New research lends credence to concerns that there are inadequate protections for investors in companies that go public under the JOBS Act, resulting in higher risk premiums for issuers.
The Jumpstart our Business Startups Act was signed into law in 2012 in the hope of spurring job creation by easing the process by which relatively small companies make initial public offerings. The law created a category of so-called “emerging growth companies” (EGCs), defined as IPO-issuing firms with less than $1 billion in revenues in the year prior to the offering.
Prominent among the benefits the law bestows on EGCs is a substantial reduction in the public disclosures these firms are required to make about their finances and operations.
Though passed with strong bipartisan majorities, the bill drew a cautionary letter to Congress from then-SEC chair Mary Schapiro. Contrasting “our responsibility to facilitate capital formation with our obligation to protect investors and markets,” she warned against “the balance [being] tipped to the point where investors are not confident that there are appropriate protections.”
Results of a study by three university professors, to be presented in the forthcoming issue of The Accounting Review, a journal of the American Accounting Association, suggests that Schapiro’s cautionary note was prescient.
The paper compares the initial public offerings of EGCs with those of non-EGCs (NEGCs), defined as companies that would have been EGCs had their IPOs occurred after the JOBS Act took effect. It finds considerably greater underpricing and volatility for shares of the EGCs than for those of the NEGCs in the wake of their respective IPOs.
Underpricing is, in effect, money left on the table for the issuer. It “reflects a risk premium that investors demand to compensate them for their uncertainty about the value of the firm,” wrote the professors, Mary E. Barth of Stanford University, Wayne R. Landsman of the University of North Carolina at Chapel Hill, and Daniel J. Taylor of the University of Pennsylvania’s Wharton School.
By reducing mandatory disclosures for EGCs, the JOBS Act “increases information uncertainty, [which] leads us to predict that EGC firms have larger underpricing and higher post-IPO volatility than NEGC firms,” the study authors said.
Indeed, they found shares of EGCs to be, on average, about 12% more volatile post-IPO than those of NEGCs. And when it comes to underpricing, the contrast between the two groups was even more striking. On IPO days, the underpricing of EGC shares (the difference between the initial offering price and the price at day’s end) was on average about 55% greater than the underpricing of NEGC shares, and at 30 business days post-IPO it was more than 100% greater.
At that point the difference in underpricing between the average EGC and the average NEGC amounted to a hefty 13% of IPO proceeds.
“That’s a lot of dollars left on the table by virtue of the JOBS Act, money that issuing companies could otherwise have collected at the IPOs,” says Taylor. “It would hardly seem to be in the interest of shareholders. At a time when the SEC is considering extending the Act’s disclosure reductions to all publicly traded firms, our findings certainly raise questions about doing so, notwithstanding current corporate complaints about burdensome disclosure requirements.”
In testimony this September before the Senate Banking Committee, the SEC’s recently appointed chairman, Jay Clayton, stated that “the Commission will soon consider a proposal … to modernize and simplify the disclosure requirements … in a manner that reduces costs and burdens on companies while still providing for the disclosure of all required material information.”
But, Taylor asks, “Does reducing the disclosure burden for companies mean sacrificing investor protections? The evidence we find in the case of the JOBS Act suggests that it does.”
The new research, which represents the most extensive analysis to date of the JOBS Act’s disclosure-reduction provisions, is based on data from all U.S. IPOs between July 1, 2009 (about 33 months before the law’s passage) and December 31, 2013 (about 21 months after its passage). The sample consists of 376 companies, 158 of which were EGCs (i.e, their IPOs occurred post-JOBS Act), while 218 were NEGCs (with IPOs occurring pre-JOBS Act).
It’s worth asking whether the JOBS Act has at least fulfilled hopes for an increase in the number of IPOs and concomitant growth in the economy and jobs.
Taylor acknowledges that evidence suggests the number of IPOs has increased since the law’s passage. But, he adds, the quantity of companies going public is less important than their quality. “Is it better to have 100 companies that each raises $50 million, or 75 companies that each raises $100 million?” he asks.
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