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US loses firms over slow growth

A Wall Street sign is seen against the backdrop of the New York Stock Exchange on July 31 in New York City. PHOTO: AFP

It has become received wisdom on Wall Street that the Sarbanes-Oxley Act has damaged US competitiveness. It made listings in the US market less attractive to foreign companies and drove initial public offerings overseas. It raised costs for US companies without providing any significant benefit.

But do the facts support that wisdom?

No.

A new study of the foreign companies that fled the US market after the Securities and Exchange Commission (SEC) made it easy for them to do so last year suggests that the companies that left were largely ones whose slow growth, and poor market performance, had reduced their need and ability to attract US capital. There is even some indication that the market punished companies that decided to leave even though they could still use the capital.

What the study shows, said one of the authors, G. Andrew Karolyi, a finance professor at Ohio State, is that the market did not react favorably when companies got out from under US regulation.

Instead, the paper by Korolyi, along with Rene Stulz, also of Ohio State, and Craig Doidge of the University of Toronto, found that share prices suffered in the few cases where foreign companies with good growth prospects left the US market.

“When they choose to leave even though they are benefiting” from the US listing, Karolyi said in an interview, “shareholders may wonder if there is something sneaky going on.”

There has long been evidence that overseas firms benefit, through a lower cost of capital, when they choose to list their shares in the US. Their shares trade for higher prices than do those of similar companies that do not choose to list here.

Why is that? The traditional answer is that investors have more faith in companies that comply with US disclosure rules and reconcile their books to US accounting standards.

The advantage of a US listing faded early in this decade, although it did not vanish.

The scandals at Enron and WorldCom did not renew faith in US rules, and it turned out that the US listing premium had soared in the late 1990s in part because foreign technology companies flocked to the US to take advantage of what turned out to be a bubble. Their collapse made the US premium seem smaller.

The premium hit bottom in 2002, and recovered somewhat after that. Was that a reflection of investor confidence being renewed by passage of Sarbanes-Oxley? Not to hear the critics tell it. The Committee on Capital Markets Regulation, an independent panel whose creation in 2006 was heralded by US Treasury Secretary Henry Paulson cited that data as proof that Sarbanes-Oxley hurt the markets.

Their logic: The average premium after 2002, when the law passed, was lower than it was before the bubble burst. The committee ignored the fact the premium rose after the law was passed.

There is no question that the costs of complying with Section 404 of the law — requiring audits of corporate internal controls — has scared executives in the US and abroad. The first year of audits found lots of problems, but for the vast majority of large companies those problems have since been fixed. And the costs of audits, which soared, have stabilized.

That does not prove the audits were worth the cost, although the fact that so many problems were fixed — in some cases requiring substantial accounting restatements — does indicate there was considerable benefit.

Those benefits are not yet available to owners of microcap US companies, those with less than US$75 million in market capitalization. The SEC has repeatedly delayed requiring them to obey the law. The heads of the congressional small-business committees, Senator John Kerry and Representative Nydia Velazquez have pushed for the delays, arguing that Sarbanes-Oxley compliance would hurt the companies.

Historically, the US made it difficult for any company, foreign or domestic, to abandon its SEC registration. The logic was that investors had bought securities with the promise that they would have the protection of US securities laws, and it was unfair to remove that protection so long as a significant number of Americans still owned the shares.

The result was that a foreign company listed on the New York Stock Exchange or NASDAQ could drop its listing, but it still had to comply with US disclosure requirements and accounting rules. Critics called it the Hotel California rule, after the Eagles song about a place where “you can check out anytime you like, but you can never leave.”

That changed last year, when the SEC made it easy for most foreign companies to leave, producing the exodus that the authors study. They focus on 59 companies that dropped their US registration. That number is too small to be definitive, but the study finds no evidence to support the thesis that companies that leave the US are rewarded by investors, and some evidence to indicate that those who could benefit from a US listing are punished.

There is some reason to think the US premium is destined to disappear anyway. By letting companies walk away easily, the advantage of a US registration is reduced, Stulz has argued. The SEC is moving to allow foreign companies to use international accounting rules, so any advantage from confidence in US accounting rules will vanish. And the commission is making it much easier for brokers to sell unregistered foreign shares to Americans.

“I think there is a grave risk that the advantage may be lost because of the continued chipping away at the rock,” Karolyi said. “It just doesn’t seem like the right time or the right place to be engaged in a serious deregulation of financial markets.”
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