I’m spending today at the Kauffman Foundation’s Economics Bloggers Forum in Kansas City. A dozen bloggers are giving short presentations, and I’m flattered to be one of them, along with the likes of Tyler Cowen, Bryan Caplan, Ryan Avent, Dean Baker, Steve Waldman, and Virginia Postrel. We’ve all been encouraged to write a post about our talk.
Following on from a question I asked Mohamed El-Erian at the Thomson Reuters Newsmaker event Thursday, I’m planning to talk a bit about a favorite subject of mine, private stock markets like SecondMarket and SharesPost. They’re hot these days, and one of the questions I’m hoping to put to the bloggers at the Forum is why that might be.
Certainly it’s easy to see why these private markets serve a useful function. Take Pimco: it gives out shadow equity to a lot of employees, which vests over a period of years. But once they have that equity, what are they meant to do with it? Pimco can unilaterally announce a price for it, and say that it will buy back its own stock at that price. But that seems a bit unfair: one of the reasons that many banking partnerships went public was that they were buying back their stock at book value, even as the public markets were valuing banks at significant multiples of that. And in general, if there’s only one buyer for an asset, that buyer always has an incentive to lowball the price.
That’s why Pimco turned to SecondMarket, to take advantage of their web-based Dutch auction system. Pimco employees entered bids and offers into the system — the amount they were willing to sell their shares for, and the amount of money they were willing to pay for new shares. The bids and offers then cleared at a certain price (I didn’t get the opportunity to ask what the price was, and I’m sure that El-Erian wouldn’t have told me if I had), and that price by its nature is a fairer value for Pimco stock than anything determined according to a formula.
El-Erian said, and I believe him, that the auction didn’t see a lot of volume: there simply weren’t all that many people interested in selling their equity. It’s easy to see why: Pimco is doing very well these days, and it pays well too. Some employees might have difficulty paying their tax bill as their equity grants vest, but most are rich enough that they can do so quite easily. Most of them, too, probably reckon that employees-only equity in Pimco is likely to be a better investment over the medium term than anything they might be able to do in the current market with the proceeds of any sale. That’s the reason that shares of SecondMarket itself have yet to trade on SecondMarket: there aren’t any sellers, only buyers.
In the specific case of Pimco, there are always rumors that it might get sold or spun off from its parent, Allianz (AZ). A strategic buyer might well be prepared to pay a substantial control premium to get its hands on more than $1.2 trillion of assets, and Pimco’s employees would surely like to collect that premium themselves rather than sell the right to receive it to someone else.
So as is quite common in these situations, buyers — including El-Erian himself — outnumbered sellers. Which raises a common objection to private markets: that they don’t allow for short selling, which is an important contributor to the way in which public markets perform their role of price discovery.
There’s also my public-policy objection: that even if these markets make sense for the companies in question, they’re bad for the general public, which gets shut out of the opportunity to own equity in strong, attractive companies. Pimco’s not a great example on this front, since it’s possible to buy shares in Allianz. But if you look at the poster child for private markets, Facebook, the only people able to buy equity are a small group of elite and well-connected global rich people. And that doesn’t seem fair.
Historically, workers have been able to get access to the class of investments available to the rich: they have had defined-benefit pensions, run by pension plans which qualify as rich and sophisticated investors and which therefore have a large universe of asset classes to invest in. But as we move from defined-benefit to defined-contribution plans, that universe shrinks.
It’s quite easy to see why companies like Facebook might not want to go public — although the NYT is now reporting that an IPO might happen early next year. Being public is expensive and annoying: CEOs almost always prefer to be public. Public shareholders are litigious; public stocks tend to move in lockstep with each other rather than due to company-specific fundamentals; and the minute that your stock price is public, everybody pays an enormous amount of attention to it and judges you by it. Given the amount of money in private markets, what upside is there in going public? Especially when SecondMarket and its ilk allow shareholders to liquidate their holdings quietly and at a good price.
What’s less easy to see is why this trend is happening now. Is there something special about the USA circa 2011 that makes private exchanges particularly timely? Yes, there’s a lot of liquidity sloshing around — but that was true in the mid-oughts, too. Yes, Sarbox has made life for public companies that much harder — but Sarbox has been around for a while as well. Maybe it’s simply the fact that SecondMarket and SharesPost have come along and executed well in a space which no one bothered to put much effort into before. I’m reminded of the current rise in couponing: there’s absolutely no reason why Groupon, LivingSocial, and the like should all be exploding now, rather than during say the first dot-com boom of the 1990s.
Markets aren’t that efficient: sometimes it takes a while for an entrepreneur to spot a big gap in the market. But if there is a good reason why private markets are booming in the USA today, I’m sure the bloggers assembled at Kauffman will be able to think of it.