The following post comes to us from Susan Chaplinsky, Tipton R. Snavely Professor of Business Administration at the University of Virginia Darden School of Business; Kathleen Weiss Hanley, Visiting Associate Professor of Finance and Senior Academic Advisor to the Center for Financial Policy at the University of Maryland Robert H. Smith School of Business; and S. Katie Moon, Visiting Scholar at the University of Southern California Marshall School of Business. It is based on their recent paper, “The JOBS Act and the Costs of Going Public,” which is available here.
In April 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law with the intent to reduce the regulatory burden of small firms and facilitate capital raising in the private and public markets. Title I of the law addresses the initial public offering (IPO) process and attempts to reverse a decade-long decline in the number of IPOs, especially smaller IPOs in the United States.
One of the central purposes of the Act is to lower the direct costs of firms seeking to go public by reducing the mandated disclosure and compliance obligations during both the IPO process and the first five years of being a public company. Title I of the law permits “emerging growth companies” (EGCs), generally firms with less than $1 billion in revenues, to scale the onset of public reporting and compliance obligations (“public on-ramp provisions”). Among other provisions, EGCs can choose to confidentially file their IPO registration statements, scale back financial and executive compensation disclosure in their IPO and subsequent public filings, and delay the onset of Sarbanes-Oxley and Dodd-Frank governance requirements until the fifth anniversary of going public.
By reducing disclosure, the Act has the potential to reduce the direct costs of going public, which are believed to be substantial. On the other hand, because the Act reduces the extent of mandated disclosure, it could reduce transparency and increase the indirect costs of issuance by increasing a firm’s cost of capital. For the Act to achieve its intended purposes, the reduction in issuers’ direct costs must not be offset by increased costs of capital due to reduced transparency.
We examine the effects of Title I of the Act for a sample of 213 EGC IPOs issued between April 5, 2012 and April 30, 2014. We compare the EGC IPOs to two control groups of IPOs with revenues less than $1 billion that were issued from January 1, 2010 to April 30, 2014 and from January 1, 2003 to April 30, 2014.
We do not find evidence that the direct costs of issuance, accounting, legal, or underwriting fees are reduced for EGC IPOs. Further, the indirect costs of issuance, as measured by underpricing, are significantly higher for EGCs compared to other IPOs. At its core, the Act extends many of the reduced disclosure requirements currently available to smaller reporting companies to a broader set of issuers. One of the central questions regarding the efficacy of the Act is whether the extension of reduced reporting requirements to a larger proportion of IPOs is beneficial? We find that the increased underpricing is concentrated in the sample of EGCs that are newly eligible for reduced disclosure, which suggests that investors require a higher rate of return to compensate for the loss of transparency. We show that the market penalizes EGCs for being ambiguous about their intentions to use the provisions of the Act by imposing a higher cost of capital. Finally, we find no significant increase in IPO volume after the Act. Overall, we find little evidence in its first two years that the Act has been effective in achieving its main objectives and conclude that there are significant consequences to extending scaled disclosure to larger issuers.