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

Copyright Notice

Everything that appears on this blog is the copyrighted property of somebody. Often, but not always, that somebody is me. For things that are not mine, I either have obtained permission, or claim fair use. Feel free to quote me, but attribute, please. My photos and poetry are dear to my heart, and may not be used without permission. Ditto, my other intellectual property, such as charts and graphs. I'm probably willing to share. Let's talk. Violators will be damned for all eternity to the circle of hell populated by Rosanne Barr, Mrs Miller [look her up], and trombonists who are unable play in tune. You cannot possibly imagine the agony. If you have a question, email me: jazzbumpa@gmail.com. I'll answer when I feel like it. Cheers!

Wednesday, January 13, 2010

Was the Sarbanes-Oxley Act Harmful to Business? Part 2

It has been proposed that Sarbanes-Oxley (SOX) drove many previously public companies into private hands, with the explicit assumption that this is a bad outcome.  I have no basis to judge the queston of whether this is good or not, and would welcome relevant facts and informed opinion.

There can be no doubt that many companies chose to either go dark or go private in the wake of Sarbane-Oxley (SOX), and that the passage of SOX was a precipitating factor.  The considerations driving the decisions among public, private, or "dark" (fewer than 300 shareholders, limited reporting requirements) ownership are many and complex.

Here are some factors that encourage going private;

Undervalued Shares make private or dark ownership an attractive bargain.

High costs, including compliance costs - namely SOX, make public status less attractive.

Lack of interest from market analysts and institutional investors diminishes benefits of public status.

Thin trading volumes and share price volatility lead to economic uncertainty for shareholders.

Business maturity, with low growth prospects but healthy cash flow, mitigate the need for liquidity.

A small number of individuals already own the majority of stock.

Owners have more tax planning flexibility, and control over estate planning.

For most of these, money is the driver, either for the insiders or for the profitability of the company - not necessary consistent or even compatible goals.  Still, these are all valid, sensible, perhaps even honorable reasons for going private.  Other reasons can come in to play though, that might be more shady, or even nefarious:

SOX specifies stiff penalties for wrong-doing, and holds the CEO and CFO responsible for doing right.  So, if any wrong-doing is part of your game plan, you'd best get out of the public arena.

Compensation and financial details can be kept secret, for good or for ill.

Scrutiny of all kinds can be avoided, with the possibility of also avoiding litigation, for good or for ill.

On the other hand, though, corporate management can focus on running the business properly, with a long-range view, rather then trying to please often fickle shareholders whose time horizon is the next quarterly statement.

Companies that went public at high evaluations in the 90's can provide windfalls by going private again at cheap evaluations in a down market.  Clearly, value perception is a big driver, according to Edward E. Nusbaum, chief executive officer of the global accounting, tax and business advisory firm Grant Thornton.

"During bear markets, many smaller publicly traded companies feel that the market is inadequately valuing their company," Nusbaum says. "In many of these cases, shareholders can unlock some of this unrecognized value by going private."

Further, he also stated:

"with the public markets in disarray the benefits of being a public company certainly have diminished for some small and mid-sized companies."

Even given all of this, there is one big exogenous factor that is vitally important in the public vs. private ownership decision: the type and amount of available financing.

Bharath and Dittmar also examined the impact of market and macroeconomic forces on firms' decisions to go private. They found that the likelihood of going private increases significantly in high sentiment and hot private equity markets and decreases in hot IPO markets. Further, supply of debt in the economy and costs of bankruptcy may be influencing factors, as well, they say.

"Since 2000, we have seen a resurgence in going-private transactions, fueled by the development of the private equity market," Dittmar said. "Given the size and growth of this market, it is important to understand the economic forces that determine these decisions.
There are downsides to going private.  The transition costs can be considerable, and the cost of capital will almost certainly increase.   Going either way in the public - private decision is, to some extent, driven by direct, or even immediate financial gain by those in a position to take advantage of it.

We can safely say that the passage of SOX tipped the balance in favor of going private for many companies.  But let's not overstate the effect - realistically, it is one factor out of many.

The premise that companies leaving the public arena due to the passage of SOX is a bad thing is simply that: a premise.

No comments: