Less is More

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Less is More
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The Problem

• In the wake of the corporate scandals of Enron,
  Worldcom, and others, the U.S. Congress passed
  the Sarbanes-Oxley Act of 2002.
• The Acts requirements dramatically increased the
  cost of being a publically traded company in the
  United States.

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SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL
CONTROLS.
((a) RULES REQUIRED.The Commission shall
prescribe rules requiring each annual report
required by section 13(a) or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or
78o(d)) to contain an internal control report,
which shall (1) state the responsibility of
management for establishing and maintaining an
adequate internal control structure and
procedures for financial reporting and (2)
contain an assessment, as of the end of the most
recent fiscal year of the issuer, of the
effectiveness of the internal control structure
and procedures of the issuer for financial
reporting.
PUBLIC LAW 107204JULY 30, 2002
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Companies that cannot comply with these rules
either
a) list on a non - U.S. exchange or b) choose
not to list
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a) list on a non - U.S. exchange
There are several viable choices of exchanges
around the world for companies who desire to go
public Technology provides easy trading
anywhere Issuers are now using a cost-benefit
analysis when deciding where to list,
considering -complexity of regulation
-potential litigation costs
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(No Transcript)
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b) choose not to list (staying dark)
Since 2003, private equity fundraising in the
U.S. has exceeded net cash flow into mutual
funds Private transactions have accounted for
more than 25 of publicly announced
takeovers. Private equity disadvantages the
average investor, who cannot participate in such
markets
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Recent Work
The Committee on Capital Markets Regulation has
found that regulatory requirements for complying
with Section 404 of Sarbox cost companies an
average of 4.36 million in the first year.
The Committee also found that securities law
class action suit liabilities have grown from
150 million in 1995 to 3.5 billion in 2004.
Luigi Zingales (2006) found that the premium for
listing on a U.S. exchange has dropped from 51
to 31 from 2002-2005(measured by difference in
market value to book value).
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Why should we care?
small companies
-are most at risk of losing access to capital,
and also the ones that need it most. -promote
innovation. (large, established companies rarely
bring industry-rocking new technologies to the
market)
Public listing provides the visibility that small
companies need to gain financing
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American entrepreneurs are creative and
productive and these numbers prove it
-Chad Moutray, Chief Economist, Small Business
Administration
-Create more than 50 of U.S. non-farm
GDP -Employ about 50 of all private-sector
workers -Make up 97 of exporters and produce
29 of all export value -Create approximately
75 of net new jobs in the economy
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The Question
If the requirements were lifted, and companies
could choose to disclose less, would the
allocation of capital change?
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The Model to each, his own
K
Every firm faces a unique demand curve, derived
from its production isoquant
L
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The Investigation
I wanted to see if the cost of obtaining capital
increases for companies listed on exchanges with
low disclosure requirements
If it does, then it is reasonable to assume that
companies would disclose as much as possible in
order to reduce this cost.
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The Model opacity is expensive
P
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The Method
Find coupon rates on corporate bonds for
companies listed on an exchange that correlates
with one of 3 disclosure requirements
1low requirement 2moderate requirement 3high
requirement
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The Results
Mean coupon rate (7-10 yr bond)
Low Moderate High
7.62 5.19 3.33
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Conclusion
Companies would rather have access to the level 3
cost of capital than the level 1 cost of capital.
Given their particular production isoquants,
level 3 disclosure is too expensive for some
These companies would face a similar required
rate of return (cost of capital) regardless of
the rules
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Implications
Companies are all different, and investors are
all different.
Risky companies and risk-tolerant investors
should have the opportunity to find one another
in the U.S.A.
The SEC is attempting to protect the most
risk-adverse investor, at the expense of those
who do not fall in the same category.