Friday, March 27, 2009

Regulation and going public

This week in my MBA class we covered IPOs and discussed that even before the economic crises that is dominating all aspects of the financial world, the number of IPOs was down significantly from 1990-1998 levels. We then discussed the increased cost of government regulation as a likely cause.

This same point was mentioned by Bill Gurley in the following Seeking Alpha article:

Dear Mr. Geithner: Do Start-Ups and VCs Really Need More Regulation?
"I have no idea how effective Sarbanes has been at reducing fraud (it obviously did not prevent our current economic malaise), but I do know one thing, Sarbox created a significant burden and tax on small companies that desired to tap into America’s public capital markets, and one that could have long-lasting negative impact on the long-term success of startups and innovation in America.

It’s pretty simple: Sarbanes-Oxley costs $2-3mm to implement, and is also a huge burden on a company's IT and development staff (taking away from feature expansion and product improvement). For a company doing $50mm in revenue with a 10% pre-tax operating margin, you only have say $6mm in after-tax earnings to report. These new Sarbox costs effectively cut your total profitability in half, which has a huge impact on valuation.

Of course, what this in fact causes is companies to feel the need to be much, much larger before they even try to go public. Notably, IPOs have been systematically reduced post-Sarbox"
This view is supported in academic literature by Piotroski and Srinivasan who find
"...we find that the listing preferences of large foreign firms choosing between U.S. exchanges and the LSE's Main Market did not change following the enactment of Sarbanes-Oxley. In contrast, we find that the likelihood of a U.S. listing among small foreign firms choosing between the Nasdaq and LSE's Alternative Investment Market decreased following the enactment of Sarbanes-Oxley. The negative effect among small firms is consistent with these marginal companies being less able to absorb the incremental costs associated with SOX compliance."

International Listings(January 1, 2008). Rock Center for Corporate Governance at Stanford University Working Paper No. 11. Available at SSRN:

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