Plugging the IPO Drain

By Reynolds Holding

To hear New York City Mayor Michael Bloomberg, Senator Charles Schumer and a host of business luminaries tell it, the U.S. is losing its financial edge--and the law is largely to blame.

Stifling regulations, absurd lawsuits and ambitious prosecutors are pushing companies to raise money overseas, the scolds in pinstripes warn, and unless the rules loosen up, within a decade New York City could slip behind London, Hong Kong or, yes, Dubai as a center of global finance. President George W. Bush chimed in during a Jan. 31 speech, saying that lawsuits and overregulation might drag the markets down.

The statistics seem to support this bleak view. In 2001, 12 of the 20 biggest-dollar initial public offerings (IPOs) occurred in the U.S. In each of 2005 and 2006, only one did. IPOs totaled $55.2 billion in Britain last year and only $46.6 billion here. Since 2000, the number of foreign companies listed on NASDAQ fell 34%.

But the law should be the hero of this tale. U.S. stock markets still attract more money and investors than any in the world, mostly because of a reputation for operating fairly. The strict rules "give companies the opportunity to tell investors, 'Look at the scrutiny we undergo. That's why you should invest with us,'" says Andrew Karolyi, an Ohio State University finance professor.

Thanks in part to this reputation for clean dealing, foreign firms can get as much as 37% more for their stock on U.S. markets than they can elsewhere, including on the London Stock Exchange, according to an article co-authored by Karolyi. That's a big reason why, per dollar raised, U.S. stock offerings are the cheapest in the world.

O.K., but what about Sarbanes-Oxley, the 2002 law enacted to prevent Enron-style scandals? Among other burdens, it requires financial statements so squeaky clean that a company's chief executive and financial officers can vouch for their accuracy. Corporate executives estimate that the law has cost U.S. companies tens of billions of dollars in extra auditing fees and other expenses.

Yet the U.S. share of IPOs began falling six years before Sarbanes-Oxley even existed. In 1996 about 60% of all IPOs took place on Wall Street. By 2001, only 8% did. In fact, the U.S. share has on average increased since then, despite Sarbanes-Oxley, to about 15% in 2005. Charles Niemeier, a member of the U.S. Public Company Accounting Oversight Board, calls it "the clearest, most straightforward evidence" that Sarbanes-Oxley is not driving companies overseas.

Shareholder lawsuits are also blamed unfairly. Those suits typically accuse a company of securities fraud soon after its stock price plummets, and a 1995 federal law made them harder to pursue. After peaking in 1998, the number of such suits declined through last year. Bloomberg and Schumer have helpfully pointed out that settlements in shareholder suits have "skyrocketed" from $150 million in 1980 to $9.6 billion in 2005, which sounds impressive, except that most of the $9.6 billion came from the WorldCom settlement of $6.1 billion and nine other settlements of $100 million or more each.

So why the drop in IPOs and foreign-stock listings? As the Wall Street Journal and others have noted, a lot has to do with economic growth abroad. In 1980 the total value of shares listed in emerging markets like Brazil and India was 6.7% of the world total. By 2004, the figure was 12%. In 2005, Egypt, Kazakhstan and 27 other countries each held more than $1 billion worth of IPOs. Stock markets abroad are more sophisticated now and offer foreign companies the convenience of staying close to home.

As for London, its financial allure derives in part from light regulation, a convenient location between Asia and New York City and lower fees for underwriting stocks. Even so, the London Stock Exchange's Main Market has lost 23% of its foreign listings since 2000. London's rising status is due instead to the Alternative Investment Market (AIM), for which foreign listings increased from 31 in 2000 to 306 last year. The AIM's attractions are clear: even lighter regulation and low thresholds for company size and operating history. Many AIM-listed companies are just too small or financially unqualified to get on a U.S. exchange.

London's experience suggests that we could lure more companies to U.S. markets by loosening the rules on accounting and shareholder rights. But doing so might endanger the markets' reputation for fairness--and the enormous financial benefits that come with it.

Which is not to say that our laws couldn't be improved. We should probably ease the penalties for foreign firms that make inadvertent mistakes squaring their financial statements with American accounting rules. Or clarify a legal system that allows companies to be pursued by an army of SEC regulators, litigious shareholders, Justice Department prosecutors and state attorneys general. But the best strategy may be just to sit tight for a while, because using the law to keep the financial world honest isn't just the right thing to do; it's also good business.