Today, Facebook finally goes public with a market capitalization of $104 billion. Its initial public offering (IPO) is the capstone of its amazing ascent that changed the way the world communicates.
By contrast, other top American companies went public at much earlier stages in their growth. Barely anyone outside of the Atlanta area had heard of Home Depot when it went public in 1981 with just four stores in its name. The difference? Much of it has to do with the layers of regulation from the past decade that have made going and staying public so costly for smaller companies.
These rules are always justified as needed to go after “fat cats.” When George W. Bush signed Sarbanes-Oxley in 2002 and Barack Obama signed Dodd-Frank in 2010, both men cited scandals involving large corporations. 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 it’s smaller firms and smaller investors who have been the most burdened by these costly and complex rules, including the firms that could be the next Facebook or Home Depot. Home Depot co-founder Bernie Marcus has said many times the company likely never could have gotten off the ground if Sarbox, Dodd-Frank, and other of today’s regulations had been in effect. “We could never succeed today,” Marcus bluntly told radio host Hugh Hewitt last June.
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.
These regulations have also robbed ordinary investors of the opportunity to grow wealthy with Facebook in its early stages. Ditto with other recent IPOs like LinkedIn, Pandora, and Zynga.
IPOs of the past few years can be called “Cheers IPOs” because to paraphrase the theme song of the 1980s 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 and similar to that of Home Depot, 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. The relative ease for companies to go public in the 1990s helped the economy power out of its recession early in that decade and move toward the boom in the latter part.
But as Marcus has noted, firms as small as Home Depot in 1981 could never go public today with the costs of Sarbox and Dodd-Frank weighing them 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. Even Obama’s Council on Jobs and Competitiveness has noted that “the share of IPOs that were smaller [in market capitalization] than $50 million fell from 80 percent in the 1990s to 20 percent in the 2000s.” In fact, in addition to Facebook, LinkedIn, Zynga, and Pandora all had market capitalizations that exceeded $1 billion when they went public.
But there is some good news. Since the slightly deregulatory Jumpstart Our Business Startups (JOBS) Act passed Congress and was signed by President Obama in early April — after much stalling from statist liberals in the Democrat-controlled Senate — 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 signature, the JOBS Act has been bashed by the usual suspects to whom regulation is religion — i.e., The New York Times editorial page and Rolling Stone’s Matt Taibbi — as somehow benefiting giant corporations and the “big banks.” But the data show the first firms taking advantage of this law are the very emerging growth firms supporters of the law had pointed to as beneficiaries. ClearSign, a 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 public 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 shouldn’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.