Whether or not a retail investor buys shares of Facebook when it finally goes public tomorrow — and OpenMarket provides public policy, rather than investment, advice — the company’s rise is something to celebrate. The firm’s ascent is a tribute to brilliant and driven entrepreneurs like Mark Zuckerberg, far-sighted venture capitalists like Peter Thiel, and (what’s left of) America’s free-market system and creative destruction.
Yet the lengthy process leading up to Facebook’s initial public offering (IPO) — and the fact that it is going public only after becoming one of America’s biggest companies — illustrates how over-regulation of the stock market through laws like Sarbanes-Oxley and Dodd-Frank has made it harder for investors to grow wealthy with emerging growth firms. These regulatory barriers on smaller and younger companies have also been fingered by a wide range of experts, including those at the respected Kauffman Foundation and on President Obama’s Council on Jobs and Competitiveness (on which Facebook Chief Operating Officer Sheryl Sandberg serves), as slowing job growth and the overall economic recovery.
After the JPMorgan Chase loss of $2 billion, the Beltway elites are painting any criticism of financial regulation as siding with the “big banks.” But the fact is that Jamie Dimon and Chase were going strong after Sarbanes-Oxley was signed by George W. Bush in 2002 and after Dodd-Frank was signed by Obama in 2010. It’s smaller firms and smaller investors who have been the most burdened by these costly and complex rules.
As I noted previously, even a firm as big as Facebook had difficulty navigating this regulatory maze, stating in its initial IPO filing that “compliance with these rules and regulations will increase our legal and financial compliance costs, make some activities more difficult, time-consuming, or costly, and increase demand on our systems and resources.” But what’s “not seen,” in the words of classical economist Frederic Bastiat, are the innovations from the number of firms that could never have launched due to the prohibitive costs of these rules. Home Depot co-founder Bernie Marcus has said many times the company likely never could have gotten off the ground if Sarbox and other of today’s regulations had been in effect. “We could never succeed today,” Marcus bluntly told radio host Hugh Hewitt in June.
We do know, however, that these regulations have robbed ordinary investors of the opportunity to grow wealthy with Facebook in its early stages. Ditto with other recent IPOs like LinkedIn or Zynga. IPOs of the past few years can be called “Cheers IPOs.” because to paraphrase the theme song of the ’80s television sitcom, everybody knows their names. But what a healthy economy needs is IPOs of companies you have never heard of, which go public not to realize market value for the shares of their founders, but to raise money to expand operations and jobs.
Unlike the case with the Cheers IPOs, no one outside of certain regions had heard of Starbucks and PetSmart when these retailers went public in the early 1990s. These firms used the money raised from the IPOs to become the dominant national chains they are today, creating thousands of jobs along the way. And when Bernie Marcus’ Home Depot went public in 1981, it had just four stores to its name.
As Marcus has noted, a firm this small has could never go public with the costs of Sarbox and Dodd-Frank weighing it down. The SEC has calculated that the average annual costs of one Sarbox provision alone — the “internal control” mandates of Section 404, come to $2.3 million.
Statistics on both the reduced number and increased size of IPOs show the dramatic effects of these regulatory costs. In the years since Sarbanes-Oxley was passed in 2002 — a span that included good economic times as well as bad — not once has the number of IPOs come close to the numbers recorded during the slow-growth years of the early 1990s, let alone the boom years of the later part of that decade. As I noted in February testimony to the House Energy and Commerce Committee, there were about 50 more IPOs in 1991 than there were in 2006 or 2007, relatively good years for economic growth. The decline is especially severe among small firms. As noted by the Obama jobs council, “the share of IPOs that were smaller [in market valuation] than $50 million fell from 80 percent in the 1990s to 20 percent in the 2000s.”
In fact, the valuations, or market caps, of the LinkedIn, Zynga, and Pandora exceeded $1 billion. And, according to media reports, Facebook’s market cap may be more than $100 billion when it goes public tomorrow.
But there is some good news. Since the bipartisan Jumpstart Our Business Startups (JOBS) Act passed Congress and was signed by President Obama in early April, there has been a trickle of smaller firms returning to the IPO market. Among other things, the JOBS Act creates a five-year “on-ramp” for most firms going public in which they are exempt from the Sarbox internal control mandates, the Dodd-Frank proxy provisions and other burdensome regulations.
Despite Obama’s support, the JOBS Act has been bashed by the usual suspect to whom regaulation is religion — i.e., The New York Times editorial page and Rolling Stone’s Matt Taibbi — as somehow benefiting giant corporation and the “big banks.” But the data shows the first firms taking advantage of this law are the very emerging growth firms supporters of the law had pointed to as beneficiaries. One Seattle-based firm that makes energy-efficient furnaces launched an IPO with a market cap of just $12 million, and cited the JOBS Act as allowing it to do that
This is good news, because every dollar a smaller firm can raise by going pubic is one less dollar that firm has to beg and grovel for from a bank. This extra cash can be used to expand the business faster with many more employees added to the firm. As the Obama jobs council and others have noted, 90 percent of a public company’s job creation occurs after it goes public.
For ordinary investors, small-cap stocks are high-risk but potentially high return. And these high returns shouln’t be restricted to the 1 percent of wealthy investors by burdensome regulation justified ironically as going after the “big guys.”
Facebook”s stock market launch should be celebrated, but the mini-IPOs enabled by the JOBS Act are the wave of our entrepreneurial future.