The Evolving IPO Market

There is a new Grant Thornton report out arguing that the U.S. is suffering from an IPO drought caused by high-frequency trading and broken market microstructure (but not SarbOx). The alleged consequences? 22-million fewer jobs in the U.S. than would otherwise be the case.

Whoa. That's a provocative claim, but does it hold up?

It would indeed be good to see more IPOs, so I’m with the authors on that, but after that they mostly lose me. I have multiple objections, including that the authors refuse to recognize that the venture industry has grown too large, that the technology industry is maturing and that financial markets have changed and are no longer engineered for brokers and bankers to make money via flipping over-valued startups to retail investors via institutional cronies.

Instead of recognizing this, the authors want to blame high-frequency trading. You know... computers. And hedge funds. Baddies in black hats, in other words.

While that is au courant, it is tough to support. It has never been easy to build institutional-class trading volumes in early-stage public companies. I used to cover them as an equity analyst, and now is no different. That market-makers in large public companies are increasingly algorithmic – 75% of the trading volume in the largest U.S. stocks -- is something to be applauded, not decried, and it has little to do with the relative dearth of IPOs in the U.S.

Further, the implied claim that market microstructure -- increased efficiency, decimalization, etc. -- has cost the U.S. 22 million jobs via the under-production of IPOs is cargo cult illogic. It is tantamount to ignoring everything that has changed in markets and technology over the last decade, all in favor of positing an immutable relation between IPO rate and GDP. Financial markets are not nearly so neat, tidy and predictable.

The authors have a solution, however. They want to turn the capital market clock back to the days of dealer-driven markets, wide spreads, research analysts who are really bankers, and a brokerage industry that preyed on retail investors. It's like hungry great white sharks proposing that newly speedier seals be fattened up, given weight handicaps and kept in open water, away from dry land and rocks.

Technology has changed the way growth companies are produced, funded and sold in this country. Some people might not like it, but not liking disruptive change is the response of most industries that have been disintermediated.

Comments

[THofler:]

Sounds like you have some considerable experience here Paul. What's your opinion on the impact of SarbOx?

Nov 10 10:39 PM

[Jason Kelly:]

Stock markets have drifted very far from their initial intention of providing investors with an efficient way to allocate capital to promising businesses.

Most start-up leaders I know say it's hardly worth it any more to seek funding via public markets, with their government-manipulated surges and crashes, relentless focus on quarterly results at the expense of long-term plans, and various "money game" schemes that push stock prices around.

Of course there will always be some companies that get funding via Wall Street, but it's not surprising to see a move toward private, more stable sources whenever possible.

Nov 11 05:25 AM

[Mike from NYC:]

I hope if we learned anything from the Dot Com fiasco it would be that IPOs are not all that they are cracked up to be. While there were some winners among the flotsam of IPOs that were floated back then, most were losers, and the only winners were the Investment Banks and the Private Equity/Venture firms that brought them public and made a killing. They dressed up the pigs by putting lipstick on them and a nice bonnet and seemingly transformed them into silk purses.

I think there are far too many small companies that shouldn't be public companies as the costs are far too high. Working at law firms in NYC I became fully aware of how expensive it is for companies to be 'public' - and it is very expensive. When I prepared Audit Response Letters I had to review the billings and in some cases they almost knocked my socks off with little gain for the company.

Nov 11 09:28 AM

[Mike from NYC:]

It's not just the 'small' companies that suffer from "relentless focus on quarterly results at the expense of long-term plans" but all public companies.

I wrote a term paper for an advanced economics class stating this exact point in 1994 and it has only gotten worse.


On Nov 11 05:25 AM Jason Kelly wrote:

> Stock markets have drifted very far from their initial intention
> of providing investors with an efficient way to allocate capital
> to promising businesses.
>
> Most start-up leaders I know say it's hardly worth it any more to
> seek funding via public markets, with their government-manipulated
> surges and crashes, relentless focus on quarterly results at the
> expense of long-term plans, and various "money game" schemes that
> push stock prices around.
>
> Of course there will always be some companies that get funding via
> Wall Street, but it's not surprising to see a move toward private,
> more stable sources whenever possible.

Nov 11 09:31 AM

[Steve in Gr...:]

So a global public accounting firm concludes that Sarbanes-Oxley is not responsible for the flight of foreign registrants and new IPOs for U.S. exchanges, eh?

I have worked for two European-headquartered multinationals. Prior to the passage of SOX, both spent a lot of time and money to have their ADRs listed on the NYSE, including converting from IFRS to U.S. GAAP. Both of them delisted after SOX was passed. Both cited the accounting and legal costs of SOX as the primary reason for their delisting.

Grant Thornton makes money from SOX, because two accounting opinions are required -- one on the financials and another one (completely irrelevant to shareholders) on the system of internal control. The global public accounting firms view SOX as the goose that lays golden eggs.

SOX has been proven to have zero impact on financial reporting fraud. It is a deadweight loss to shareholders in American companies. SOX is responsible for the flight of IPOs from the NYSE to European exchanges and delistings of foreign registrants.
.
It should be repealed.

Nov 11 02:41 PM

[User 512993:]

Has anyone even read the paper? The key thing that Paul (and all the commentators) seem to have missed is that the number of publicly listed companies is going down down down while most of the foreign nations are going up up up.

The paper is a tour de force and Paul has lost all credibility - The paper didn't say that 22 million jobs were lost - it gives scenarios and 22 million jobs was the top end of the range. But, it makes a convincing case that the United States should have 2x the number of public companies, for whatever reason. And, it doesn't say SOX is not a problem, it says that the loss of shedding of listings from the public markets started before SOX.

Nov 14 12:26 AM