Sarbanes-Oxley promotes inequality

See A Pox on SOX, It’s Bad for Stocks: Sarbanes-Oxley promotes inequality by discouraging companies from going or remaining public by Scott S. Powell. Mr. Powell is an economist and senior fellow at Discovery Institute in Seattle. Excerpts:

"Section 404 of Sarbanes-Oxley imposed an intrusive audit regime on almost every aspect of a public company’s operation. This has proved to be one of the most costly and counterproductive regulations ever introduced, with compliance adding about $2 million in annual costs for the smallest public companies and far more for bigger companies.

Section 404 audits focus on minute operational details, not on detecting the kind of high-level accounting fraud that took WorldCom down. The costs Section 404 imposes have disproportionately affected small public companies and discouraged many promising venture-capital-backed enterprises from going public."

"Combined with the impact of mergers, acquisitions and corporate failures, Sarbanes-Oxley has dramatically reduced the number of public company investment opportunities in the U.S. In 1996 there were 7,322 public companies listed on U.S. stock exchanges; today there are 3,671. With fewer initial public offerings, powerful incumbent firms have raised barriers to new entrepreneurship and made it harder for competing startups to raise funding, tamping down innovation.

Before Sarbanes-Oxley, young companies on the path to an IPO could remain entrepreneurial and nimble. But the law created massive disincentives to seeking capital from public markets. Instead of going public and accepting the huge costs of SOX compliance, young companies increasingly sought acquisition by other larger public or private businesses. Many startups chose to stay private in the portfolios of venture-capital and private-equity firms.

Wall Street and the capital markets also adjusted to the law. Investment banks redirected resources into originating, structuring and trading real-estate mortgage debt, which helped create the financial excesses that nearly sank the economy in 2007-08. Investment dollars increasingly fled from public markets, finding their way instead into private equity and venture capital firms.

By reducing investment opportunities for middle-class Americans, Sarbanes-Oxley had the unexpected consequence of exacerbating wealth inequality. The world of venture capital and private equity is an exclusive club for the rich, while the public markets cater to diverse investors—both affluent and of modest means. When companies went public earlier in their lifetimes, employees and average investors had more opportunities to build wealth.

The share of wealth owned by the top 1% of Americans has surged over the last generation in part because those not already at the top have been increasingly shut out of the wealth-creation process. To redress this growing wealth disparity and invigorate entrepreneurial dynamism in the U.S. economy and capital markets, Congress can take some fairly simple legislative action."