Corporate America is whining about costs associated with the Sarbanes-Oxley Act, the regulatory bill passed in the wake of the corporate scandals. A study released last week by the law firm Foley & Lardner found that 21 percent of public firms surveyed said they were considering going private “as a result of new corporate governance and disclosure reforms.” Business Week’s May 24 issue suggested that smaller companies are avoiding the public stock markets, perhaps hindering capital formation.
But while many executives are bitching about the costs of Sarbanes-Oxley, few are doing anything about it. If being a public company were really so troublesome post-Sarbanes-Oxley, managers, being rational creatures, would be taking their companies private at a rapid rate. And they’d be shying away from taking private companies public. The data shows neither is happening. Since Sarbanes-Oxley went into effect, more than twice as many companies have gone public as have gone private.
There’s no doubt that Sarbanes-Oxley has imposed new costs on public companies. They have to spend more on audits and to install new financial controls, and they’re paying more to insure directors and officers. The legislation is regressive because small companies are subject to the same regime as large ones. But the total amounts in question are still small. According to the Foley & Lardner study, the annual cost of being public for companies with revenues under $1 billion has risen from $1.2 million in 2001 to $2.9 million in 2003. For companies in the sample with revenues greater than $1 billion, the average cost of being public in 2003 was $7.4 million. Sarbanes-Oxley has increased costs, but they’re still very manageable.
What’s more, some of those companies that complain most loudly about the burdens of being public are ones that are doing horribly. Business Week opened its recent article on companies going private with the example of John A. Catsimatidis, the head of Manhattan grocery store chain Gristede’s, who was described as “fed up with the headaches of running a listed company valued at a mere $16 million.” But Sarbanes-Oxley is the least of the problems Gristede’s has. It operates a low-margin business in a high-cost, competitive marketplace. Gristede’s has lost money four of the last five years. (In 2001, it managed to eke out a net income of $275,000 on sales of $229 million.) Its stock trades at 86 cents. Is this the sort of company that the public markets will miss?
The accounting firm Grant Thornton noted that in the 16 months after the Sarbanes-Oxley legislation was passed—August 2002 to November 2003—the number of public companies going private rose 30 percent from the 16-month period before the act went into effect. In 2001, 53 publicly held companies went private. The number rose to 86 in 2003. And so far this year, only 24companies have gone private, according to Thomson Financial. Given that there are about 6,300 publicly traded U.S.-based companies, the rate of going private is remarkably low—barely 1 percent. (And the combination of falling interest rates and depressed stocks, rather than Sarbanes-Oxley, may have had something to do with the spike in 2002.)
Meanwhile, the heightened Sarbanes-Oxley regulations aren’t dissuading ambitious managers from taking companies public. Renaissance Capital reports that in the first quarter of 2004, there were 32 total IPO pricings, “the highest level for a first calendar quarter in four years.” Year to date, the dollar volume of IPOs is $12 billion, up 1,053 percent from the same period last year. The number of filings is up 905 percent, to 161. (Click here to view recent new filings.)
The truth is that for the overwhelming majority of companies, the benefits of being public outweigh the costs—even when you take into account the mandates of Sarbanes-Oxley. Publicly held firms generally enjoy a lower cost of capital than privately held firms. They possess a currency, shares, they can use to buy other companies. Most of all, being public means you can provide liquidity for employees—especially for the executives. Executives at public companies—even ones that perform poorly—are generally the biggest beneficiaries of the options culture. By contrast, privately held companies essentially have to pay their executives in cash.
Going private doesn’t mean a company will avoid the costs of complying with Sarbanes-Oxley forever. In the case of most management-led buyouts, investors and executives start to think about exit strategies a few years after the transaction closes. And that frequently means selling out to a publicly held company or holding an initial public offering. Even for the companies going private to flee the harsh mandates of Sarbanes-Oxley, it’ll only be a matter of time before they return to its prickly embrace.