Reviving the U.S. IPO Market

Good morning, and thank you, Dean Henry, for that kind introduction. It is a pleasure to be here. Thanks also to Alexander Ljungqvist and others from the Salomon Center for the Study of Financial Institutions at New York University, as well as the staff in the Securities and Exchange Commission’s (“SEC”) Division of Economic and Risk Analysis, for organizing today’s [May 10, 2017] Dialogue.

I am happy to join you in this discussion and exchange of ideas on the current state of, and outlook for, the U.S. initial public offering (“IPO”) market. This event is particularly timely, because it coincides with the arrival of Jay Clayton, the SEC’s new Chairman as of last week. He has made it clear that, under his leadership, making public capital markets more attractive to business while providing appropriate safeguards for investors will be a priority for the Commission.

An IPO has historically been one of the most meaningful steps in the lifecycle of a company. Going public gives a growing company access to an important source of funding—the public equity market—allowing it to raise capital from a diverse group of investors, often at a lower cost compared to other funding sources. This capital can be used to hire employees, develop new products and technologies, and expand operations. The beneficial uses to which that capital may be put are even more pronounced for small companies because they tend to be more innovative than large companies and they account for a substantial percentage of the jobs created every year.

Furthermore, IPOs give successful entrepreneurs an exit strategy for some or all of their investment, and provide an opportunity for them to allocate their capital and talent to other productive ventures. The same is true for institutional and other early-stage investors. IPOs also have important implications for employees for whom a portion of compensation before the IPO is a promise of future payment from options and stock grants. Through an IPO, such employees can access secondary market trading of the firm’s securities and therefore translate anticipated compensation to real dollars.

A vibrant IPO market also allows retail investors to add economic exposure from growing firms and industries to their investment portfolios, either directly or through vehicles such as mutual funds. As such, investors can share in the wealth created by these companies and enhance their overall risk diversification.

Notably, IPOs can enhance capital formation in both public and private markets. For example, if private sources of capital are aware that companies have a viable financing alternative through public markets, an entrepreneur may be in a better position to realize more favorable financing terms from more sources. The number of value-enhancing projects and innovations thus may increase.

In addition, an active IPO market can enhance efficient decision-making among suppliers of capital. The robust disclosures generated by newly public firms provide investors information to better evaluate investment options because they serve as benchmarks versus other companies both public and private. When complemented with the information provided to the market by third parties such as securities analysts, disclosures by IPO firms provide an important layer of investor protection that typically is not available in private markets.

Given all of the benefits I just articulated, the importance of IPOs to the U.S. economy cannot be overstated. In a nutshell, a robust IPO market encourages entrepreneurship, facilitates growth, creates jobs, and fosters innovation, while providing attractive opportunities for investors to increase their wealth and mitigate risk.

For decades, the United States enjoyed a strong IPO market that produced a steady supply of newly public firms and allowed millions of investors to participate in the value creation generated by those firms. Many foreign companies chose to go public in the United States, which gave U.S. investors global investment options to diversify portfolios. For those foreign companies, an IPO in the United States enabled them to expand their funding sources and take advantage of a lower cost of capital compared to their domestic markets. In fact, between 30 percent and 50 percent of worldwide IPOs occurred in the United States during the 1990s. [1]

In the last 15 years, however, the reduction in IPO activity has been dramatic. For example, since 2000, the average annual number of IPOs is 135—less than one-third the average annual number of IPOs—457—in the 1990s. [2] This decline has occurred despite the fact that there has been no downward trend in the creation of new companies over the same period. Traditional economic factors, such as fluctuations in companies’ demand for capital and changes in investor sentiment, also cannot explain the large decrease. Strikingly, the fraction of worldwide IPOs occurring on U.S. markets fell below 10 percent between 2007 and 2011. [3]

The substantial drop in the number of IPOs in the United States is primarily driven by the disappearance of small IPOs. In the 1980s and 1990s, IPOs with proceeds of less than $30 million constituted approximately 60 percent and 30 percent, respectively, of all IPOs. [4] In fact, some of the most iconic and innovative U.S. companies, such as Apple, Cisco, and Genentech, entered the public market as small IPOs. This trend reversed in the 2000s. [5] IPOs with proceeds less than $30 million accounted for only 10 percent of all IPOs in the period 2000-2015. By comparison, large IPOs have increased from 13 percent in the 1990s to approximately 45 percent of all IPOs since then. [6]

What caused this precipitous decline in IPOs, particularly those of small firms, after 2000? Today’s event is intended to identify and discuss the potential causes and consequences. I suspect panelists will highlight a variety of factors that have contributed to making it more difficult, or less attractive, for small companies to go public. For instance, the availability of alternative sources of capital, such as from private equity, hedge funds, and even mutual funds, means that private firms may be able to finance growth without having to go public. The emergence of trading venues that provide liquidity for privately-held shares has had the same effect.

In the interest of time, let me quickly list several other possibilities. New offering methods—namely Crowdfunding and Regulation A—have provided alternatives to the IPO. Consolidation in investment banking and brokerage services has left fewer underwriters for small IPOs. Changes in the economic environment due to globalization, along with the “winner-takes-all” trend in some industries, means that firms have to get bigger faster to improve profitability, and therefore may prefer being acquired by a large company instead of growing organically. Macroeconomic factors, such as cheaper debt financing and increased mergers and acquisitions activity, may also play a role.

Moreover, regulatory changes may have contributed to the downward trend in IPOs. The Sarbanes-Oxley Act of 2002 imposed higher regulatory burdens on smaller public companies. Decimalization and Regulation NMS changed the economics of market making for small company stocks and left fewer market makers willing to organize a market for small stocks post-IPO. Modifications to the Section 12(g) shareholder threshold introduced by the Jumpstart Our Business Startups (“JOBS”) Act in 2012 also make it more likely that companies will stay private for a longer period of time.

What, then, can be done to revitalize the IPO market, particularly for smaller companies? As a start, during my tenure as Acting Chairman the Commission adopted amendments to conform our rules and forms to Title I of the JOBS Act. [7] Specifically, Title I of the JOBS Act provided an IPO on-ramp for emerging growth companies, allowing them to use scaled disclosure for a certain period of time. It also improved the information available for IPO firms by allowing analyst reports to be published during the quiet period.

I hope that today’s Dialogue will generate even more interesting insights and ideas. I look forward to hearing your discussions, analyses, and recommendations. Both Chairman Clayton and I are especially interested in any suggestions for regulatory and other reforms that could be implemented to reverse the more than decade long decline in U.S. IPOs.

Thank you all for agreeing to spend your time with us so that we can benefit from your perspectives. I wish you a day full of enjoyable and fruitful discussions.

Endnotes

1See Craig Doidge, G. Andrew Karolyi, and Rene M. Stulz, “The U.S. left behind? Financial globalization and the rise of IPOs outside the U.S.,” Journal of Financial Economics (Dec. 2013).(go back)

2 See Michelle Lowry, Roni Michaely, and Ekaterina Volkova, “Initial Public Offerings: A Synthesis of the Literature and Directions for Future Research” (Mar. 20, 2017), available athttps://ssrn.com/abstract=2912354 .(go back)

3See Doidge, et al., supra note 2.(go back)

4See Lowry, et al., supra note 3.(go back)

5Id.(go back)

6Large IPOs are IPOs with proceeds of more than $120 million. Dollar values are inflation-adjusted.(go back)

7Securities Act Rel. No. 10332 (Mar. 31, 2017), available at https://www.sec.gov/rules/final/2017/33-10332.pdf.(go back)