I had the pleasure of seeing Eric Talley present yesterday at UCLA's Corporate Governance Colloquium, which Steve Bainbridge is organizing. (The paper is not on SSRN but can be viewed on the UCLA colloquium page linked above.)
The paper (with Ehud Kumar and Pinar Kunaca-Mandic) compares rates of going private before and after Sarbanes-Oxley in the US and in Europe. As you might expect, small firms are more likely to go private after SOX in the US (but not in Europe), which is consistent with the story that SOX is burdensome on small public corporations.
I do have one nit, which is that some of the evidence might be explained by the 2003 reduction in the tax rate on dividends. Now that the tax rate is lower, on the margins it's easier (cheaper) for managers at small firms to extract profits from the corporate level. And managers have a stronger incentive to do so in a private company, where managers typically own more equity.
Imagine the CEO of a public company who holds 10% of the stock, looking at a pile of cash. If dividends are taxed at 35%, she might reinvest the money or buy back some outstanding stock. If dividends are taxed at only 15%, she might cooperate with a buyout fund to take the company private, increasing her ownership interest in the process, and then pay a dividend on the common stock. There's a lot of moving parts there, so I'm not 100% sure, but it seems like on the margins the reduction in the dividend tax rate could help produce exactly the same results that Talley attributes to SOX.
More likely, of course, the tax change might account for a few cases but SOX accounts for more. What's really interesting is the normative question of what to do with Talley's result. If SOX is indeed encouraging small firms to go private or stay private, should we care? If SOX benefits large companies (and it's not yet clear if it does or doesn't) but hurts small ones, then maybe the status quo is just fine. Why should a company with a $25 million market cap should be publicly-traded in the first place? It's not like there's a shortage of capital in the private equity markets these days.
Anyway, go check out the paper. It's a good one.
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1. Posted by Michael Guttentag on January 24, 2006 @ 19:59 | Permalink
In addition to your dividend point, it would seem like the extent of going private transactions would be influenced by a number of “local” factors, particularly the effective availability of private equity. Is there really a compelling case that can be made for treating SOX as the only significant difference in the level of going private transactions in the US versus Europe during this period?
2. Posted by Vic on January 24, 2006 @ 23:46 | Permalink
Talley was asked a similar question during the talk, and I think his response was that the availability of private equity was an effect of SOX, not a cause. In other words, once it became apparent that small companies were more valuable in private form, buyout funds raised more money to take advantage of the opportunity. Or maybe they concentrated on smaller firms instead of larger ones (or divisions of larger ones).
His case is made stronger, I think, by the fact that most of the institutional factors that make private equity stronger in the US were around before SOX. The one thing that occurred to me is the development of club deals or consortium deals, which I understand to also have developed in recent years for reasons unrelated to SOX. Are there others?
3. Posted by Paul Rose on January 25, 2006 @ 9:49 | Permalink
A company with a $25 million market cap probably should not be publicly traded (at least other than on the Pink Sheets). In fact, I suspect most bankers would probably say that a company smaller than $50 million should not go public. The concern is not just the impact that Sarbanes-Oxley has on a $25 or even $100 million dollar company, but the impact it has on the $500 or $750 million dollar company. If you look at the new rules that are being proposed by the Small Business Committee that the SEC has asked to look at the effect of its regulations on smaller companies, it is clear that the Committee is working hard to make sure that the SEC recognizes how far out of line its "small business" definition is with the market, and that if it is going to tailor its regulations to help out smaller public companies, it needs to recognize that a $500-750 million company is still a pretty small company.
4. Posted by Robert Schwartz on January 25, 2006 @ 21:10 | Permalink
my father practiced securities law back in the 1960s. He took a number of companies public. mostly in regulation A offerings of $100,000. all but one of them are gone. The one is The Limited which is worth billions of dollars and is one of the largest employers in this area.
The market that supported those little IPOs disappeared years ago. By the 1990s the little regional brokerages that had created that market and maintained it, had been merged out or driven under.
SOX was just the last nail in the coffin.
Is it a good thing or a bad thing, that micro IPOs no longer exist?
On one hand most of the issuers went under without a trace. So investors lost money. On the other hand investors made a boat load of money on the success stories like the Limited and (another one in central Ohio) Wendy's. To the best of my knowledge the whole thing was actually a winner.
What the micro IPO provided to entrepreneur was a source of relatively cheap public capital, with few restrictions on management. Venture funds are more expensive (at least in terms of dilution and rights) and more onerous. I think the trade-off for the whole economy has been bad and that we need to find a better set of solutions to the problem of entrepreneural capital formation.
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