Sunday, March 29, 2009

How Regulations killed American entrepreneurship

The Sarbanes-Oxley Act of 2002 has devastated new business creation in the United States.

The Wall Street Journal notes:

According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986. Faced with crushing reporting costs if they go public, new companies are instead selling themselves to big, existing corporations. For the last four years it has seemed that every new business plan in Silicon Valley has ended with the statement 'And then we sell to Google.' The venture capital industry is now underwater, paying out less than it is taking in. Small potential shareholders are denied access to future gains. Power is being ever more centralized in big, established companies. For all of this, we can first thank Sarbanes-Oxley. Cooked up in the wake of accounting scandals earlier this decade, it has essentially killed the creation of new public companies in America, hamstrung the NYSE and Nasdaq (while making the London Stock Exchange rich), and cost U.S. industry more than $200 billion by some estimates.

An advisory committee to the SEC found that:

beyond the aggregate costs involved with Section 404 compliance, costs in relation to revenue have been disproportionately borne by smaller public companies. The lack of proportionality of the cost and amount of resources devoted to Section 404 compliance for smaller public companies is evidenced by data which shows that the expected cost of Section 404 implementation, as a percentage of revenue, is dramatically higher for smaller public companies than it is for larger public companies.

The committee found that compliance with Sarbanes-Oxley costs small companies, defined as those with a market capitalization of less than $100 million, an average of 2.55% of revenues. For large companies on the other hand, compliance only costs an average of 0.06% of revenues.

That's a 42.5 times greater relative cost that this regulation imposes on small companies versus large ones.

The situation is absolutely intolerable and needs to be reformed, given how important new business creation is for the US economy. Many of the most dynamic companies today, companies like Google, Ebay, and Yahoo, began in the last 10-15 years. How many future Googles and Ebays has Sarbanes-Oxley prevented from emerging? How many jobs and billions in revenues have been lost to this misguided intervention in the financial sector?

As Ron Paul pointed out following the Madoff scandal, the idea of regulating away financial scandals with regulations enforced by an SEC cannot work, and only imposes more costs on the US economy:

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