Are Company Mergers and Acquisitions Shrinking the Stock Market?

What the Trend of Merging Companies Could Mean for Investors

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The proposed AT&T — Time Warner merger raised eyebrows across the political spectrum, with both Democrats and Republicans expressing skepticism about concentrating so much media power in one company.

There's also another problem represented by this potential $85 billion deal. In recent years we’ve seen a significant diminishment in the number of publicly traded stocks.  That’s a troubling trend that shows no sign of slowing down.

Fewer stocks mean fewer choices for investors, and more concentration of economic power in large companies.

A Shrinking Stock Market

The number of publically traded companies in the US fell from about 8,800 in 1997 to just 5,300 at the end of 2015. The iconic Wilshire 5000 index, started in 1974 to measure the breadth of the market — small, mid and large-cap stocks — now includes just 3,600 equities (down from an original 5000).  The AT&T — TW deal would, of course, remove one more stock from the marketplace.

Experts have identified many reasons for this shrinkage. Heightened regulation, which saw a particular uptick in 2002, has made it difficult, expensive and generally less attractive to be a publicly traded company. As a result, initial public offerings are off dramatically. Just 71 companies have gone public this year, a 47% decrease from the same point in 2015. There has been an average 111 IPOs per year since 2001, just one-third the average number in the 1980s and 1990’s.

Businesses are instead finding other ways to get the funding they need to grow, including private equity investments. Thanks to low-interest rates, private equity firms can snap up promising young companies and keep them private until the PE firm decides to cash out. It’s no wonder that since 1990, 90% of the companies that have been exited by private equity firms have been sold to other companies rather than going public.

It’s also a seller’s market for buyouts. Large companies are aggressively courting smaller firms with innovative technology or strong customer bases that offer an instant, new revenue stream. So far in 2016, about $1.1 trillion in acquisitions have been proposed, making this the third year in a row in which buyout activity topped $1 trillion.

Why a Shrinking Stock Market Matters

These are problematic long-term trends for the country. While consolidation within an industry is a natural and often healthy thing, a drift towards monopoly or excessive concentration of market power should be avoided at all costs.

While a monopoly offers some pluses for investors in the monopoly company, it’s bad for consumers and the economy. It is troubling that the AT&T — Time Warner deal would see a major creator of entertainment content join with a major distributor of such material.

The anemic service and sky-high long distance rates charged by the old monopoly AT&T are classic examples of how consumers are hurt by excessive market power. Similarly, in communities where one cable company competes only against DirecTV, we also see high prices and lackadaisical customer care (We're looking at you, Comcast).

Investors in an excessively dominant company might benefit from the firm’s almost guaranteed revenues, but there are downsides to owning such stocks. Near-monopolies get content and lazy and are thus unlikely to show the sort of growth that comes from innovation and diversification.

Overly large firms can also hurt the economy by blocking innovation they deem a threat to their business model. They do this by flexing their muscle with regulators or by simply acquiring the threatening competitor.

Wall Street watchdog groups also warn that as more companies go private, thus shedding many reporting requirements, citizens are losing transparency with entities that may have a great impact on their lives.

How This Impacts Investors Like You

But let’s come back to the present. How does the shrinking pool of stocks affect investors right now?

It certainly reduces the asset purchase options for both professional and personal investors. Being an American, I hate anything that limits my choices or options to diversify. There are currently still plenty of stocks to choose from when building a well-diversified portfolio. But if the current trends continue over the next decade, investors could face serious constraints.