Very interesting special report in last week's Economist on the growth of superstar companies--especially in tech--that dominate their sectors. In the lead article, Adrian Wooldridge observes that:
A small number of giant companies are once again on the march, tightening their grip on global markets, merging with each other to get even bigger, and enjoying vast profits. As a proportion of GDP, American corporate profits are higher than they have been at any time since 1929. Apple, Google, Amazon and their peers dominate today’s economy just as surely as US Steel, Standard Oil and Sears, Roebuck and Company dominated the economy of Roosevelt’s day. Some of these modern giants are long-established stars that have reinvented themselves many times over. Some are brash newcomers from the emerging world. Some are high-tech wizards that are conjuring business empires out of noughts and ones. But all of them have learned how to combine the advantages of size with the virtues of entrepreneurialism. They are pulling ahead of their rivals in one area after another and building up powerful defences against competition, including enormous cash piles equivalent to 10% of GDP in America and as much as 47% in Japan. ...
The McKinsey Global Institute, the consultancy’s research arm, calculates that 10% of the world’s public companies generate 80% of all profits. Firms with more than $1 billion in annual revenue account for nearly 60% of total global revenues and 65% of market capitalisation.
What's driving this development? Wooldridge suggests several forces are at work, which are complementary rather than competing. But the one I want to focus on is the role of regulation:
The most powerful force behind the rise of the new giants is technology. But two other forces are pushing in the same direction: globalisation and regulation. ...
The growth in regulation has also played into the hands of powerful incumbents. The collapse of Enron in 2001 arguably marked the end of the age of deregulation, which began in the late 1970s, and the beginning of re-regulation. The financial crisis of 2008 served to reinforce that trend. The 2002 Sarbanes-Oxley legislation that followed Enron’s demise the previous year reshaped general corporate governance; the 2010 Affordable Care act re-engineered the health-care industry, which accounts for nearly a fifth of the American economy; and in the same year the Dodd-Frank act rejigged the financial-services industry.
Regulatory bodies have got bigger. Between 1995 and 2016 the budget of America’s Securities and Exchange Commission increased from $300m to $1.6 billion. They have also become much more active. America’s Department of Justice has used the Foreign Corrupt Practices act of 1977 to challenge companies that have engaged in questionable behaviour abroad. The average cost of a resolution under this act rose from $7.2m in 2005 to $157m in 2014.
Regulation inevitably imposes a disproportionate burden on smaller companies because compliance has a high fixed cost. Nicole and Mark Crain, of Lafayette College, calculate that the cost per employee of federal regulatory compliance is $10,585 for businesses with 19 or fewer employees but only $7,755 for companies with 500 or more. Younger companies also suffer more from regulation because they have less experience of dealing with it. Sarbanes-Oxley imposed a particularly heavy burden on smaller public companies. The share of non-executive directors’ pay at smaller firms increased from $5.91 out of every $1,000 in sales before the legislation to $9.76 afterwards. The JOBS act of 2012 exempted small businesses from some of the more onerous requirements of the legislation, but the number of startups and IPOs in America remains at disappointingly low levels.
The complexity of the American system also serves to penalise small firms. The country’s tax code runs to more than 3.4m words. The Dodd-Frank bill was 2,319 pages long. Big organisations can afford to employ experts who can work their way through these mountains of legislation; indeed, Dodd-Frank was quickly dubbed the “Lawyers’ and Consultants’ Full-Employment act”. General Electric has 900 people working in its tax division. In 2010 it paid hardly any tax. Smaller companies have to spend money on outside lawyers and constantly worry about falling foul of one of the Inland Revenue Service’s often contradictory rules.
I think that analysis is spot on. I wrote about the role SOX and Dodd-Frank have played in retarding economic growth in my article, Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010), available at SSRN: http://ssrn.com/abstract=1696303, and which was published in The American Illness: Essays on the Rule of Law. In that essay I argued that:
During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.
Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.
This essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.
I'd also refer you to Chester Spatt's essay Complexity of Regulation, which cogently argues that:
Complexity in regulation leads to complexity in financial structures and systems, particularly in light of the efforts of market participants to mitigate the costs and complications induced by regulation, including attempts to engage in regulatory arbitrage. Consequently, much of the costs of regulation in my view are associated with its intricacies. It also is useful to recognize that complexity in regulation leads to huge entry barriers associated with the cost of regulatory compliance. Instead of addressing “too big to fail,” this can lead to maintaining “too big to fail” institutions. This is a connection that appears to be underappreciated by our financial regulators.