With the U.S. Securities and Exchange Commissions heavy-handed regulating and enforcement, and with the 2002 Sarbanes-Oxley Act the cherry on the regulatory cake, an economist would expect American capital markets to lose some of their lustre in favour of less constrained marketplaces. A new study has just documented that this is indeed happening. The implications for Canada run counter to accepted wisdom in political and bureaucratic circles.
Produced for the Committee on Capital Markets Regulation and to be released today, the study is titled, Is the U.S. Capital Market Losing its Competitive Edge? The author, Luigi Zingales, an economist at the University of Chicagos business school, calculates that the American share of global IPOs (initial purchase offerings in markets other than the issuers home markets) has decreased dramatically since the late 1990s.
Our chart shows that the share of global IPOs from highly developed countries (Old Europe, Canada, Japan, Australia and New Zealand) captured by U.S. exchanges has dropped from a third in 2000 to less than 10% today in actual numbers, and from 50% in 1999 to less than 5% in value. The numbers are not much differentin fact, slightly more favourable to the U.S. capital marketsif we add developing countries to the picture. Nor are the conclusions much different if we exclude the technology run-up of the late 1990s.
Dr. Zingales uses another recent study by Craig Doidge et al. to evaluate the premium that investors pay for foreign companies listed in the United States, as opposed to companies quoted only on their home markets. This premium, calculated as the difference between the ratios of market value to book value for the two sorts of companies, went from 51 percentage points in the five years before 2002 to 31 percentage points since a drop of 20 percentage points. For Canadian companies listed in the United States, the premium drop is 21 percentage points. In general, the premium fell most sharply for companies located in developed countries, ruling out the hypothesis that American regulations just keep out the most shabby issuers.
Dr. Zingales attributes the relative decline of American capital markets partly to excessive regulation and overly burdensome litigation risk in the post-Sarbanes-Oxley period.
The Committee on Capital Markets Regulation is an independent organization composed of two dozen high-level executives, financiers and academics, with the support of Treasury Secretary Henry Paulson. It was created in early September with two goals: to produce a study to assess the degree to which U.S. public markets are losing ground to foreign and private markets and what impact that has on the financial industry and the economy more generally; and to make consequent recommendations to the government. The promised study is the one penned by Dr. Zingales. An interim report, also due today, will likely recommend easing U.S. regulations.
Recently, many other observers have expressed concern over the relative decline of American capital markets, including former Federal Reserve chairman Alan Greenspan and the chief executive of the New York Stock Exchange. In recent years, even some American companies have chosen to list in London rather than in the United States. And the connection with over-regulation is clear: In London, some fear that the participation of Nasdaq in the London Stock Exchange could introduce detrimental U.S. regulations through the back door.
Now, the problem may be much deeper than Sarbanes-Oxley. Although the Zingales study does not address this question, a good argument can be made that pre-Sarbanes-Oxley regulations were dampening the premium that would otherwise have attached to the rich and liquid U.S. capital market. After all, Sarbanes-Oxley, which is partly enforced by the SEC, is only one of a long string of heavy regulations imposed in the United States since 1934, in the wake of Roosevelts New Deal. At any rate, the study of the Committee on Capital Markets Regulation does show what is rather obvious for an economist: that there can be too much securities regulation. And there is.
When the Committee on Capital Markets Regulation was created in September, Hal Scott, a law professor at Harvard and the committees director, said: We are witnessing a crucial moment in economic historythe movement of U.S. capital markets abroad, and the growth of private markets at the expense of public ones. As often happens with government intervention, the growth of securities regulation has gone hand in hand with a twist in the language. What is meant by public markets is private markets (that is, markets where private parties meet) regulated by the statejust like restaurants and bars are now defined as public places only to be regulated by the state, and cleared of smokers.
The consequences of the growth of securities regulation in the United States should send strong signals to Ottawa. The Canadian-way enforcement of securities laws, as opposed to an American-style witchhunt, is a benefit, not a cost. Senator Jerry Grafstein, who plans hearings before his banking committee, is mistaken to assume that an American type of jail-happy enforcement is warranted.
Competition between jurisdictions is efficient. Had it not been for less-regulated markets in the world, we would never have known for certain that investors think that American regulation is inefficient. In capital markets, as in other markets, market-sustained diversity is an advantage, not a cost. And Canadian capital markets could benefit greatly from the decline of their American competitors that is, if the Canadian government does not imitate American mistakes.
This seems very difficult to do. The former Liberal government had created the so-called Wise Persons Committee, which recommended the new Conservative government move toward a single securities regulator in Canada. In its budget of last May, the new Conservative government announced its intention to implement this proposal. The questioning of U.S.-style securities regulation should send a strong signal to Finance Minister Jim Flaherty: Dont try to create a Canadian SEC.