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E-MailSteven M. Davidoff is Professor of Law and Finance at Ohio State University College of Law. As of July 2014, Professor Davidoff will be Professor of Law at the University of California, Berkeley School of Law. The following post is based on a paper by Professor Davidoff and Paul Rose of Ohio State University College of Law.
The small company initial public offering (IPO) is dead. In 1997, there were 168 exchange-listed IPOs for companies with an initial market capitalization of less than $75 million. In 2012, there were seven such IPOs, the same number as in 2003.
While there is no doubt that the small company IPO has disappeared, the cause of this decline is uncertain and disputed.
A number of theories have been offered for this decline, but the most prominent theory attributes the decline to increased federal regulation and market structure changes also driven by federal regulation. The explanation for this decline is important, because it has driven passage of the JumpStart Our Business Start-ups Act (the JOBS Act) as well as recently introduced Congressional legislation to mandate decimalization for a five-year period for all companies with a market capitalization of $750 million or below.
In The Disappearing Small IPO and the Lifecycle of the Small Firm, Professor Paul Rose and I analyze the reasons for the decline of the small IPO by examining the lifecycle of small IPOs.
Using a dataset of 3,081 IPOs from the year 1996 through 2012, we compare companies arrayed in three significant regulatory categories—those with a market capitalization of less than $75 million, those with a middle market capitalization between $75 and $700 million, and those large capital companies with a market capitalization greater than $700 million.
We examine firm lifecycles from 1996–2012 and find that small IPOs do indeed have a different lifecycle than other, larger companies. Small IPOs have a short half-life: within five years of an IPO, only 55% remain listed on a public exchange, compared to 61.3% and 67.1% for middle and large capitalized companies, respectively. Of those that are no longer listed, the majority either voluntarily or involuntarily delist. This compares to medium and large-sized companies that largely exit the markets through takeover transactions. Moreover, those small companies that remain listed largely fail to grow, remaining in the small capitalized category. Over the life of our sample time period, the initial median market capitalization of surviving small IPOs in year one is $52 million while in year five it falls to $34 million and in year seven rises to only $58 million.
We also perform regression analysis to further determine delisting attributes for smaller as opposed to bigger IPO companies. We find no indication that regulation and relatedly increased audit fee expenses spurred the probability of involuntary delistings due to bankruptcy and other distress events. However, we do find that there is an uptick in voluntary delistings and takeover exits among small firms in the time after the passage of Sarbanes-Oxley. Our findings give at best mixed support to the regulatory theory.
We also find that, on the whole, smaller capitalized companies appear to be more likely to delist if their asset size is smaller compared to revenues for larger companies, implying they are more prone to shocks but may be more capable than previously thought of incurring increased regulatory costs. We ultimately conclude that small IPO companies are simply different than middle or large capitalized IPOs. They historically have not performed well in the markets, are less stable due to their size and are more susceptible to delisting for involuntary reasons.
Ultimately, we also conclude that the evidence derived from the lifecycle of small IPOs points to supply side changes, rather than regulatory changes, as the reason for the vanished small IPO. In short, we believe that investors simply tired of investing in these small IPOs due to their inability to survive and grow in the public markets. In the absence of investor demand, supply side forces still pushed these IPOs into the market, forces, which have disappeared in light of technological and market structure changes.
Nor do we find any evidence that the JOBS Act has changed anything. 2013 was a terrific year for IPOs. In 2013, there were 179 IPOs on the Nasdaq, NYSE and the successor to AMEX, which meet our sample criteria. However, of these IPOs, only 9 (5%) were small IPOs while 88 (49%) were middle market IPOs and 80 (46%) were large capitalized IPOs. Percentagewise, the number of small IPOs was one of the lowest since 1996. The trend instead is toward ever larger IPOs. The number of large IPOs was the largest since at least 1996.
We also examine what steps may be needed to restart the small IPO market. We conclude that further regulatory changes such as decimalization are unlikely to work. Instead, if a fix is to come, it necessitates creating a market environment that fosters growth in small companies both before and after a small company’s IPO. In other words, relaxing regulation alone may only bring back companies that are ill-suited to the public markets. Absent changes to the type of small companies that have historically gone public, the loss of the small IPO may not be something to mourn.
The full paper is available for download here.
