In yesterday's WSJ, the lead editorial dealt with the continuing dearth of US IPOs:
Recent news of a potential $25 billion initial public offering for the Web-based bargain hunting company Groupon is an exception because the overall trend is down. Last year 72 venture-capital-backed companies went public in the U.S., according to data from Thomson Reuters and the National Venture Capital Association. Over the last decade, the annual number has never reached 100 and has averaged fewer than 50.
Yes, it's unrealistic to expect a repeat of the late-1990s Internet boom, when annual IPOs twice exceeded 270. But how about the early 1990s, before the dot-com mania skewed the numbers? The U.S. averaged 160 a year from 1990-1994, three times the current rate.
As the Journal explained, this is a serious problem:
New companies are the lifeblood of a capitalist economy. Every venture-backed start-up that grows into a public company could be the next Google, Intel, Starbucks or Amgen. Venture investment adds up to 0.2% of U.S. GDP, but the revenue of companies created with such investment amounted to 21% of the economy in 2008. The diminished ability of start-ups to hit the long ball with an IPO discourages investments at all the earlier stages. Venture capitalists know they need some equity home runs to offset losses in the thousands of firms that never find a market.
So what's to blame? The Journal targets Sarbanes-Oxley:
A 2009 survey from the Securities and Exchange Commission speaks volumes. The SEC asked public companies about Sarbox's infamous Section 404, which mandates an external audit of an internal audit of a company's financial practices, known as "internal controls," on top of the traditional audits of corporate financial statements. That's as much bureaucracy as any human should be forced to endure under the Geneva Convention.
Not surprisingly, 70% of small public companies told the SEC that Section 404 has motivated them to consider going private again, and 77% of small foreign firms said the law has motivated them to consider abandoning their U.S. listings.
Unfortunately, there is now an organized constituency that benefits from Sarbanes-Oxley:
... the accountants who profit from Sarbox and the Treasury maintain that the law is merely one of many factors discouraging new public companies. This view is shared by most in Washington because Sarbox was a bipartisan overreaction to the accounting scandals at Enron and WorldCom and was signed by George W. Bush.
You can add to that list the large companies who find it convenient that small potential competitors are priced out of the capital markets. SOX-related costs do not scale well. As a result, the costs tend to be proportionately higher for smaller firms. Sarbanes-Oxley thus has become a barrier to entry protecting large entrenched firms.
I detail all this, as well as other regulatory failures in the IPO market in my article Corporate Governance and U.S. Capital Market Competitiveness, which explains 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.
The organized interest groups that support SOX will simply make all that much harder to unwind the ratchet effect.
