Over the past 20 years, the U.S. has made it much more costly for public corporations to comply with the array of regulations that govern their behavior. Unsurprisingly, this has led to fewer companies choosing to become publicly traded, and that development has hurt the U.S. economy.
That we are continuing to add to the burdensome reporting requirements for public companies means this trend likely will accelerate and the U.S. economy will pay a price with fewer jobs created, lower productivity and wages, and greater wealth inequality.
For decades, the standard story for a successful start-up business entailed reaching the stage when investors took the company public by selling shares via an initial public offering. Not only does becoming a publicly-traded corporation allow its founders and early investors the opportunity to cash in, but the corporate structure and governance of a publicly-traded firm provides advantages to help the company continue its growth.
For example, the requirement of regular audits and concomitant obeisance to generally accepted accounting principles, a board with at least nominal independence, and the stock market’s liquidity help make investment in a public company more attractive and reduce its capital costs. But with the cost of becoming a publicly-traded company significantly higher, some firms are delaying their initial public offerings and fewer firms are choosing to go public altogether.
The trend began with the passage of Sarbanes-Oxley in 2002, which significantly increased the costs of preparing accounting statements and opened up CEOs to the possibility of being personally liable for any accounting irregularities.
In 2010, the passage of Dodd-Frank further increased compliance costs for public corporations, and in ways that could not be construed as responses to the financial crisis that precipitated its passage. For example, the law requires that companies disclose whether they possess or obtain any conflict minerals, which my former American Action Forum Colleague Sam Batkins and I estimated would entail $16 billion in compliance costs.
It also requires that a publicly-traded company disclose the ratio of its CEO’s salary to the median compensation of its workforce. Congressional staff suggested to members that the calculation of such a statistic would be a trifle, but Batkins and I showed that computing the actual compensation costs for employees across several continents, with different fringe benefits and public pension access, as well as deferred compensation packages tied to company stock, make this a complex number to derive.
The Securities and Exchange Commission (SEC) is preparing to impose new and costly reporting requirements related to climate change, even though corporations already must incorporate a good-faith estimate of how it may affect their long-range profits, and companies most likely to be impacted already produce detailed analyses of their exposure as part of their fiduciary responsibilities.
However, while climate change may be a key focus of the administration, the SEC’s actions will neither induce companies to take steps to reduce greenhouse gas emissions nor help to better inform investors about such risks.
The proposed regulation is clearly redundant; issuers already are required to discuss “material” information. Companies for whom this is an issue have included it in annual reports for years.
What’s more, the proposed regulation’s prescriptive nature — whereby the SEC delineates precisely how such risks should be categorized and detailed — will add scarcely any additional useful information for investors and would establish a bad precedent. Environmental, social and governance (ESG) disclosure standards should remain principles-based, instead of prescriptive, because materiality largely depends upon the circumstances and context of the issuer and the industry. A single set of standards will make little sense for the oil and gas extraction industry and the arts and entertainment industry.
In addition, a decade ago the SEC released guidance detailing how to report climate change risk to investors, which covers issues raised by those arguing more prescriptive disclosure such as risk of regulation and risks of physical impacts to facilities. The proposed regulation is unclear regarding the incremental gains from the new reporting standards, and it’s unclear whether it would pass any sort of cost-benefit analysis.
The purpose of the SEC, first and foremost, is to protect investors. The clear intent of the proposed rule is to help fight climate change and reduce greenhouse gas emissions. That may be a worthy goal, but blithely ignoring nearly a century of precedent and the agency’s explicit mission statement to achieve a largely symbolic victory sets a terrible precedent. The SEC should remain focused on protecting investors and encouraging efficient capital formation.
While Congress has been keen to increase compliance costs for public companies, efforts to reduce the compliance cost for publicly-traded companies are rare. My former Indiana University colleague Robert Jennings and I recently argued that changing the reporting requirements from quarterly to just two or three times a year would not only reduce compliance costs but also help correct the incentives many believe management has of focusing unduly on short-term profit goals at the expense of a company’s long-run performance.
But few people, apparently, see the problem with higher compliance costs for publicly-traded companies, which is a shame because they are manifold. Many fewer companies are going public. The number of IPOs in the post-2000 stock market run-up has been less than one-third of what it was in the 1990s, and the recent advent of the special purpose acquisition company (SPAC) has done little to ameliorate this gap.
A National Bureau of Economic Research (NBER) working paper estimates there were 14 percent fewer public companies in 2012 than in 1975, and that there were thousands of fewer public companies than we would have expected had trends continued, with an economy 2½ times larger.
Fewer IPOs and public companies has several consequences for the U.S. economy. First, companies that delay or forgo going public grow more slowly, which means that job growth and wages grow more slowly as well. Second, those companies that delay their IPOs because of compliance costs end up generating more money for investors who have the ability to put money into a startup, which is not possible for most investors. That means ordinary investors with most of their wealth invested in mutual funds via their retirement accounts miss out on those companies that are likely to have high growth rates, which exacerbates wealth inequality.
It may be fashionable for both political parties to bash big business as being to blame for various crises in the U.S., but the fact is that big companies pay better than smaller firms, their workers tend to be more productive and have longer tenure, and they tend to grow much faster than privately-held companies.
The notion that big business is a pox upon our economy is an old one, but it’s a gross distortion of reality. Laws that deter the creation of public corporations are costly to workers and U.S. competitiveness in general, and SEC Chairman Gary GenslerGary GenslerRegulators must act to protect financial system from climate risk: report SEC probing Wall Street banks' documentation of digital employee communication: report Protecting consumers requires protecting and incentivizing whistleblowers, too MORE should take steps to reduce the barriers to taking firms public and boost capital formation.