Why Regulation Punishes IPOs
Are our capital markets broken? The global economy is operating on one cylinder and economic data from the U.S. continues to disappoint. A dangerous disconnect exists between the real economy and financial markets threatening the emergence of young companies and the jobs that they normally create.
August 23 2012 by ChiefExecutive.net
“Perhaps the biggest financial story so far this year is not the fiasco of the Facebook IPO or the computer malfunctions that brought down venerable Knight Capital in a matter of minutes, but the persistently low volumes on the major North American and European exchanges,” argues John Browne, senior market strategist for Euro Pacific Capital. “For generations, many investors assumed the benefits of economic growth were most likely transferred to the public through the ownership of common stock. For decades they were right. But the past dozen years of substandard stock performance, financial fraud, flash crashes and overhyped IPOs have threatened this assumption.”
Add to this the fact that in dollar volume, the number of initial public offerings in 2011 was around $27 billion versus $31 billion in 1993. In 1993, for example,there were 509 offerings. In 2011 there were 81 offerings according to Professor Jay Ritter of the University of Florida.
“What these numbers mean,” writes John Ransom in Townhall Finance,” is that over a period of time when world wealth was growing from $25 trillion to $64 trillion, the number of initial offerings on what are supposed to be the greatest financial markets in the world, fell by 84 percent. And 1993 was not one of the go-go 1990s years in the stock market either. Instead it was a stock market coming out of recession at 3,435 on the Dow Jones.” The average size of the offering in 1993 was around $61 million in 1993. Today’s offerings average about $333 million.
It didn’t take long after Facebook’s IPO debacle for many companies to abandon their dreams of going public. This year, 29 companies have pulled their plans to go public. “Some people thought the (Facebook) IPO would jump-start the IPO market,” says Richard Peterson of S&P Capital IQ. “But it’s caused just the reverse.” Many of the companies getting cold feet are in tech: Popular travel search company Kayak Software among others quickly delayed their IPOs after Facebook’s fizzle.
Both Ransom and Browne reckon that what’s particularly worrying about the numbers is that they tend to confirm that smaller companies no longer have access to the type of capital that only Wall Street can raise to help companies grow and prosper. Ransom adds, “ According to Motley Fool, Intuit, the makers of QuickBooks and Quicken went public in 1993. According to filing from the company, they had about $132 million in revenues that year. The IPO allowed Intuit to make some strategic acquisitions with shares of stock that set it up to be the company it is today: 8,000 employees with over $3 billion in annual revenue and a market capitalization of about $17 billion as of March 2012.”
“These regulations are damaging American capital markets by providing an incentive for small US firms and foreign firms to deregister from US stock exchanges,” says Rep. Ron Paul one of the few House members who voted against Sarbanes-Oxley. “According to a study by the prestigious Wharton Business School, the number of American companies deregistering from public stock exchanges nearly tripled during the year after Sarbanes-Oxley became law, while the New York Stock Exchange had only 10 new foreign listings in all of 2004.”
When the Competitive Enterprise Institute examined some of the knock-on effects of Sarbanes-Oxley, it found that the feature that requires accountants to attest to the internal controls in a company’s annual audit costs American businesses $35 billion per year in direct compliance costs, more than all the money raised annually by IPOs since 2000, with the sole exception of 2007.
The decline in IPOs likely owes a lot to a sputtering global but there are additional effects that hurt job creation. A Kauffman Foundation study analyzing the revenues and jobs created by companies before and after they went public, found that from June 1996 to 2010, a total of 2,766 companies completed IPOs in the U.S. Those companies employed five million people prior to the public offerings, and 7.3 million people in 2010. From 1980 to 2000, the U.S. was producing roughly 298 new IPOs per year. But from the 2001 to 2011, the average had dropped to just 90 per year. That slow down in the number of IPOs has had an impact on job creation. According to the study, had the number of IPOs kept pace during the past decade, those companies could have produced another 1.8 million jobs.
“What kind of an economy are we creating when we are paying compliance costs per year in excess of the actual money inflows to newly financed businesses?” Ransom asks.