Thank you so much.
Good morning, committee members, fellow witnesses and everyone else. I appreciate the opportunity to present my views at this committee.
All of the statements I am about to make are based on the draft of a research paper that my co-author Ray Bawania and I completed in 2019. In this paper, we asked whether the nature of the Canadian economic environment has changed over the past few decades. Our research question was motivated by the trends revealed in the U.S. markets, as well as academic articles that argue that product markets in the U.S. have become more concentrated over the past two decades.
In the project that underlies this statement, my co-author and I examined the business environment in Canada from the standpoint of financial markets. By analyzing the data that is typically used in corporate finance research, my work provides some descriptive statistical analysis of Canadian financial markets that potentially can serve as a starting point for future and more detailed research.
In the centre of our analysis are Canadian publicly traded firms. We first focus on the number of firms traded on the Toronto Stock Exchange, the TSX. Since publicly traded firms are typically the key players in the economy and tend to be much larger compared with private firms, the falling number of public firms could be the first sign of a structural change.
This is what we found. The number of non-financial firms—that is, firms that are not set up as an investment vehicle, such as investments funds, mutual funds and so on—have indeed dropped, by around 30%, since its peak around 2006 to 2008. To ensure that the trend could not be due to industry composition, we also split the overall number of firms into major sectors, and found that the decline in the number of firms is not limited to a specific sector but rather has affected firms across the entire spectrum of Canadian industries.
Next we turned to examining the size of public firms, measured as the market capitalization in constant Canadian dollars of 2002. Market cap measures what a company is worth in the open market and, therefore, serves as the most updated indicator of its perceived value. In addition, it reflects the market's perception of the firm's future prospects and incorporates both tangible and intangible components.
We found that the mean firm size has been persistently rising over the last 35 years. However, the growth has not been equal. Large firms have essentially grown at a much steeper rate over the past 10 or 15 years. For example, the inflation-adjusted market cap of firms in the top quartile of size distribution has swelled from a quarter-billion dollars in 2008 to almost $1 billion in 2016.
We also explored the combined effects of firm number and firm size by constructing a measure of concentration, the Herfindahl-Hirschman index, which is defined as the sum of squared market shares of all the firms within the same industry. We found that concentration has increased in most industries and this increase has been economically significant. Further, consistent with the increase in concentration, we found that the largest firms in each industry have become more dominant. The share of sales by market leaders compared to the total industry sales has also increased substantially over the same period.
In the second part of the paper, we examined possible implications of the systematic increase in concentration along with the decline in the number of publicly traded firms. It is possible that the increase in dominance of large firms could reflect barriers to entry. In general, barriers can be driven by a number of various factors, which include economies of scale and large capital requirements, regulatory changes that potentially discourage new firms from entering the market, and the increasing role of technology behind all this.
To examine the barriers-to-entry explanation, we performed several tests. First, we looked at the link between concentration and profitability. If markets are becoming more concentrated due to greater barriers to entry, we should find evidence that profit margins are increasing in those industries. Consistent with this argument, our analysis showed a positive and significant link between accounting measures and concentration.
It looks like I am running out of time.
In this case, let me mention that, going forward, I would like to set this result into a large frame and consider the relevance of Canadian public firms becoming more valuable and obtaining better investment opportunities. More research is needed to understand the reasons behind the secular decline in the number of firms, which is accompanied by an increase in size and vibrant M and A activity.
I hope these findings can provide an opportunity for policy-makers to further examine the trends of the increased concentration.