Why the Number of Public Companies & IPOs are in Decline
The decline in the number of public companies in the United States and the decline in the number of initial public offerings (IPOs) that occur each year are widely decried. It is irony that many who bemoan these changes are the very persons who created the problems.
The cause of these trends is that being a public company is too expensive, too risky, both to the enterprise and the people running it, and just generally inconvenient. Because the private capital sources have become more efficient, public companies no longer have an advantage over private firms. Being a public company is only attractive for the largest companies.2 If offering and compliance costs are too high, public companies and their investors will seek alternatives. It is very important to hold on to this thought—capital will run away from excessive regulation and interference. And companies, public and private, will follow the capital.
At the same time, federal legislation and federal and state nuisance litigation have increased the exposure of public companies, and their officers and directors to liabilities for mistakes, real and alleged. Since most of this exposure and inconvenience can be avoided by becoming a private company, these laws and lawsuits have an unintended consequence of motivating companies and their management to look favorably on other options.
For a comparison of the baggage for public and private companies, please see Appendix A. Why there are trends away from IPOs and being a public company should be evident after reviewing Appendix A.
Those who have caused these problems include members of Congress; decision-makers at the Securities and Exchange Commission (SEC) and stock exchanges; the Public Company Accounting Oversight Board (PCAOB); stockholder activists; plaintiffs’ lawyers and the legislatures and judges who fail to curtail the litigation excesses; academics, accountants, and corporate lawyers who author innumerable papers on corporate governance and the like; and various officious intermeddlers who assert that they are the true arbiters for social justice, environmental protection, political correctness, and other “absolute truths.
By and large, these individuals have no experience running large businesses like public companies. Our current regulatory system reflects this lack of perspective. At the principal regulator over the public capital markets, the SEC, this lack of business perspective is exacerbated by leadership out of touch with most of the country.
The capital markets in the United States are the best and largest in the world, and it makes no sense to let government and others destroy this national trade advantage. However, because these forces are so numerous and few are likely to acknowledge their culpability, I do not foresee a ready fix to the problems. At some point, the public with the corporate and finance leaders will have to exert enough pressure to force a relaxation. I hope that it is not too late.
From 1977 until 2016 when I retired from private practice, I practiced corporate, securities and M&A law in the Dallas-Fort Worth area. In 1980, my law firm, including me as a young associate, represented the underwriters in an IPO by a small Houston-based oilfield service company. The gross amount raised in the IPO was slightly over $19 million, which adjusted for inflation would be approximately $57 million in 2017. Today, a comparably-sized underwritten IPO is not feasible. The economics of IPOs have changed too much.
As IPO costs and annual compliance costs have risen, the bright minds of finance have devised alternatives. Some of the options for financing, growth and monetizing investments available to companies both private and public are:
- To finance the company’s growth through venture capital or private equity or sell the company to those financiers,
- To sell the company to another company, public or private, U.S. or foreign, and
- To seek funding from offshore sources, including non-U.S. exchanges.
It is reasonable to assume that many of the companies with the greatest profit potential will be drawn to these options. If this assumption is correct, the future rates of return from the stock markets will likely be lower than if the departed companies had stayed public. Average Americans, and their retirement accounts and pensions will suffer.
As strange as it may seem to the mindset of those in government or academia, the public markets and the accompanying regulation and other baggage are in competition with these less costly options. Their faulty analysis is, “If we regulate and micromanage the heck out of public companies, these companies and their capital markets will improve.” In fact, the opposite is true.
Finally, I know that the owners of some private companies elect to forego the pain of financings and to limit their companies’ growth to levels that can be funded “organically” (i.e., from internal cashflow) or in combination with bank lending
Of course, I am not the only person to write about the decline in the overall number of public companies in the United States and the annual number of IPOs. Other articles and studies have been written by the SEC, quasi-regulators such as the exchanges and the Financial Industry Regulatory Authority, Inc. (FINRA), some members of Congress, stockholder activists, academics, and professionals.
I have found most of these to be unsatisfactory in their analysis. In this paper, I explain that the lack of business and management experience among regulators and groups named above is the leading cause of declines in the public company market.
Lack of Experience
Operating a public company is difficult. One need go no further than reading a few issues of The Wall Street Journal to see the turnover in the C-level positions of public companies.
Sadly, most regulators and corporate commentators have no experience running a public company or any private company. As one former CFO once commented to me;
“They have never signed the front of a business check.”
Yet, they adopt one proposal after another. The effect, as I have heard it described, is “the triumph of ideas over common sense.”
Some members of Congress have business experience, but many do not.
For example, Senator Elizabeth Warren’s website reflects that she has no private sector experience, despite Sen. Warren being Congress’s most vocal critic of “Wall Street” and large corporations.
At the SEC, the lack of business experience is combined with a lack of understanding of most of the country. The commissioners and senior staff are and have been for some time a relatively closed, largely homogeneous group of attorneys, executives, and others from the Northeast United States. (See Appendix B)
Past Congressional Actions
Congress and occupants of the White House have sought to punish all public companies for the sins of a few. These actions include increasing the exposure of the executives and directors of public companies to personal liability for certain mistakes or willful acts. In addition, Congress inflicts public companies with various social or political correctness requirements that have nothing to do with the operation of businesses.
Examples of Congressional meddling in public companies include the following.
- Enactment of the Sarbanes-Oxley Act of 2002 as a reaction to the excesses of Enron Corp. No matter that several top Enron executives and at least one outside professional went to jail, Congress leapt into the perceived breach and enacted laws on establishing internal controls and executive accountability for disclosures. Some of the changes were:
- Increasing the role and powers of audit committees, mandating member independence, and setting other standards for members of the audit committee.
- Mandating internal control tests.
- Increasing liability exposure of executives and officers for inaccurate financial statements.
- Strengthening criminal penalties for securities fraud.
- Creating the PCAOB to set standards for audits of public companies.
- Accelerating reporting requirements for executive and director trades in their public company’s stock
- Enactment of the Dodd-Frank Act in 2010 as a reaction to the Great Recession. In addition to creating the Consumer Financial Protection Bureau and a host of new bank laws, some of the other requirements of that infamous act included the following:
- Public companies must disclose the median annual compensation of all employees (other than the principal executive officer) and separately the annual compensation of the principal executive officer, and the ratio of the two amounts.
- The New York Stock Exchange and NASDAQ stock markets had to promulgate rules mandating independent compensation committees that may hire their own consultants and legal counsel.
- Public companies must disclose audited information on the use of minerals from conflict nations.
- Public companies must allow stockholder advisory votes on executive compensation.
- The law directed national exchanges to provide three-year claw back provisions to recover incentive compensation from current or past executives after a material error requiring restatement of financial statements.
- Requiring oil, gas and other mining companies to compile and disclose payments to the U.S. government, foreign governments, and companies owned by foreign governments.
- Hectoring public company executives and directors. Congress regularly calls before its committees executives and directors of both public and private companies.7 The public disclosures of compensation and other matters open these individuals to abusive questioning.
Failed SEC Regulation
The SEC is an independent government organization with a governing body of five commissioners appointed by the President. The five commissioners, three from the President’s party and two from the other, are supposed to assure independence. The SEC, however, is dependent on Congressional funding, and its commissioners and top staff are subject to appearing before Congressional committees. This means that the SEC is subject to political winds. At the extreme, a member of Congress can even attempt to badger the SEC into taking action that the member cannot achieve legislatively.
The SEC has three functions—protecting investors, regulating the capital markets, and facilitating capital formation. Until Congress lit a fire under the SEC in 2012, the most noteworthy shortcoming of the SEC was its ignoring of the last of these, facilitating capital formation. Despite the axiom that capital formation is an economic stimulant, the SEC never felt the need to reexamine its regulations affecting capital formation during the Great Recession. Instead, Congress had to act, enacting the Jumpstart Our Business Startups Act (JOBS Act) in 2012. This law relaxed various statutes affecting capital formation and directed the SEC to take other actions with the same effect.
Had the Commissioners seen their role in a severe recession as being to loosen restrictions on capital formation, the SEC could have achieved virtually the same results much faster by relaxing regulations. Instead, it was business as usual at the SEC, and Congress had to force the issue by enacting the JOBS Act.
Three things need to happen at the SEC
First, Congress and the president should appoint some commissioners (a) with significant business experience, and (b) who are from other parts of the country.
Second, the chair and the other commissioners should hire persons with business management experience in the top leadership positions, such the heads of the divisions at the SEC, and the other 23 direct reports to the Chair. Again, representation from all of the country is needed. These steps would help the SEC understand better capital formation.
Third, the SEC should use its improved perspective to reduce the regulatory burden on public companies.
The SEC has a new chairman, who joins two well-qualified commissioners presently serving. As two commissioner vacancies are filled, the Commission will have the opportunity to become proactive. I have my fingers crossed that they will fight back the excessive regulation.
As noted above and shown on Appendix A, there are other sources of expense and aggravation for public companies. These includes stockholder activists, federal and state courts, stock exchanges, special interest groups and others. Public companies have been too easy a target for those with an agenda.
The public must force Congress and their state legislations (particularly the Delaware legislature) to block the intermeddling.
It is a tribute to the American economy that U.S. public companies have been able to succeed despite the albatross of excessive regulation and interference. However, those days are coming to an end. Successful private companies are foregoing IPOs, and companies that are already public are looking at other options.
Because the solutions to problems for public companies lie largely with people who created the problems, I am not optimistic about solutions. Will Congress, the SEC, and others realistically gaze into the mirror and see themselves as the causes of the decline in public companies? I am skeptical. Perhaps the SEC will try to improve the situation, but proponents of government regulation may cry that the SEC is leaving investing widows and orphans to the unscrupulous corporate villains. Various groups on Capitol Hill are likely to resist giving up their favorite regulations.
In the end, change will not come from elected officials, regulators and the various special interest groups. Change will come from a public that subscribes to the idea across many subjects including finance that less regulation is better. I fear that only when the public is ready to impose this philosophy on government and our legal system will change come.
Too much is at stake. The best and largest capital markets in the world cannot be allowed to wither. Tell Congress, the regulators, and others to stop trying to kill the golden goose!