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Forbes
13 hours ago
- Business
- Forbes
Have Reporting Burdens Led To More Firms Staying Private?
The best evidence for this hypothesis comes from micro-caps. Confounding trends and offsetting benefits of being public are often ignored by advocates for reducing reporting rules. The number of US public firms has fallen in recent times. Prof. Jay Ritter, who tracks these numbers, documents that we had 3,804 US listed firms at the end of 2024 relative to the peak of around 8000 in 1996. Remarkably we had 1,384 foreign firms listed at the end of 2024. Many blame higher costs reporting and auditing for the smaller number of US listed firms. They point to the cumulative onslaught of Sarbanes Oxley 2022, the 2003 Global Settlement that alleged made it harder for analysts to cover small firms, Dodd-Frank 2010, and the supposedly relentless pace of accounting and auditing regulation pushed by Congress, the SEC and the FASB. The question I want to address is whether there is any evidence for that claim. Trend depends on benchmark period In a research note, Vanguard points out that if we go back to 1972, the decline shrinks to a third. On top of that, 1972 was the year NASDAQ was set up and 3,000 odd new companies entered the public arena. Why the fall? Doidge, Karolyi, Shen and Stulz (2025) list two potential underlying reasons: (i) it is easier to stay private because restrictions on staying private have softened and it has become easier to raise funds for private firms, perhaps due to the low interest rate environment; and (ii) antitrust enforcement over the last decade has been relatively lax and product market competition has heated up leading to a greater number of mergers. They don't seem to devote much space to reporting cost burden. Acquisitions drive most of the decline A McKinsey piece shows that 95% of the exits from our markets are driven by acquisitions. Thus, the so-called missing companies have not left the investible universe for the US investor as the investor gets indirect exposure to the target via the acquirer's stock. Espen Eckbo makes the acquisition point more rigorously. However, the rate of entry and exit into public markets is not uniform across industries. We had more IPOs, relative to exits, in pharmaceutical and biotech industries. The number of IPOs, relative to exits, are more or less the same in retail, materials, consumer apparel and durables. Exits far exceed IPOs in banking, software, technology hardware, media and telecom. Any theory that argues reporting burdens are a first order problem needs to explain why such burden has massively increased for banking, software, tech hardware, media and telecom relative to pharma. Smaller IPOs, mostly micro-caps, gone The McKinsey piece also makes the interesting point that we have far fewer smaller IPOs now relative to the past. This suggests that more of the earlier value is captured by private investors, as private equity firms seem to take longer to exit their positions now relative to before (3 years in 2007 relative to 6 years in 2015). One could argue that the costs of reporting, auditing and compliance have become too large for smaller IPOs to even think about going public. Vanguard points out that the missing IPOs are micro-caps. Is the loss of micro-caps a policy concern? Moreover, Mauboussin, Callahan, and Majd (2017) and Doidge, Karolyi, and Stulz (2017) note that half of what can be referred to as the 'listing gap' (exits more than IPOs) occurred before Sarbanes Oxley became law. Start-ups have declined too Somewhat intriguing, the number of start-ups appears to display mixed patterns since 1996. The Kaufmann index of startup activity falls from 1996 to its nadir in 2013, after which it picks up till 2017, when the index was last published but the 2017 number was still lower than the 1996 number. This suggests that there may be fewer businesses even available to go public. International exchanges I am in the UK as I write this and an institutional investor I know here suggested that the London stock exchange has suffered a similar decline in IPOs. In fact, there is some angst in the UK that they are losing listings to the US. The loss in listings applies to other advanced economies as well, as Espen Eckbo points out. The theory pushing for reporting burdens as the primary explanation will have to explain why UK reporting and reporting in other advanced economies has also become onerously burdensome. Burgeoning private equity (PE) A senior executive tells me,' the payouts achieved by management and their VCs by arranging acquisitions to PE firms, as well as PE to PE sales have been, in recent times, just as compelling as anything other than a truly dramatic IPO. Smaller companies, companies with significant internal ownership, companies without strong growth or high investment opportunities (that is to say not pharma or biotech who absolutely need risk capital), companies where management would like to stay involved but are not keen on public company visibility. These are all great reasons to be acquired by PE rather than either IPO or even getting acquired by a public company rapidly, with certainty, without much publicity. PE is incredibly well equipped at maximizing ongoing cashflows, and growth, while still maintaining: (i) particularly attractive incentives for management in the transaction, (ii) management that stays post transaction with significant incentive retentions and milestones -- all without pesky proxy announcements about executive compensation; and (iii) objectively great returns to those equity holders that are just selling.' The role of reporting for intangibles Rene Stulz (2018) has suggested that new firms heavily invest in intangibles and forced disclosure of intangibles by securities laws, all else constant, encourage firms to stay private. I am not sure of this argument as US public firms barely tell us anything about their intangible investments, especially home grown ones. Papers suggesting that SOX increased regulatory burdens Zhang (2007) finds negative returns of around -15% to -13% around the events surrounding the passage of SOX. I find these returns too large to be credible. Engel, Hayes, and Wang (2007) observed an increase in decisions to go private after SOX. But this evidence is mixed. Bartlett (2008) of the Stanford Law School re-examines this question and concludes, 'non-SOX factors were the primary impetus for the "name brand" buyouts commonly evoked as evidence that SOX has harmed the competitiveness of U.S. capital markets.' Iliev (2010) is perhaps the best cited paper in the area. Using careful research designs, Iliev documents that section 404 of the SOX, which mandates that the auditor attest the internal controls of the firm for the absence of a material weakness, led to conservative reported earnings but also imposed real costs. Iliev compares audit fees and earnings quality for firms with float of $50-75 million to those just above at $75 million-$100 million. The idea is that firms in these two partitions are mostly similar except that Section 404 applies only to firms with float greater than $75 million. He concludes, 'on net, SOX compliance reduced the market value of small firms' and increases audit fees by 167%. Atanasov and Black (2020) replicate Iliev (2010) and conclude that not controlling for firm growth led Iliev (2010) to overestimate SOX compliance costs in his analysis. However, the increase in audit fees suffered by the small firms is real, by about 80%. The dollar numbers underlying these estimates are worth reiterating. The average firm in Iliev's affected firm sample pays more than $0.7 million in greater audit fees. The mean and median earnings of sample firms is -$4.8 million and -$1.4 million respectively. Iliev uses this comparison to argue that the compliance costs of section 404 were substantial. Were they? Would these firms have survived had section 404 not been enacted? Is it obvious that investors would have wanted to invest in such firms? And, how much of the audit fee hike is temporary for a year or two. Even more noteworthy, this evidence relates to micro caps (defined as stocks with market capitalizations of between $50 million and $250 million in 2024). These numbers would be smaller if we went back in time as stock markets have gone up quite a bit in the last 20 years or so. The bigger question is how can we possibly generalize evidence reliant on a sample of microcaps to the entire corporate ecosystem? Ewens, Xiao and Xu (2024), in a new paper, move this literature forward and consider three such natural breakpoints to estimate costs of mandatory reporting: (i) firms below $25 million in float in 1992 were designated as 'small businesses' and escaped a few disclosure requirements; (ii) the $75 million float threshold that Iliev looked for section 404 of SOX; and (iii) the $700 million float threshold used in the 2012 JOBS Act. The 2012 JOBS Act is interesting because the point of that legislation was to exempt smaller firms from a few reporting requirements. So, the JOBS Act presents a bit of a counterfactual to the usual setting whereby regulation increased. Based on these events, they claim that the median firm spends 4.3% of its market capitalization on compliance costs. I find the 4.3% number somewhat big. Moreover, even with the clever econometrics used in the paper, can one really generalize estimates from SOX and JOBS Act to the universe of firms? I don't know. Interestingly, Ewens et al. themselves seem to conclude, 'heightened regulatory costs only explain a small fraction of the decline in the number of public firms over the last two decades. Our results suggest that non-regulatory factors likely played a more important role in explaining the decline in the number of U.S. public firms.' Evidence around the 2012 JOBS Act Researchers are generally good at coming up with unintended consequences of regulations that public firms are required to follow. But we don't often see studies that document the offsetting benefits of going or staying public. The 2012 JOBS Act presents a rare opportunity to consider whether relaxing reporting regulations encourages more IPOs. Dambra et al. (2015) conclude that the 2012 JOBS Act led to an increase of 21 IPOs a year, on average. Ewens et al. (2024) find a slightly higher estimate: roughly 28 additional IPOs. One must wonder whether 20 odd IPOs per year are worth the potential collateral damage to the credibility of US reporting and compliance systems, if the PCAOB were to be dismantled or SOX were to be repealed. Incidentally, many other advanced economies passed regulation, modeled on SOX, in their own countries. Did they not conduct a careful assessment of costs of such regulation on their IPO activity? Or did they recognize the need to tighten up reporting and audit rules after the tech bubble burst in 2001? IPO Tax Robert Jackson's, the ex-SEC commissioner, analysis highlights the 7% tax that middle market IPOs must pay even before they go public, to investment bankers, lawyers and the like. Surely, the IPO tax, which has little to do per se with the reporting and compliance costs of 4.3% highlighted by Ewens et al, deserves more attention. The advocates of cutting reporting burdens are somewhat silent about reducing the 7% middle market IPO tax. And I am aware of startups that are working on software that can write an S1 in minutes with AI. Shouldn't the 4.3% reporting costs, estimated by Ewens et al., fall? Benefits of staying public are often ignored Owners, VCs, and capital providers get liquidity. Public firms can potentially pay labor mostly via stock and hence attract higher quality talent. Stock can be used as a means of payment to buy another company and hence take out a rival or to buy a complementary firm. If you get acquired, the acquirer is usually expected to pay a 25% control premium over the prevailing stock price. In sum, the case for reporting burdens forcing companies to stay private is far from clear. The best evidence relates to micro-caps and generalizing from that set to other companies is not straightforward. Partisan debate about the evidence often tends to ignore the vast number of confounding factors such as low interest rates, falling number of start-ups, special time periods chosen for the analysis and large number of acquisitions of public firms and the 7% IPO tax. If anything, US reporting rules need to be strengthened, not weakened. I have pointed out, time and again, the deficiencies in our financial reporting system and how auditors could potentially do a better job. Regulators may want to proceed with caution the next time someone brings up the hypothesis that reporting burdens are a significant barrier to US firms going public.
Yahoo
2 days ago
- Business
- Yahoo
Circle IPO leaves $1.72 billion on the table, seventh biggest underpricing in decades
Here we go again. Traditionally, IPOs are a great deal for Wall Street and its prized clients, not so much for the companies the investment banks take public. Those fabled outfits argue that if they price the shares for the underwriting low enough, so that the hedge and mutual funds and other financial institutions that subscribe get a big 'pop' the first day of trading, the grateful buyers will repay the favor by staying loyal and holding for the long term, providing a steadfast ownership base going forward. Whatever the real benefits of that arrangement may be to the issuer, it most often comes at an enormous cost. Though we haven't seen many IPOs, and hence much underpricing recently, we've just witnessed an outstanding case of the phenomenon in action. It's one for the ages, and specifically, this case's stunning dimensions exemplify the craziness that typifies the surreal Age of Crypto. On June 5, Circle Internet Group, issuer of the highly successful stablecoin USDC, debuted on the New York Stock Exchange (ticker: CRCL). In the days prior, the deal team led by JP Morgan, Citigroup and Goldman Sachs sold 34 million shares to institutional purchasers at $31 per share. Hence, the offering raised $1.1 billion in cash that in its prospectus, Circle stated that it plans to deploy for 'investment in new products,' 'potential acquisitions,' and 'investment in expanding awareness.' By 1:00 PM, Circle (CRCL) had jumped to $95, and then drifted downwards to close at $82.84, still posting a 167% gain for the day. The rub: Circle could have piled more than twice as much into its treasury had it gotten full price. It appears that the $31 per share that Circle collected in the underwriting was nearly $52 less than what investors were willing to pay once its stock hit the open market. If Circle had pocketed the full $82.84 where its shares closed the day, it would have collected $2.82 billion instead of $1.1 billion. So the process led the crypto highflier to forego $1.72 billion that it could have added to its cash horde. In the annals of 'amounts left on the table' from IPOs, that $1.72 billion is big. Jay Ritter, a professor at the University of Florida and the world's leading expert on IPOs, told Fortune that the figure ranks seventh largest for all offerings since 1980. The underwriting versus first day price shortfall is only exceeded by the instances of Visa, Airbnb, Snowflake, Rivian, DoorDash, and Coupang (the South Korean e-commerce platform that sacrificed just a tad more on its 2021 outing at $1.85 billion). The $1.72 billion that went to first day gains for the Wall Street favorites and not to Circle is almost exactly twice the $849 million in cash that, as the prospectus disclosed, the USDC purveyor held on its balance sheet prior to the offer. At the market close, Circle's market cap sat at a towering $16.6 billion. That's gives Circle a PE of 106 based on its net earnings of $157 million in 2024, making it according to Ritter 'an incredibly expensive way to get exposure to cryptocurrencies.' He notes that Circle makes money by issuing USDC, on which it pays nothing to holders, and collects interest garnered by channeling the proceeds into what appear to be Treasuries and other 'safe' fixed income securities that as of Q1, were yielding around 4.2%. To grow into its big multiple, Circle needs to mint huge new quantities of the stablecoin so that its spread income rises at a rapid rate. 'It all depends if they can grow fast enough and get away without paying interest,' says Ritter. 'For that to happen, stablecoins would have to become a preferred way for people to make transactions. What if their coin turns out to be incredibly lucrative, which is what needs to happen given that PE? In that case, a competitor could come in and pay interest,' and grab a big chunk of the stablecoin market from Circle. Put simply, if competition rises and times get tough, Circle and its shareholders may sorely miss the extra almost $1.7 billion that went to first day gains for the underwriters' clients and not into it coffers. That's over ten-times its profits for last year. Considering the risks in the Circle business model that hinges on virtually creating a revolutionary new medium of exchange, losing that 'rainy day' cushion, what now seems a minor sacrifice amid all the hoopla, may someday loom large. This story was originally featured on Error in retrieving data Sign in to access your portfolio Error in retrieving data Error in retrieving data Error in retrieving data Error in retrieving data
Yahoo
05-03-2025
- Business
- Yahoo
IPO market, trading takeaways, the S&P 500: Asking for a Trend
As Tuesday's trading winds down and transitions into extended hours, Josh Lipton looks back on the day's top market themes on Asking for a Trend. University of Florida Finance Professor Jay Ritter breaks down current forecasts for the IPO market in 2025. Yahoo Finance host Julie Hyman examines how the S&P 500's (^GSPC) current break from momentum is lining up with the index's 200-day moving average. To watch more expert insights and analysis on the latest market action, check out more Asking for a Trend here. This post was written by Luke Carberry Mogan. Sign in to access your portfolio
