Look: I am eager to learn stuff I don't know--which requires actively courting and posting smart disagreement.

But as you will understand, I don't like to post things that mischaracterize and are aimed to mislead.

-- Brad Delong

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Tuesday, January 12, 2010

Was the Sarbanes-Oxley Act Harmful to Business? Part 1

Dale, in comments to D.S. #14, asserts unequivocally that SOX, as it is called, reduced the number of U.S. IPO's (I'm being generous to him in stating it that way,) that the expense of over $4 million per year drove hundreds of publicly traded companies private, and that it has not met any of its goals.

Let's do some fact checking.

In this post, we'll consider IPOs.  Here (above and in the link)  is a chart of venture capital backed IPO's per year, as mentioned in a Business Week article for the years 1980 through 2008.  The latter, of course, was a dismal year for a variety of reasons.  The text of the article informs us that the average number of venture capital backed  IPO's in the 80's was 52, while the average of the naughts through '08, was 49.   Scant difference, especially considering that in the post-bubble shock and recession of  '01 to '03, IPO activity was torpid, and close to non-existant in the recession starting year of '08.    The chart also reveals how Dale cherry-picked 1996 as a bench-mark year, with over 250 VC IPO's, the second highest year of the 1980 - 2008 period.   In my chart, above, the pink line is a 5 year average, to smooth out yearly abberations, such as the big drop in 1997-8.

Now (chart above) look at the number of VC IPO's from '03 through '07. There appears to be a release of pent-up demand in '04, followed by very respectable, and growing activity after '05 until the '08 collapse.  Raw data found here.   Venture capital backed IPO's are only a portion of the total, which also includes buy-out backed IPO's, and a remainder with financing unspecified.  VC IPO's represent new companies going public for the first time, and are the sub-group most relevant to the discussion.  Private equity IPO's are essentially reverse LBO's, and not relevant.  

For comparison, here is chart of relative performance of the S&P 500 stock index, which I am taking as a proxy for general stock market pricing activity.  Data from Yahoo Finance, graph by me.  The graphed line is the percentage increase of the annual S&P average for the subject year, compared to the prior year (YoY.)

Correction:  Wrong data in the graph: see Update 1.

I'm not suggesting anything like perfect correlation to the IPO chart, but there is a general similarity.  Which only makes sense.  When you go public, you want as rich a capitalization as you can get, and an up-market is clearly better than a down-market.

So, sorry Dale.  Your first point is very unconvincing.  Realistic relevant factors influencing IPO activity appear to be general stock market performance in the year leading up to the IPO (no surprise) and the availability of VC money (also no surprise.)  The Business Week article, which never mentions SOX, suggests that VC IPO activity might now be permanently low, inhibiting total innovation, because venture capital is limited.    

It closes with this thought:

All of this could prove problematic for entrepreneurs who need VC-style equity investments. If there are fewer VC firms around to put several million into a high-growth startup, some of those firms aren't going to get the investment that they need. And that could mean fewer successful companies like Google (GOOG) and Genentech (DNA) that provide jobs for many people and innovative products that are valuable to all of us.

Update 1:   I made a data manipulation error in constructing the Relative S&P Performance graph above.   The graph actually represents a year over year change in the running three year average of performance - hence a smoother plot.  I graphed the wrong column from my spread sheet.  Corrected chart follows.  YoY performance in the 80's was generally good, but erratic.  The 90's were up-up-and away.  The naughts were like Ohio - zeros on the ends, "hi" in the middle.  This shows why 2004 was a much better year for IPOs.  It was a much better year for the market.
In fact, here (below) are IPOs plotted (blue line) along with the S&P performance - rescaled and translated to fit on the same chart (yellow line.)  Through the 80's and the noughts, they track together quite well.  Through the 90's bubble - not so much.

Update 2:   As I've indicated, IPO activity in 2004, was pretty robust.  Interestingly, it involved not only domestic IPOs, but also a sharp increase in foreign companies listing on U.S. exchanges, as this article from AltAssets indicates.  The end of the article quotes Scott Gehsmann,  North American leader of PricewaterhouseCoopers Global Capital Markets Group.

'In fact, across virtually every metric - number of deals, size of deals and IPOs by industry sector - 2004 saw a sizable increase over 2003. Moreover, the sharp rise in IPO activity suggests that the enhanced reporting requirements of Sarbanes-Oxley have not had the dampening effect on IPOs that some had predicted,' Gehsmann continued.

The number of non-US companies completing IPOs in the US markets also more than tripled in 2004, with Chinese companies leading the way.

I think Gehsmann might have a better understanding in his field of expertise than Ron Paul does.


Dale B. Halling said...

Not only is your analysis of SOX not convincing. The chart clearly shows that IPOs are down after the passage of SOX. But here are two other facts to illuminate you.

1) There was not a single VC backed IPO in the 2nd quarter of 2008 - something that had not happened since 1978

2) There was not a single VC backed IPO in the 2nd or 3rd Q of 2009.

You can ignore the facts, but don't pretend that you are interested in reason.

J said...

Note that the charts spiked under Reagan, but even more under Clinton (i.e. the dot.com bubble, and then the bubble burst). Moral of the story? Demopublicans are good for business, and then bad for bidness (which is to say, Clinton was hardly any different than Reagan, or Bush I and II).

SOX looks like it was a fancy way for the investors (supported by the investor-puppets, ie Senate and House) to protect their investments after the dot.com and Enron debacles. GOPers generally all oppose to regs and would not have supported SOX otherwise. So, really Mr Dale blame the GOP congress and senate for passing it.

Jazzbumpa said...

Dale -

The chart shows IPOs falling off a cliff in 2001, and rising back to 80's levels in 2004-7. SOX was passed in '02, which was also the stock market low.

I'm reminded of Grover Norquist saying the market crash of Oct. '07 was caused by Obama being elected - in Nov. '08.

The lack of VC IPOs from '08 on is due to lack of VC funding availability. Did you even look at the Business Week article?

Your last sentence is absurd, and contrary to the facts, which the graph plainly shows, if you would look at it both open eyes and brain. Repeat after me: Four years of IPO's at '80's levels, after SOX - when the stock market went back up, until '08, when it went down again. Note that the stock market tanked in late '07.

The 90's were a bubble, and an aberration, not typical. End of story.

I have a rational hypothesis, gathered actual facts that support it, and made a graphic representation. You made naked assertions, and will not let go of a single variant mindset and A precedes B, therefore A causes B reasoning.

I welcome dissent, but please, make some kind of sense; and don't accuse me of not being interested in reason, after I researched and presented a factual post. That is acting stupid.

And your $4 million compliance cost is bullshit, too.


Come back with some facts, start making sense, and we'll have something to talk about. But, if you want to stamp your feet, and say, "Is so, is so, is so!" and act like an ass, then go start your own damned blog.

And here's something else to think about. Who cares if companies are pubic or private? Either way, they employ workers and contribute to GDP.

J -

Yup. Companies go public when it the insiders can gain, and companies go private when the insiders can gain. I'll posit that one of the big reasons companies went private after SOX passed was to conceal the shadiness of their bookkeeping.


Jazzbumpa said...

If anyone is still following, I updated the post with new, corrected charts, and additional information.