Too long has the Toronto Stock Exchange been shrunken and battered. No more
Pedestrians walk past the old Toronto Stock Exchange sign on Bay Street in Toronto’s Financial District, on Oct. 1 2019.Fred Lum
Bryce C. Tingle is the N. Murray Edwards Chair in Business Law at the University of Calgary’s faculty of law. His book Hard Lessons in Corporate Governance was shortlisted for the Donner Prize.
Canada has been shaken out of its complacency by the actions of the Trump administration over the past 100 days. As this country considers how it can compete against a suddenly antagonistic southern neighbour, some consideration should be given to the woeful state of our public markets.
The Toronto Stock Exchange, long the crown jewel of Canada’s financial system, has shrunk almost by half in terms of the number of operating companies it supports. Most of the missing companies have gone to the U.S. In the terminology we generally use for businesses, the TSX is being badly outcompeted by the U.S.
At a time when Quebec’s Premier is musing about accepting pipelines, and various other provinces are considering reducing long-standing trade barriers, improving the competitiveness of our public markets needs to be a priority.
Our stock exchanges’ competitors include both American companies that buy the Canadian startups that would otherwise have listed on the TSX, as well as the American stock exchanges that directly attract Canadian companies away from the TSX.
Many Canadians shrug at the news that the TSX is faring poorly, but that would be a mistake. The decline of operating companies on the TSX is not just a problem for Bay Street, but a problem for the whole country.
Canada has largely failed to economically keep pace with the rest of the world this century. The past 10 years have been particularly bad, but low productivity (and the real wage growth it brings) has been a problem since the 1990s. It is probably the most important public policy issue we face – particularly as we cope with a suddenly hostile trading partner.
The decline of Canada’s economic fortunes has been intensively studied. Most researchers have concluded that a major problem is the country’s failure to grow its innovative new businesses into large companies.
This growth process is called “scaling up,” and it is the subject of research by Charles Plant, founder of the Narwhal Project, which is focused on improving Canada’s ability to create world-class technology companies. According to a recent paper by Mr. Plant we are worse at scaling up than any developed country he examined.
This gets us to the reason the average Canadian should care about the travails of the TSX. Such stock exchanges provide companies with locked-in capital and the time and peace to pursue long-term growth strategies. When a company’s shares are traded publicly, investors can buy and sell shares in that company constantly without significantly affecting the company’s business operations.
Thus, money given to the company by investors does not have to be given back by the company (the locked-in capital), and the investment decisions of investors don’t impact the business (allowing long-term growth strategies). For these reasons, most of Canada’s national champions have historically scaled up through the TSX.
In contrast to public companies, private businesses must provide liquidity to their investors every five to seven years. As a result, the life of private companies is marked by frequent sales of the entire company to new owners.
Corporate sales produce considerable disruption to management and the business, along with efforts by each new owner to extract as much from the business as they can during the time they control the company. The techniques of private equity firms to maximize the returns from a business through asset stripping and high levels of leverage are well known.
The competitive problem of the TSX can be stated simply: Canadian companies don’t want to join the exchange. Instead, startups increasingly sell themselves to larger competitors.
In many industries, such as tech, these purchasers are foreign. One study found that of 164 acquisitions of Canadian technology firms between 2004 and 2021, just one featured a Canadian purchaser. These sorts of corporate sales now constitute nearly all the exits tracked by the Canadian Venture Capital Association.
Initial public offerings on the TSX aren’t even a rounding error in the statistics. In some recent years, there hasn’t been even a single new listing on the exchange.
The TSX has two interlocking problems. First, it has a regulatory regime (much of which is generated by Canada’s securities commissions and other third parties) that is regarded with considerable dislike by Canadian entrepreneurs considering whether to pursue a public listing. (Polls regularly show that even the directors of established public companies have a low regard for the corporate governance regime we impose upon them.)
Second, this unpopular regulatory regime is, in some ways, worse than the one in the U.S. In that country, 90 per cent of new listings have staggered boards, making it hard to replace all directors quickly. Ninety-four per cent do not have majority voting, which means directors can often stay even if most shareholders oppose them. Eight-four per cent don’t permit shareholders to call special elections, which prevent them from causing disruptions between annual meetings. And almost all IPO companies have poison pills or other types of takeover defences in place.
These measures heavily insulate companies from undue shareholder influence or hostile takeovers. Without exception, none of these choices by newly listed companies in America would be permitted in Canada.
Indeed, the TSX itself has rules mandating majority voting and forbidding staggered boards. They would make sense if empirical studies showed that companies with such measures performed better than their peers. But the evidence doesn’t show this. In fact, it shows the opposite.
The public markets in Canada are filled with long lists of best practices to be observed by boards and managers in everything from the kind of people they hire, to the ways they pay are paid. Board processes that once were the site of experimentation and firm-specific adjustments are now one-size-fits-all practices imposed on directors by outside actors.
Again, none of these best practices are supported by empirical studies as benefiting public companies’ operational performance. The U.S. has, for this reason, preserved greater heterogeneity in their governance regime.
The TSX has an unusual business. Like Amazon and Google, the TSX’s core business is to create a market bringing the buyers of shares (investors) together with the sellers of shares (companies). What we have been seeing over the past two decades or so is that the TSX now has a market that is attracting buyers of shares, but doing a very bad job of attracting sellers of shares.
This is unsurprising, as investors have been the principal beneficiaries of Canada’s public market changes over the past three decades, at the expense of companies and their managers. The result is a market that most sellers have decided to boycott.
Canada will never be able to equal the depth and volume of the American stock exchanges, but it can create a better market for public companies. This would require the TSX and Canadian securities regulators to dramatically reverse course.
For most of the past few decades, Canada has diligently copied reforms in the U.S., even mandating best policies that remain voluntary in that country. Any attempt to improve the TSX’s competitive fortunes will require differentiating the two countries’ regulatory regimes, almost certainly in ways that remove the pain points for companies considering listing their shares.
There are reasons for hope that the TSX can improve its position. The U.S. doesn’t have all the advantages in the competition for public companies. The American legal system is expensive and volatile, compared with the predictability of Canadian courts.
Our deeply polarized neighbour produces wild swings at the level of securities regulation depending on who sits in the White House. Regulators and prosecutors in the US have so much power that nearly all securities indictments end in conviction or plea deals. (This should be a source of soul-searching in a liberal country. No one thinks that every party targeted by the police is guilty.)
The biggest advantage Canada has, however, is that we can cater to smaller companies. The very size of the American markets prevents them from doing this. Historically, we have been the best in the world at supporting small and medium-sized public companies. We are the only country, after all, that has been able to maintain a junior public market for more than a few years. Ours has lasted over a century.
Canada will probably never be able to overcome the attractions of the American exchanges for giant companies in hot sectors. But for every other company (and that is most of them), we can create a public market that works.
We can design a public market in which smaller issuers scaling themselves up will not get lost. A market that pays attention to rapidly growing businesses in temporarily ignored industries. A market with a regulatory regime that is right-sized for the kinds of smaller companies the TSX has historically nurtured.