Elon Musk’s $44 billion purchase of Twitter in October 2022 has been one of the most publicly discussed and dissected corporate acquisitions in recent history. The media has covered every detail, from a lack of toilet paper in the company’s offices to a lack of staff after mass firings. Musk has changed the order in which people see tweets on their timeline, reinstated controversial accounts such as that of former US president Donald Trump, and launched an $8-per-month service that gives subscribers a once-coveted blue check mark next to their name.
There has been consternation about Twitter’s banning of aggressive journalists while touting its free-speech credentials, about the role of Saudi Arabia as the second-largest shareholder, and about Musk sitting with News Corporation chairman Rupert Murdoch at the Super Bowl.
In all of this coverage, however, less attention has been paid to the accounting veil that fell virtually overnight—obscuring some information far bigger than the availability of office supplies or the company Musk keeps. As the deal was completed, Musk took the company private. One day, Twitter was a publicly listed company with stock that could be bought and sold by all investors and a management team and board required by law to implement and monitor internal accounting controls, and which had to file detailed quarterly reports with the US Securities and Exchange Commission. The next day, it wasn’t. Twitter’s senior management team and board were let go, its shares were delisted, and, like all privately held businesses, the company no longer needed to disclose financial information to regulators. Twitter must still adhere to laws such as federal labor legislation and safety standards, but information on revenues, profits, and the company’s financial commitments are now confined to an accounting black box.
Twitter joined a crowded field. Some 47 formerly public companies in the United States became privately owned last year, including the data provider Nielsen Holdings, cloud-computing company Citrix Systems, and customer-software company Zendesk. Buyout firms spent $195 billion taking such companies private, with an average deal size of $4.15 billion, according to PitchBook, which provides data and insights on global capital markets.
Private companies have always dominated the US economy. Of the 33 million businesses in the US, more than 99 percent are privately held. More than 80 percent are one-person outfits, according to the Small Business Administration: think your local plumber or piano teacher. Others are huge and have a long history. Agribusiness Cargill dates back to 1865, pet-care supplier and candymaker Mars traces its origins to 1911, and the first location of the Publix Super Markets chain opened in 1930.
But in recent decades, there has been a sharp rise in the number of companies either crossing over to private ownership or remaining privately held long after they might previously have had an initial public offering. Behind this trend is the growth of private-equity firms, which raise funds and scour the landscape for companies that they can take over with the intention of running the businesses more profitably. In the US, PE funds, which provide financing to PE firms to grow private companies or take public companies private, raised about $360 billion in 2022, up from $100 billion a decade earlier, per Pitchbook. Private equity now funds about 10 percent of US mergers and acquisitions, according to Standard and Poor’s. Overall, consulting giant McKinsey says, private assets under management hit $9.8 trillion in 2021, up from $7.4 trillion the year before.
Trending toward privacy
Private-equity fundraising and deal activity in the United States has grown steadily in the past decade. And despite difficult economic conditions for the sector in 2022, deal activity outperformed most recent years.
By comparison, the average annual number of initial public offerings has dropped, from 572 in the 1990s to 260 since 2000, meaning there were almost as many IPOs in the last decade of the 20th century (5,724) as there have been in the 23 years since (5,965). The number of companies listed in the US dropped from about 5,500 in 2000 to about 4,000 in 2020. The Wilshire 5000, a broad index of US-headquartered public companies, listed 7,500 companies in 1998. Today it has about 3,500. Some smaller companies that might otherwise go public can choose to raise capital on over-the-counter markets, where companies do not register with regulators and have much lower reporting requirements.
Some experts worry about the increasing number of employers who are keeping all financial information to themselves. “The fact that more capital is now being raised in private markets means that a burgeoning portion of the US economy itself is going dark,” warned former SEC commissioner Allison Herren Lee in October 2021. But is this concern warranted? And if it is, what, if anything, should be done?
Public officials take note
At an event held by Chicago Booth’s Chookaszian Accounting Research Center last April, SEC commissioner Caroline A. Crenshaw spoke bluntly. “My ever-present fear is that the capital formation rules that we put in place pay lip service to the needs of everyday American entrepreneurs, but really serve another master,” she opined. “And because of the less stringent disclosure requirements in private markets, they do that at the expense of actual, substantive, meaningful disclosure to investors, stakeholders, and regulators.”
Crenshaw’s call for meaningful disclosure was taken by some attendees and media outlets as a plea to bring greater transparency to the private markets by requiring companies in them to report financial information to regulators. As the Financial Times’ Robin Wigglesworth put it, the speech indicated that the commissioner “fears that lighter disclosure and compliance enjoyed by private companies is just shifting costs and risks on to investors and markets.”
There’s similar unease from some of the highest political pulpits. “As Wall Street firms take over more nursing homes, quality in those homes has gone down and costs have gone up. That ends on my watch,” said US President Joe Biden in his 2022 State of the Union address, referring to findings by University of Pennsylvania’s Atul Gupta, NYU’s Sabrina T. Howell, Chicago Booth’s Constantine Yannelis, and University of North Carolina’s Abhinav Gupta. Since 2019, Senator Elizabeth Warren (Democrat of Massachusetts) and four of her Senate colleagues have been pushing the Stop Wall Street Looting Act, which would limit the ability of PE-owned companies to take on debt and pay dividends, and would raise taxes on PE funds.
Other jurisdictions have acted to keep the economy better lit. The European Union’s Alternative Investment Fund Managers Directive, implemented just over a decade ago, ended the regime that existed in the region before the 2008–09 global financial crisis, under which alternative investments such as private equity and hedge funds were largely unregulated. The directive requires disclosure of conflicts of interest, liquidity, and financial leverage as well as independent valuation of assets, and mandates that pay policies should not encourage excessive risk-taking.
But the 2010 Dodd-Frank Act, the US’s legislative response to the crisis, does not mandate any additional reporting from private companies, leaving minimal disclosure requirements in place for private-equity firms and hedge funds.
Why go (or stay) private?
Among developed economies, the US has perhaps the starkest dichotomy in corporate reporting. Publicly listed companies have to publish quarterly financial statements, while private companies do not. The result is that US-listed companies devote significant resources to reporting. “Public companies are forced to hire a lot of people just to deal with providing all of this information,” Yannelis notes.
In the EU, by contrast, public companies report financial statements every six months, and most private firms such as limited liability companies are required to publish their annual accounts and have them audited. There is, therefore, a relatively narrow reporting gap.
The US reporting anomaly reflects an assumption that public companies receive much of their funding from retail investors, who gain protection by obtaining regular, accurate snapshots of a company’s situation. Private companies are assumed to be chiefly funded by sophisticated institutional investors who have the capacity to conduct their own due diligence.
The anomaly also means that for US companies that have a choice, the option of going private and avoiding such costs completely can be attractive. “We’ve made it miserable to be a public company,” says Booth’s Steve Kaplan, who has conducted a host of PE research in recent decades and is himself an investor in several PE funds.
The shrinking public markets
The number of domestic companies listed on the NASDAQ and the New York Stock Exchange has fallen sharply since the mid-1990s.
The regulatory burden could be one factor driving the growth of private companies in the US, although the evidence on this is mixed. Some compliance costs stem from the Sarbanes-Oxley Act of 2002, which was designed to strengthen investor protections from fraudulent financial reporting in the wake of a string of high-profile financial scandals, at Enron, Tyco, and WorldCom. SOX requires corporate boards to have standing audit committees made up of independent directors, obliges senior executives at public companies to verify personally that corporate financial statements are trustworthy, and forces public corporations to set up internal controls.
SOX may have made it more enticing for companies to become privately held if they had the opportunity to do so. University of California at Riverside’s Ivy Zhang, for example, finds that news highlighting how SOX would strengthen financial regulation had a negative effect on US stock returns relative to non-US markets. University of Illinois Chicago’s Ellen Engel, University of Utah’s Rachel M. Hayes, and Ohio State’s Xue Wang find that for smaller companies and those with greater ownership by insiders, the costs of complying with SOX tend to outweigh the benefits, driving more of these companies to become privately owned.
However, others are skeptical that SOX was a key driver. Booth’s Christian Leuz shows in a research paper that Zhang’s analysis failed to account for US-specific events that weighed on investor sentiment and influenced returns, such as the then-impending war in Iraq or the creation of the Department of Homeland Security. In further research, Leuz, Johns Hopkins’s Alexander Triantis, and University of Minnesota’s Tracy Yue Wang make a distinction between companies that go dark (deregister from the SEC but continue to have shares traded in unregulated markets) and those that go private (do not trade). They point out that while transactions studied by Engel, Hayes, and Wang meet the SEC’s definition of going private, the researchers did not make that same distinction. Leuz, Triantis, and Wang find that after SOX, there was a spike in companies that went dark but not in those that went private.
A much more likely cause for the increase in going-private transactions starting in 2005, according to Leuz’s research, is the rise of the availability of debt capital. It has become easier to tap private funding. Traditionally, US federal securities law offered businesses what Duke’s Elisabeth de Fontenay calls a “disclosure bargain”—in return for greater financial disclosures, companies could access the stock market, the largest and cheapest source of capital. Private companies, meanwhile, raised funds chiefly from insiders and financial institutions, and rules limited the development of a market for private-company equity. But starting in 1982, regulators gradually lifted restrictions on private companies’ ability to raise capital and trade, leading to a situation in which it is relatively easy for private companies to fund themselves. “The disclosure bargain has largely been revoked,” de Fontenay writes in a 2017 paper.
Harvard’s John Coates argues that a form of the bargain still exists, just with different terms. But the changing dynamic has clearly reshaped the traditional path of corporate growth. Startups no longer necessarily aspire for an IPO, since it’s arguably easier to become a “unicorn”—a private startup valued at $1 billion or more—than a listed company with a similar value. As of April, there were 682 unicorns in the US, including household names such as grocery-delivery app Instacart, Fortnite maker Epic Games, and Elon Musk’s space-travel company SpaceX, whose $100 billion valuation makes it by far the biggest unicorn in the herd. Even SpaceX is only about half as large as the world’s biggest unicorn so far, TikTok owner ByteDance.
These startups didn’t need public markets
Privately held startups that reach billion-dollar valuations are known as unicorns in venture-capital parlance, but they’re getting less rare. More were created in the past two years than in the previous five years combined.
And a benefit of going private: more flexibility to focus on the long run. Having to report quarterly leads managers to focus on projects that flatter the numbers every three months rather than on those that create longer-term value, suggests research by University of Minnesota’s Frank Gigler and Chandra Kanodia, Booth’s Haresh Sapra, and University of Houston’s Raghu Venugopalan. Short-term projects are more likely to earn bigger cash flows—but only initially. Long-term ones are usually more profitable in terms of the total cash flows produced.
The pressure of public reporting hinders the type of innovation that requires long-term investment, Sapra says. Quarterly reporting gives executives an incentive to pursue projects that make companies look good in the eyes of the market—especially for those facing a lot of market pressure—rather than to undertake risky but potentially industry-disrupting innovations. Plus, executives may worry that longer-term investments will depress a company’s short-term share prices and make it harder to raise money.
The idea that reporting can impede innovation is demonstrated in a study that analyzed data on public companies in 26 European countries from 2000 to 2014. While the EU requires all limited liability companies, public and private, to report audited financial statements, individual countries in the bloc are allowed to grant exemptions to smaller firms. Since those exemptions are set at different levels in each country, Columbia’s Matthias Breuer (a graduate of Booth’s PhD Program), Leuz, and Erasmus University’s Steven Vanhaverbeke used the variation to analyze the reporting requirement’s effects. Similarly, Germany delayed enforcing the EU accounting directives until 2007, creating another opportunity for study. The researchers find that in countries with greater financial-reporting mandates, fewer companies had staff working in research and development, and came up with new processes and products. Increasing the share of companies that are subject to mandatory reporting by 10 percentage points would result in a 3 percent decrease in the share of innovating firms compared with the average across the region, the researchers estimate.
All this appears to chime with the experience of US companies and PE firms that say being private gives them the space they need to improve efficiency, increase profitability, and invest for the long run. Take Dell Technologies, which went public in 1988 but then private in 2013. At the time, Dell was widely portrayed in the media as a formerly innovative company that had missed the shift to tablet computers and smartphones and lost its dominant share of the global PC market. “We will have to make investments, and we will have to be patient to implement the strategy. And under a new private company structure, we will have time and flexibility to really pursue and realize the end-to-end solutions strategy,” then-CFO Brian Gladden told Reuters. “We won’t have the scrutiny and limitations associated with operating as a public company.” Dell ended up returning to the public markets in 2018, but it had refocused and was making gains in cloud computing and PC gaming. The company is now the leading PC maker, with a 27 percent market share, up from 10 percent when it went private. (Musk reportedly spoke to Dell a few years before making an offer for Twitter.)
Is privacy problematic? Consider efficiency
The natural question is whether the growth in private ownership in the US is anything to worry about. Kaplan argues that it’s not and that when regulators assert this growth is problematic, they often do so without looking at the evidence. “What would be the point of getting private companies to disclose more information?” he says. “I don’t see the systemic problem that would be trying to address.”
What he does see is private equity creating value, especially in terms of efficiency. Kaplan wrote a pioneering paper in 1989—about a decade after PE firms emerged in the US—that found PE buyouts led to improved operating margins and cash flows. A string of subsequent studies added more evidence that PE-owned companies outperformed other companies in their industries, both in the US and in Europe. Historically, PE firms tried to buy companies at less than market price, explain Kaplan and Harvard’s Paul A. Gompers in their book, Advanced Introduction to Private Equity. That became harder as competition increased, so strategies generally switched to buying companies at full valuations with the aim of making them more profitable or faster growing.
Booth’s Steven J. Davis, University of Maryland’s John Haltiwanger, University of California at San Diego’s Kyle Handley, the Census Bureau’s Ron Jarmin, Harvard’s Josh Lerner, and the Census Bureau’s Javier Miranda have also documented productivity increases delivered by PE ownership. In a study that analyzed 3,200 US companies targeted in buyouts from 1980 to 2005, they find that PE buyouts led to a net increase in productivity growth of 2 percent. The deals yielded $15 billion of extra output two years after the sample period, they estimate. This value was driven by PE owners accelerating the process of creative destruction by closing less productive facilities and opening new, more productive ones. This activity increased employee churn, but the size of the workforce fell by just 1 percent.
In a subsequent study, the research team, joined by Deutsche Bank’s Ben Lipsius, analyzed 3,600 deals from 1980 to 2013, finding that productivity increased at target businesses by an average of 8 percent over the two years after a PE buyout compared with similar companies. These increases were all the more remarkable for happening at established businesses in mature industries such as manufacturing, food service, and information technology.
But efficiency can help some parties more than others. In this second study, employment dropped by 13 percent in the two years following a public-to-private buyout, suggesting that for these companies, PE ownership led to increased productivity at least in part through firing workers. However, in deals involving one private company buying another, employment rose by 13 percent, and by 10 percent for secondary buyouts, in which a PE-backed company is sold to another PE firm.
Duke Energy’s Shourun Guo, Boston College’s Edith S. Hotchkiss, and the late Weihong Song find that public-to-private buyouts create significant value for new owners although only modest operating gains. University of Texas’s Jonathan B. Cohn and Lillian F. Mills and University of Georgia’s Erin Towery reach a similar conclusion using tax data.
One economically significant way PE firms make the companies they control more efficient is by reducing their local tax bills, according to London Business School’s Marcel Olbert and Bain & Company’s Peter H. Severin. Analyzing more than 11,000 European PE acquisitions from 2001 to 2018, they find that as well as introducing operational changes, PE owners tend to focus on “tax management and aggressive tax planning strategies” in the pursuit of greater profitability through strategies such as claiming tax credits and preferential tax rates when investing, and increasing the use of subsidiaries based in tax havens.
And in certain circumstances, private owners may be making (or attempting to make) profits by exploiting the availability of government subsidies, then delivering poorer outcomes for end users. Nursing homes are one example: when a nursing home was taken over by a PE firm, the short-term mortality rate of residents rose by 10 percent, resulting in an additional 1,000 deaths annually, according to the research conducted by Yannelis and his collaborators that was mentioned by President Biden. In this case, the government subsidy came in the form of nursing-home fees paid by Medicare and Medicaid, the US government health-insurance programs. Because the homes were paid a set fee per patient, they had an incentive to maximize the number of patients and cut the number of staff, raising productivity but hurting patient care. The team reached their conclusions by analyzing the records of some 1,700 US facilities bought by PE firms between 2004 and 2019.
For-profit colleges in the US provide another example, with PE firms seemingly making out better than students. University of California at Merced’s Charlie Eaton, NYU’s Howell, and Yannelis analyzed 88 private-equity deals involving 994 for-profit colleges that PE firms either took over or launched. The PE firms set tuition at roughly 50 percent above average community college rates in response to an increase in student-loan borrowing limits, the researchers find. Per-student borrowing increased by 12 percent above the average, while per-student federal grants rose by 14 percent above the average. PE owners were particularly productive in securing more federally funded loans to pay the higher fees they introduced.
“This is a purely rent-seeking phenomenon and is unambiguously not in students’ or taxpayers’ interest,” the researchers write. While enrollment at PE-owned colleges swelled to about 50 percent above the average for all colleges, student outcomes worsened: graduation rates fell by 13 percent, loan-repayment rates dropped by 5.6 percent, and postcollege earnings dipped to almost 6 percent below the average.
The effects on capital allocation and competition
The relative efficiency of PE-owned companies helps explain their attraction to investors. But it is also possible that privacy damages capital allocation across the entire economy.
Not all economists accept the assumption underpinning the public-private reporting dichotomy, that sophisticated investors who can access private-equity funds can look after themselves and don’t need protection. In a paper he wrote proposing how financial regulation could be improved following the Great Recession, Booth’s Luigi Zingales notes that even big investors such as university endowment funds, pension funds, and the family offices of wealthy individuals could misallocate their capital because the lack of standardized reporting among private funds makes it hard to compare performance.
In recent research, Booth’s Michael Minnis discusses two papers that use European data and conclude that more private-firm disclosure might even benefit the PE industry. Harvard’s Brian Baik, Boston College’s Natalie Berfeld, and MIT’s Rodrigo Verdi find that increased public disclosure by private firms allows PE and VC firms to more easily identify investible targets; while Stanford’s Jinhwan Kim and LBS’s Olbert find that as private firms increase their disclosures, investors reallocate capital in their direction. Minnis says these findings, while early and in need of further testing, suggest that the more information available to both institutional and retail investors, the more efficiently they can invest. Given that PE firms make their targets more efficient, more disclosure could actually help them to identify companies ripe for improvement and to direct their expertise to where it could add the most value. Minnis also points out that these results suggest the capital markets are working: private markets are competing with public markets for capital.
Yannelis has a wider concern about privacy: the lack of transparency may make it harder to prevent monopolies from forming. Many PE firms buy up small and midsize companies in deals that fly under the radar of regulators. The US Federal Trade Commission, which is charged with enforcing civil antitrust law, does not review mergers and acquisitions smaller than about $110 million.
A considerable amount of buyout activity could be taking place in this way, potentially allowing PE-owned companies to build up regional market power. It’s impossible to know for sure, Yannelis says. PE ownership may benefit consumers by enabling companies to scale up and become more efficient. On the flip side, an increase in concentration could create consumer costs. In the absence of greater disclosure, Yannelis says, it is difficult to say definitively either way.
When it comes to the effects on competition, again the implications are far from clear. One argument is that without the pressure of regular reporting, private companies can better protect their innovations from rivals and therefore compete less. This naturally benefits the company that escapes prying eyes. Booth’s Philip G. Berger, and Stanford’s Jung Ho Choi and Southern Methodist University’s Sorabh Tomar (both graduates of Booth’s PhD Program), studied what happened when South Korea–listed companies were given the ability to report fewer details about their cost of sales. The companies that opted to release less information saw increased productivity and profits. These benefits come at least in part by avoiding competition: the less disclosure, the less ability rivals have to copy innovative cost savings.
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But reducing privacy could actually create more competition. Columbia’s Breuer conducted research using a methodology similar to the one in his paper with Leuz and Vanhaverbeke, examining the differences between EU countries in the sizes of companies that they exempt from financial reporting. Mandating disclosure by private companies prompted more startups and other signs of greater competition in local markets, he finds. Breuer estimates, for example, that mandating an additional 10 percent of companies in an industry to disclose full financial statements publicly would increase the rate of new companies entering the market by 6 percent above the current EU average.
However, he clarifies that this increased competition in local markets does not seem to improve how all companies there allocated their resources in the aggregate. In his study, while customers, suppliers, and competitors benefited from the released information, the reporting regime deterred companies from making productivity-enhancing investments.
And while one might expect competition in local markets to reduce market power and concentration, Breuer’s work with Leuz and Vanhaverbeke finds that it may have had the opposite effect at the EU level. The intensified competition produced by transparency led to a reallocation of resources from smaller companies, operating in local markets, to bigger ones that operate nationally or even internationally and have more resources than their local counterparts.
Lastly, in a third potential systemic risk of privacy, the growing privately held sector may be pushing some costs onto investors and society—environmental costs chief among them. The SEC proposed last year that companies should be required to regularly report their greenhouse gas emissions and business risks associated with climate change. However, only SEC-registered companies would need to share this information.
This, notes Leuz, threatens to undermine the entire exercise, especially given the increasing importance of private companies in the US economy. Emissions have social costs, and if private companies are exempt from disclosures, the resulting picture of the emissions landscape would be woefully incomplete.
What should be done?
Both those who are and aren’t concerned about the growing “dark economy” agree that the heart of the trend is the reporting gap between public and private companies, and, depending on their perspectives, they suggest three general areas for reform.
Reduce the reporting burden for public companies
For some economists, the optimal approach is to lighten the reporting load of public companies—perhaps by allowing them to report every six months, or annually. In 2018, the SEC examined this idea, with the goal of reducing what it called the “overly short-term focus by managers” of listed companies. When Chicago Booth’s Initiative on Global Markets asked its European Economic Experts Panel in 2019 if moving from quarterly to annual reports would lead executives to focus more on the long run, one-third of the respondents predicted that it would, more than double those who disagreed. The SEC’s requirements, however, have not changed.
The US could also (or instead) reduce the amount of information companies have to report. The Jumpstart Our Business Startups Act of 2012, for example, attempted to make IPOs less burdensome by lowering disclosure requirements for companies with less than $1 billion in revenue. Kaplan argues that SOX is overdue to be rolled back, pointing in particular to the rules requiring annual reports on internal controls. The reports are repetitive and add little value, he says, suggesting they be required once every three years.
And regulation could do more to incentivize certain kinds of behavior. To reorient the mindset of corporate leaders toward long-term investments, regulators could make greater use of the clawback provisions in SOX, under which executives have to repay some of their salaries if they are found to have presented a more favorable picture of the company’s finances than was warranted in the longer run, Sapra suggests. In 2022, the SEC strengthened the rules requiring public companies to claw back incentive-based compensation awarded to current and former executives if the company’s accounts had to be restated. This past March, the US Department of Justice launched a program to reduce fines for companies being investigated for misconduct if they sought to recoup compensation from their executives. And in the wake of the failure of Silicon Valley Bank, a bipartisan group of Senators introduced a bill requiring federal regulators to claw back five years of pay for executives of failed banks.
Increase disclosure requirements for private businesses
While Kaplan argues that policy should focus on reducing the burden on public companies, Sapra, Leuz, and Zingales all contend that any such reduction should be accompanied by an increase in reporting requirements for the privately held sector.
A modest step toward greater disclosure would be to require privately held companies to report some information, just not publicly. Information is sensitive corporate data, and it’s legitimate for companies to want to protect it, Sapra acknowledges. However, in his view, there’s room for companies to share more information with investors and regulators, particularly about cash flows, liquidity, and insiders and their conflicts of interest.
Zingales, too, advocates for some basic level of disclosure. He says PE firms could share how they calculate their internal rates of return, along with information on past investments. Buyout funds, specifically, could disclose the financial structure of the companies they invest in, which would allow investors and not only managers to assess how much risk is involved. Such data requirements, Zingales says, “can be imposed with very little cost to the issuer, but with great benefits to investors.”
He argues, however, that these disclosures should be made public, to help prevent regulators from becoming captured by the companies they oversee. “Private disclosure wouldn’t be very effective,” he says. “Public disclosure would help the media, regulators, and society at large to perform their roles of keeping companies in check.” To accommodate the objection that some privately held companies value privacy for competitive reasons, Zingales suggests that certain kinds of data could be disclosed after an interval of up to two years, enough time for the company not to lose its edge, while still bringing transparency.
Hedge funds provide an interesting precedent. In 2004, the SEC required most hedge funds to register with a securities regulator, making them subject to public disclosures and the risk of government inspections, among other things. The courts vacated this rule in 2006, but Congress again imposed a registration requirement as part of the Dodd-Frank Act. Stanford Law School’s Colleen Honigsberg finds that mandating disclosure improved the accuracy of hedge funds’ financial reporting. Her research points to auditing as a possible channel for the reduction in misreporting: when funds had to publicly disclose whether they were audited and by whom, many hired an auditor or switched auditors, and these funds experienced greater declines in misreporting.
Leuz is also in favor of public reporting by privately held businesses. Private companies enjoy the benefits of limited liability, he notes, and in return they should provide some information about their financial situation, which he says is in the interest of not just investors but others too. “Once you reach a certain size, it’s legitimate for the public to say, ‘We want to have a sense of what these firms do,’” Leuz says.
And when it comes to disclosures about carbon emissions, Leuz would mandate that most private companies measure and report their impact on the environment. “If certain corporate activities have externalities, we should have some information about them, so that whatever forces we have in society can work and put pressure on firms to internalize these,” he says.
At public companies, shareholders can exert that force and play a critical role in prompting companies to adopt better practices. For example, when the US required listed mining companies to disclose safety breaches, mutual funds, especially those identifying as socially responsible, were more likely to sell the stock of companies that received citations, according to research by Chicago Booth’s Hans B. Christensen, UC San Diego’s Eric Floyd and Columbia’s Lisa Yao Liu (both graduates of Booth’s PhD Program), and Booth’s Mark G. Maffett.
One way of easing the burden of regulation for all companies could be to make greater use of technology. Almost all companies use software to record their own financials for internal use, Yannelis notes. Standardizing the information would enable some of it to be shared automatically with regulators, for example, without necessarily having to prepare separate forms for quarterly reports.
Focus on size, not ownership structure
The JOBS Act lightened disclosure requirements for companies with less than $1 billion in revenues, which currently includes businesses such as the cloud storage company Box, the gym chain Planet Fitness, and visual media provider Getty Images.
The spirit of that reform—which made size, rather than ownership type, the basis for regulation—could guide policy makers in crafting a more effective reporting regime. Smaller public companies could have a lighter reporting burden, while bigger private businesses would be required to share more, albeit not in quite as much detail as their publicly listed peers. Leuz suggests, for example, that US companies with a workforce of more than, say, 500 or 1,000 could be required to disclose some information. “Those are not small companies anymore,” he says.
To private companies in the US, the prospect of having to issue public financial reports might seem burdensome, but research suggests that as long as the rules are widely applied, the proposal may be able to win support among corporations. Booth’s Minnis and MIT’s Nemit Shroff find that companies may be more open to disclosing financial information if their rivals are forced to do the same. The researchers surveyed more than 2,000 European companies and 25 global accounting standard setters about their views on EU rules requiring companies with at least 50 employees and annual revenues of at least €5 million to make financial results public and subject to annual audits. They find that a slight majority of the respondents supported the rules and preferred them to the more opaque North American system. Although respondents didn’t like disclosing their own financial data, they valued access to rivals’ financial information.
This suggests that private companies need not necessarily fear greater transparency. At the same time, regulators should be aware of the complete costs—in terms of innovation, growth, and efficiency—of trying to shed light on America’s dark economy.
In the meantime, the growth of America’s privately held economy seems set to continue. Twitter appears to be settling in to a world more opaque to outsiders. Musk has gutted the company’s communications team amid staff cuts that have shrunk Twitter’s head count from 8,000 to 1,500, according to news reports. The company did not respond to an interview request.
- Brian Baik, Natalie Berfeld, and Rodrigo Verdi, “Do Public Financial Statements Influence Venture Capital and Private Equity Financing?” Working paper, July 2022.
- Philip G. Berger, Jung Ho Choi, and Sorabh Tomar, “Breaking It Down: Economic Consequences of Disaggregated Cost Disclosures,” Management Science, forthcoming.
- Matthias Breuer, “How Does Financial-Reporting Regulation Affect Industry-Wide Resource Allocation?” Journal of Accounting Research, January 2021.
- Matthias Breuer, Christian Leuz, and Steven Vanhaverbeke, “Reporting Regulation and Corporate Innovation,” Working paper, March 2022.
- Hans B. Christensen, Eric Floyd, Lisa Yao Liu, and Mark G. Maffett, “The Real Effects of Mandated Information on Social Responsibility in Financial Reports: Evidence from Mine-Safety Records,” Journal of Accounting and Economics, November 2017.
- Jonathan B. Cohn, Lillian F. Mills, and Erin Towery, “The Evolution of Capital Structure and Operating Performance after Leveraged Buyouts: Evidence from US Corporate Tax Returns,” Journal of Financial Economics, February 2014.
- Steven J. Davis, John Haltiwanger, Kyle Handley, Ron Jarmin, Josh Lerner, and Javier Miranda, “Private Equity, Jobs, and Productivity,” American Economic Review, December 2014.
- Steven J. Davis, John Haltiwanger, Kyle Handley, Ben Lipsius, Josh Lerner, and Javier Miranda, “The (Heterogenous) Economic Effects of Private Equity Buyouts,” Working paper, November 2021.
- Elisabeth de Fontenay, “The Deregulation of Private Capital and the Decline of the Public Company,” Hastings Law Journal, April 2017.
- Charlie Eaton, Sabrina T. Howell, and Constantine Yannelis, “When Investor Incentives and Consumer Interests Diverge: Private Equity in Higher Education,” Review of Financial Studies, September 2020.
- Ellen Engel, Rachel M. Hayes, and Xue Wang, “The Sarbanes-Oxley Act and Firms’ Going-Private Decisions,” Journal of Accounting and Economics, September 2007.
- Frank Gigler, Chandra Kanodia, Haresh Sapra, and Raghu Venugopalan, “How Frequent Financial Reporting Causes Managerial Short-Termism: An Analysis of the Costs and Benefits of Reporting Frequency,” Journal of Accounting Research, May 2014.
- Paul A. Gompers and Steve Kaplan, Advanced Introduction to Private Equity, Cheltenham: Edward Elgar Publishing, 2022.
- Shourun Guo, Edith S. Hotchkiss, and Weihong Song, “Do Buyouts (Still) Create Value?” Journal of Finance, April 2011.
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