The Public Company Regulatory Burden and Privatization of the U.S. Economy
This column has analyzed both the probable impact of private equity investment in the satellite sector and the regulatory burdens imposed on publicly listed companies in the United States in the wake of the Arthur Andersen, WorldCom and Enron accounting standards cases — notably by the Sarbanes-Oxley Act of 2002. However, we have not examined their interplay.
Private equity growth generally and in the satellite sector particularly is due partly to increased public company regulation and contingent liability for non-complying companies, directors and officers. The financial news has been filled in recent months with evidence of dampening of enthusiasm for U.S. initial public offerings and the rise of alternative markets such as London, Hong Kong and Shanghai, particularly for non-U.S. issuers. The problem is on the radar screens of legislators and regulators, and people such as New York City Mayor Michael Bloomberg and New York Stock Exchange Chairman John Thain have warned that Wall Street is in danger of losing its preeminent capital markets status.
Not all of this is the fault of Sarbanes-Oxley; the forces of globalization are naturally creating alternatives to Wall Street. Moreover, the rise of alternatives to the U.S. public capital markets is due not only to burdensome and expensive regulation but to the necessity of meeting institutional investors’ quarterly benchmarks, sometimes at the expense of longer-term and more strategic thinking. Also, U.S. public markets are no longer, except in rare instances, a source of capital that other markets or private equity cannot supply.
At the same time that U.S. public capital markets have lost their luster, private equity has grown. Of course, readily available debt financing at historically low interest rates and the leverage it allows to be deployed for acquisitions have played a role. Other factors include the development of complex convertible and derivative securities that allow risk premiums to be allocated with microsurgical precision and the rise of shareholder activism, often hedge fund-led. But private equity at its core entails the “privatization” of the companies acquired and that its growth has moved in tandem with the decreasing attractiveness of public company status is no accident.
Most regulatory choices are matters of policy, not objective truth. When that is forgotten, and legislators and regulators wield too blunt an instrument, there is hesitation to fine-tune by pulling back. In 2003, as European colleagues were heralding the dismantling of sector-specific regulatory regimes in favor of purely “competition-based” regulatory paradigms, we accurately predicted a U.S. “re-regulatory” swing of the policy pendulum.
The U.S. securities laws are a disclosure-based regime, and the exemptions from registration under those laws arise when a specifically targeted group of investors is deemed sufficiently sophisticated not to need the benefit of those disclosures, whether by dint of their wealth, insider status, institutional nature or other factors. The raising of private equity funds depends on these exemptions. Private equity funds are currently breaking the $20 billion barrier. There is plenty of exempt liquidity out there; if anything, there is too much money chasing too few [good] deals, creating a real sellers’ market reflected increasingly in seller-favorable deal terms. The problem is not so much raising the $20 billion-plus fund as it is deploying the money raised in companies that will generate the kind of returns that private equity limited partner investors expect as a risk premium, net of the fees that private equity general partner fund managers expect.
Sarbanes-Oxley is so routinely reviled that its role in restoring investor confidence in U.S. accounting standards, thereby preserving the transparency, liquidity and depth of U.S. capital markets, is underappreciated. But it is time for some fine-tuning of the pendulum’s arc. If issuers and investors are making a cost-benefit analysis in favor of other markets despite whatever added protection the U.S. securities laws and regulations provide, then the diminishing return of benefit provided for burden inflicted is critically breached.
If the regulatory burden is reduced, going public or staying public in the United States may again become a palatable and competitive choice. There will be even fewer [good] deals for private equity capital to chase and a flight to quality and redeployment of that capital will ensue. Some private equity shakeout may occur, restoring private equity buyer-seller parity and private equity-public capital market balance.