Private Companies Invest While Public Companies Punt

A new study suggests that short-term goals drive public-company conservatism when it comes to seizing investment opportunities.
Mary Ellen BierySeptember 27, 2012

Privately held companies are 3.5 times more responsive to investment opportunities than publicly traded firms, and the difference increases in industries where stock prices are more sensitive to earnings news, according to recent research out of Harvard and New York University.

“On average, private firms invest nearly 10% of total assets a year compared to only 4% among public firms,” the study found.

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The study, a working paper for the National Bureau of Economic Research using private-company data from Sageworks to match up a sample of private firms with public companies, found that, matched by industry and size, public companies had substantially lower investment rates than privately held companies.

Why? Analysis suggests that public-company focus on short-term objectives could be an important driver of the differences.

“Our evidence is consistent with the interpretation that public firms are more conservative when it comes to investing because their managers are affected by what is usually known as ‘short-termism’ or ‘managerial myopia,’” study co-author Joan Farre-Mensa, assistant professor at Harvard Business School, said in a recent interview. “They will not only look at whether [an investment] is a long-term value-creating opportunity but they’ll also be affected by what they believe will be the short-term reaction of the stock market.”

As U.S. policymakers and politicians debate the best way to energize a still-slow economic recovery, most agree that investments in new equipment, plants, and acquisitions will play a major role. Investments by private companies, in particular, are critical, as 99% of U.S. firms with employees are privately held.   

The investment behavior of private companies, however, has been relatively unknown, because unlike listed companies, private companies are rarely required to disclose their financials. Of more than 6 million employer firms in the United States in 2007, only 4,584 had a listing on a U.S. exchange.

“Almost everything we know about corporate investment at the micro level is based on evidence from public firms, which number only a few thousand, yet private firms form a substantial part of the U.S. economy,” wrote study co-authors Farre-Mensa; John Asker, associate professor of economics at New York University’s Stern School of Business; and Alexander Ljungqvist, NYU professor of finance and entrepreneurship.  The study also found that, on average, stock marketlisted companies are “significantly and substantially less responsive to changes in their investment opportunities, despite their relatively easier access to capital.”

That difference was even more pronounced in industries where stock prices are especially sensitive to earnings news.

The findings hint at the trade-offs involved with being a public versus private company, though Farre-Mensa stopped short of saying the investing differences put public companies at a long-term disadvantage. However, “Our findings suggest that short-termism is a potential cost of being public for all but the very largest public firms,” said Farre-Mensa.

The researchers estimate that in 2007, private companies accounted for 54.5% of aggregate U.S. nonresidential fixed investment. They believe 67.1% of private-sector employment and 57.6% of sales are generated by privately held firms.

Mary Ellen Biery is a research specialist at Sageworks, a financial-information company that collects and analyzes data on the performance of privately held companies.