The FINANCIAL — A study released today by Grant Thornton LLP, A Wake-Up Call for America, demonstrates that market structure changes implemented beginning in the late 1990s are leading to a dramatic long-term decline in the number of publicly listed companies in the United States.
According to the study, SEC actions over recent decades have encouraged the development of markets that favor the most technologically sophisticated traders. The rise of high-frequency trading is the natural consequence of regulations designed to increase efficiency, but those same regulations have tended to undermine market support for small, innovative companies.
"Our 'one-size-fits-all' market structure has added liquidity to large cap stocks, but has created a black hole for small cap listed companies," said David Weild, Capital Markets Advisor at Grant Thornton LLP and former vice chairman of NASDAQ. "Wall Street's very nature has been substantially transformed."
"This important study demonstrates convincingly further cause for concern about rules that encourage high-frequency trading to thrive, but perhaps have undermined one of Wall Street's most important purposes: to provide the infrastructure for smaller, growing companies in the United States to gain access to the public markets to facilitate further growth and innovation," said Senator Ted Kaufman (D-Del.). "The Grant Thornton study is a call to action. U.S. innovation policy must include an intelligent review of our U.S. equity markets, so that Wall Street once again helps innovative small companies to succeed."
Known in the 1990s as the "Four Horsemen," the investment banks that once catered to emerging-growth companies are gone. Today the market is dominated by firms that buy and sell in milliseconds, using automated algorithms that have no interest in the fundamental valuations underlying stocks. They include proprietary trading, statistical arbitrage hedge funds, and automated market makers.
The result? Investors, issuers and the economy have all been harmed. Wall Street is now fixated on trading profits and has abandoned investments in quality sell-side analysis, underwriting and sales support – the infrastructure necessary to support and create value in small cap stocks. Policymakers must recognize that the structure and regulatory framework guiding U.S. equity markets has become not only an important issue for investors due to fairness concerns, but also a critical component of U.S. economic policy that is affecting our economy's ability to innovate, create jobs and grow.
The decline in the number of new listings began before the technology bubble burst a decade ago – before the enactment of Sarbanes-Oxley in 2002 – and has continued through bull and bear markets. The number of U.S. listed companies has fallen by more than 22 percent since 1991, or 53 percent when calculating in inflation-adjusted GDP growth. In contrast, exchanges in Asia are adding new listings faster than GDP growth rates.
According to the study, 360 new listings per year – a number not approached since 2000 – are required by the United States simply to replace the number of listed companies that are lost every year. Moreover, 520 new listings per year are needed to grow the U.S. listed markets roughly in line with GDP growth. In reality, the U.S. has averaged fewer than 166 IPOs per year since 2001, with only 54 in 2008.
Believed to be the first of its kind, the study was conducted by David Weild and Edward Kim, Capital Markets Advisors at Grant Thornton LLP, using data from a number of sources, including the World Federation of Exchanges, and from direct interaction with major stock exchanges.
"This study confirms that America's slipping global competitiveness in the capital markets is rooted in long-term structural problems, with devastating consequences for growth capital formation in the U.S.," said Pascal Levensohn, Founder and Managing Partner of Levensohn Venture Partners, Board Member of the National Venture Capital Association (NVCA), and member of the Council on Foreign Relations. "The inability for emerging growth companies to access U.S. public equity capital by completing IPOs below $50 million inhibits job creation and hurts American entrepreneurs more than any other group. If we can't repair the bridge into public markets, the next generation of innovative private enterprises – starved for long-term risk capital in the U.S. – will continue to move to non-U.S. emerging innovation hotspots, where startups are nurtured through attractive capital incentives."
Barry Silbert, Founder and CEO of SecondMarket, the industry leader in private company stock transactions, said "The growth and development of a robust private market is critical to creating a better alternative and viable bridge to the public market. The time from company formation to IPO is now so long – nearly 10 years – that it undermines the development of small businesses, entrepreneurship and American global competitiveness."
"Today, our stock markets are increasingly structured to favor computer-driven trading interests at the expense of long-term investors and the U.S. taxpayer," said Grant Thornton's Kim. "We need a regulatory framework that guides Wall Street to help small companies with their capital formation needs, not just build faster and more powerful trading algorithms."
Recommended Changes
The Grant Thornton study calls for immediate action and includes recommendations on how to improve both public and private stock markets in ways that provide investors and issuers with more choice. It argues that the opportunity cost of poor primary capital formation is so extreme that the U.S. needs significant improvements to both the public and private markets to restore U.S. competitiveness. Recommendations include:
Alternative Public Market Segment: A public market solution that provides an economic model that supports the "value components" (research, sales and capital commitment) in the marketplace. It would establish a new, parallel market segment that benefits from a fixed spread and commission structure.
Enhancements to the Private Market: A private market solution that enables the creation of a qualified investor marketplace – consisting of both institutional investors and large accredited investors – that allows issuers to defer many of the costs of accessing private capital as a precursor to becoming a public company. This market would serve as an important bridge to an IPO, notably in improving the market for 144A PIPO (pre-IPO) transactions that require an issuer to list publicly in the future.
Grant Thornton urges Congress and the SEC to hold immediate hearings to understand why the U.S. markets have failed to keep up with foreign markets and to craft solutions quickly – solutions that, together with thoughtful oversight, will advance the U.S. economy, create high-quality jobs, improve U.S. competitiveness, increase the tax base and decrease the U.S. budget deficit, all without major expenditures by the U.S. government.
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