Adios, IPOs

Don’t blame America’s declining IPO business on Sarbanes-Oxley.

New York Stock Exchange

Wall Street and Washington are fretting that many of the world’s biggest initial public offerings are taking place on exchanges in London, Hong Kong, and Shanghai —and not in New York. Rep. Tom Feeney, R-Fla., earlier this week warned darkly of “an outsourcing of America’s 100-year lead in capital formation.” Feeney, a self-styled “American economic Paul Revere,” and other horsemen of the regulatory apocalypse are quick to blame the Sarbanes-Oxley Act and America’s compliance and legal systems, which place burdens on companies seeking to list shares.

There is no single reason why IPOs are heading overseas. Nationalism and geographical parochialism certainly influence the trend. China’s government, for example, is eager to encourage the growth of local capital markets, so it’s no surprise that the massive IPOs of China Construction Bank and Industrial & Commercial Bank of China are launched close to home. But as Alan Murray suggested in the Wall Street Journal this morning, Americans are also losing our IPO advantage because we’re not as good at them anymore. A report by Oxera Consulting, which the London Stock Exchange and the City of London commissioned, found that the United States—for reasons that have little to do with Sarbanes-Oxley—is more expensive and not particularly efficient at IPOs. We’re the Europe of capital formation.

For starters, U.S. investment banks charge underwriting fees—the percentage of the offering that investment banks keep for themselves—that are the highest in the world. Examining IPOs from Jan. 1, 2003, through June 30, 2005, Oxera found that average fees paid by companies going public on the NYSE and the NASDAQ were 6.5 percent and 7 percent, respectively. By contrast, the median fee for companies on the LSE’s Main Market and the Alternative Investment Market were 3.25 percent and 4 percent, respectively. (It’s unclear why Oxera chose to calculate averages for the American exchanges and medians for the British ones.) Raise $100 million in the United States, and you pay the New York-based bankers at Merrill Lynch or Goldman Sachs somewhere between $6.5 million and $7 million. Raise the same amount in London, and you pay the London-based bankers at Merrill Lynch or Goldman Sachs about half as much. Indeed, Oxera found that “the same bank would indeed charge higher fees for a transaction on Nasdaq and NYSE than for a floatation, say, on London’s Main Market.”

Oxera also found that “IPO discounts”—the amount an IPO rises on the first day—are higher in the United States than they are in Europe. Higher “discounts” are good news for the clients of investment banks who buy in at the IPO price. But they’re bad news for the companies selling the shares. It means they’ve left money on the table. If an investment bank prices Company X’s shares at $10 each when the market was willing to pay $11, it increases the cost of capital by 10 percent. Oxera noted that the pricing differences between the United States and Europe weren’t huge, but they weren’t nothing. If you’re doing a U.S. IPO, it must be particularly galling to pay a higher fee and get worse pricing, too.

Aside from paying the underwriters, companies going public have to pay lawyers, accountants, printers, and investor relations professionals, which can eat up another few percentage points of a typical offering. Oxera didn’t crunch numbers on such costs but noted that there was a “perception among some of the companies consulted” that they were highest in the United States. Here, Sarbanes-Oxley—a nonfactor in the first two examples of higher costs—certainly comes into play. But I would venture to bet that the New York-based lawyers, accountants, and public relations professionals who work on IPOs bill at a higher hourly rate than do their counterparts in Europe.

Until recently, companies probably didn’t consider cost when trying to decide where they should list their stock offerings. American and foreign companies were willing to pay the going rates to get access to the U.S. investor base and to gain the prestige associated with a NYSE or NASDAQ listing. After all, investors have historically been willing to pay a premium for stocks listed in countries with superior corporate governance regimes, transparency, and liquidity. Here, again, however, the United States is losing its advantage. A company doesn’t have to be listed on the NYSE or NASDAQ to have a U.S. investor base. Savvy U.S. hedge funds and other investors trade shares all over the world. Rapidly proliferating exchange-traded funds allow individuals to do the same. And foreign competitors are working hard to meet the standards set by U.S. exchanges. Treasury Secretary Henry Paulson said as much in an interview (subscription required) yesterday with Maria Bartiromo, noting that “markets overseas are much stronger and more competitive than they were a few years ago.” The global adaptation of Wall Street innovations has undercut the primacy of the U.S. exchanges.

The reality is that with the spread of wealth, experience, infrastructure, and expertise around the world, IPOs are becoming more of a commodity. And when you are in a commodity business, you have to be competitive on price. Alas, that price-cutting mentality doesn’t come naturally to the well-dressed, well-fed, and well-housed bankers who run American IPOs. As Mayor Michael Bloomberg, a former partner at Salomon Brothers, put it: “If New York City is a business, it isn’t Wal-Mart—it isn’t trying to be the lowest-priced product in the market. It’s a high-end product, maybe even a luxury product.” But if a luxury product doesn’t offer superior value, it could easily lose market share.

For years, Wall Street investment bankers have been telling their client companies that they must seek out the lowest-cost operating environments. That trend has placed great pressure on the wages and earning power of blue-collar workers in the United States. Now it looks as if the bankers may be getting a taste of their own medicine.