Posted on Harvard Business Review: January 6, 2011 8:01 AM
In case you hadn't noticed, Facebook really doesn't want to go public. At least, not yet. The seven-year-old company is now valued at $50 billion, significantly more than one-time Internet behemoths Yahoo! or eBay. (It's also been said that the company's value tops media giant Time Warner's, but that's only if you ignore the value of Time Warner's long-term debt; throw that in and the companies' enterprise values seem to be pretty much equivalent — which is still pretty amazing.) And this week the big news (and the source of that $50 billion valuation) was that Goldman Sachs had handed over $450 million and committed to invest as much as $1 billion more in the company — money that it plans to raise from wealthy investors.
This arrangement is already attracting all sorts of scrutiny as a possibly out-of-bounds end run around the Securities and Exchange Commission's rule that companies with more than 500 shareholders have to regularly disclose financial information. Facebook doesn't want to do that yet. CEO/founder Mark Zuckerberg and his management team clearly don't want the scrutiny, hassle and distraction that comes with being a public company. A couple of guys named Larry and Sergey took that approach, too, and it seems to have worked out okay for them.
Larry Page and Sergey Brin eventually did take Google public, of course. Not because the company needed the money, but because its shareholder count was passing the 500 mark — and its early employees and investors (and, one presumes, Larry and Sergey) wanted to cash in on some of the wealth bound up in their Google shares.
Similar pressures will keep growing at Facebook. But Zuckerberg may try harder than the Google guys to resist them. And the very fact that the hottest big corporation in the land, and possibly the planet, is going to such great lengths to avoid the indignity of being listed on Nasdaq or the New York Stock Exchange may tell us something interesting and disturbing about the current state of public financial markets. And it's not just about disclosing financial information — which is already starting to leak out from the Goldman deal anyway.
Accounting firm Grant Thornton has been sounding the alarm for several years that the market for initial public offerings is broken. The primary cause, according to Grant Thornton, is changes in how stock markets work. Not the dread Sarbanes-Oxley, or increased disclosure requirements, but things like .... decimalization. Take it away, Grant Thornton:
Generally speaking, economists and regulators have maintained that competition, and reduced transaction costs are of great benefit to consumers — but only to a point. When it comes to investments, higher front-end or transaction costs and tax structures that penalize speculative (short-term) behavior can disincent speculative behavior and incent investment (buy-and-hold) behavior that may be essential to avoiding boom-and-bust cycles and maintaining the infrastructure necessary to support a healthy investment culture. As markets become frictionless (i.e., when there is little cost to entering into a transaction), it becomes easier for massive numbers of investors to engage in speculative activity.
In the January issue of Wired, Felix Salmon and Jon Stokes describe a stock market now in the thrall of split-second algorithmic computer trading. A computer scientist they quote says the market has become a "largely automated adaptive dynamical system." In other words, it's no longer ruled by investors placing bets on companies. It's ruled by computers seeking patterns.
Those who worry about this transformation, such as Salmon and Stokes, tend to focus on the threat of feedback effects and possible breakdowns. Those dangers are real enough, as last year's "flash crash" indicated. But the argument made by the folks at Grant Thornton is that such high-volume, hyperefficient markets are also increasingly inhospitable to the companies whose shares are traded upon them — and that smaller, newer, less-established companies (basically, the ones where the potential growth is) feel the brunt of this.
This argument that more efficient, more liquid stock markets aren't an unmitigated good isn't a new one. Amar Bhide made it in the pages of HBR in 1994, and others surely did the same before him. But it was silenced for a while by the seeming success of the American way of financial capitalism. Now it's back, and I imagine it won't go away anytime soon. At least not as long as Facebook and its ilk keep bending over backward to avoid contact with the nation's stock exchanges.
And here's the thing. Maybe we — by which I mean the SEC — ought to think about doing more to accommodate these companies. Our whole system of securities regulation was set up in the 1930s to protect small investors from the depredations of securities issuers and brokers. But the typical stock market investor today is a big, wealthy institution — or, increasingly, a computer doing the bidding of such an institution. They may not be the ones who need looking out for.