be at least somewhat of a big deal, the kind of thing that required connecting with a professional downtown who was presumed to have some expertise and ought to be paid for the work.
Now, just click it. No big deal.
But the money that once went to the professionals downtown helped fund the ecosystem that supported small public companies. Today, there isn’t nearly enough economic incentive remaining in our system of capital markets for anyone to create and nurture small public companies.
The people who once did that for a living are mostly off doing other things, and so the number of public companies has and will continue to decline as existing public companies go private or get acquired.
It’s not just a regional phenomenon, of course. The Wilshire 5000 index, the broadest measure of stocks in the country, has long since fallen below 5,000 stocks. As of April 30 it had just 3,560, down from a peak of 7,562 on July 31, 1998.
The accounting firm Grant Thornton has published extensively on the contraction in new public-company creation and the dearth of initial public offerings, or IPOs. Its research traces the start of the decline to well before the last recession or the collapse of the dot-com bubble market at the turn of the century.
Before and during the great technology bubble of the late 1990s, there was an average of more than 500 IPOs per year, according to Grant Thornton. That included bubble-era companies that not only had no business being public, but really had no business.
After the bubble burst, the number of IPOs did not bounce back to pre-bubble levels. Nationally, there were only 128 last year, according to the firm Renaissance Capital.
The slowdown in IPO activity is no surprise to anyone in the brokerage business. The magnitude of changes in the business is quite striking.
Brokers used to make a lot of money on spreads, the difference between the price they paid for stock and the price at which it was sold. The whittling away began in the mid-1990s, when the Nasdaq settled antitrust charges and adopted new rules to curtail what was seen as tacit collusion among market makers of over-the-counter stocks.
In 2001 came the end of quoting stocks by fractions, such as “13 5/8,” and the arrival of pricing in increments of a penny, like $13.63 per share. While it may seem like common sense to do away with fractions, it pretty much ended the spread as a way for brokers to make any money.
The other part of the revenue model for brokers was commissions, of course, and here is where the online brokerage accounts that appeared in the mid-1990s played a decisive role. E-Trade, Charles Schwab and others started out by offering prices of $25 per trade, a price that may have been 10 percent or so of what conventional brokers were charging for the same basic service.
This was a classic “disruptive” innovation, as Harvard’s Clayton Christensen would describe it, in which a new service finds customers at the bottom of a market and then moves up to kick out the established players.
Pressure on the revenue model affected what brokers could spend on stock research departments, too, as did a couple of reforms aimed directly at research. One was the 2003 global settlement with regulators that was meant to completely sever research from investment banking, so analysts would have no incentive to talk up the stocks their firm had just been paid a handsome fee to bring public.
There still are investment banking firms in the Twin Cities working with public companies, the likes of Craig-Hallum Capital Group, Dougherty & Co. and Northland Capital Markets, but they are scratching out a crop in much poorer soil. Those firms work for 3 cents per share in commissions on trading they do for their institutional clients and have had to move upmarket to larger-company stocks.
Easy to see why. On Thursday MGC Diagnostics Corp., No. 84 on the Star Tribune 100, traded 100 shares. That was a bad day. But the recent average daily trading in MGC Diagnostics, according to Bloomberg, is about 3,500 shares.
At 3 cents per share commission rates, an institutional broker can’t afford to place a phone call on MGC Diagnostics’ stock or even let an intern write a research report.
Advocates for consumers might take a look at 20 years of changes in the capital markets with some satisfaction. Now we have a fully transparent market without collusion among over-the-counter stock traders, excessive markups on thinly traded stocks, unjustified commissions for brokers or research analysts shilling for investment banking clients.
But we also are going to have a world without anyone left in it who is paid to care about small-company stocks.
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