One of the things we’ve heard Tim Carney, the author of The Big Ripoff: How Big Business and Big Government Steal Your Money and brother of DealBreaker’s John Carney, argue is that market regulation can be viewed as a subsidy to certain publicly listed companies (and, of course, to investment banks).
Some companies may use tighter market regulation—think Sarbanes Oxley—to reduce their cost of capital by bolstering investor confidence. Of course, companies with better reputations among investors bear the cost of these regulations, as well, and find themselves competing in the capital markets for investor dollars against the companies enjoying the boost. So the regulations essentially transfer wealth from companies with better reputations to companies with worse reputations. What’s more, the cost of enforcement is largely born by the taxpayers—another transfer of wealth to the companies who most benefit from the regulations.
Nowhere have we seen this better spelled out than in a Wall Street Journal op-ed piece that ran yesterday, in which the chief executive of a foreign company extolled the virtues of regulations on US exchanges precisely for the added credibility they bring companies. Our thought was, “Well, this makes a lot of sense if you are running a company whose creditability might otherwise be questionable. But that doesn’t mean lawmakers are justified in imposing those costs on already creditable companies.”
Today Going Private raises the possibility that this reputation bolstering effect of increased regulation might create opportunities for private equity. At first, the creditability gains for companies entering US exchanges might outweigh the costs of regulation. But as time passes and they’ve had a few years of disclosure, those gains from regulation should have diminishing returns, making it less worthwhile to bear the costs.
After several years as a NYSE listed firm, and therefore several years of history in a highly regulated environment, is the credibility margin worth the yearly audit cost anymore? Surely a firm with such history won't suddenly lose its reputation if it goes private or moves offshore? I suspect mid and large cap LBO firms might consider stalking foreign firms from countries with local exchanges of ill repute that have been public in the United States for 2-3 years already. If the theory holds, this should be right about the time when the costs start to hurt more than they are worth.
There are few things as sexy in this world as a woman who can look at a problem with the public markets—regulatory wealth transfers to companies with poor reputations—and see it as a money making opportunity. That said, one problem with this idea is that evidence has begun to show that the costs of SOX decrease over time. Getting compliant costs more than staying compliant, so the scale of costs and benefits is sliding on both sides. That’s not to say it won’t work but it would take some more work to see if it does.
Efficient Markets Theories [Going Private]