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The Great Depression in Listings

(Guest Commentary by Rick Konrad – November 19, 2009)

Dear Subscribers and Readers,

For those who had wanted to learn more about picking stocks, evaluating companies, industry trends, and other issues related to the stock market, we have again brought in one of our regular guest commentators, Mr. Rick Konrad for a guest commentary.  As I mentioned a couple of weeks ago, Rick has been a regular guest commentator for a few years now (every third Wednesday of the month) but is now offering his insights every first Wednesday of the month as well!  We highly appreciate your investment insights and general wisdom, Rick!

In this commentary, Rick will discuss the structural decline in US public equity listings since 1997 - the reasons and implications for such a decline.  Interestingly, public equity listings have continued to rise outside of the US over the last decade, especially in Asia.  Rick attributes this strictly US phenomenon to the evolution of the brokerage markets over the last 15 years, as well as the regulatory environment since 2002.  This is a must-read.  Without further ado, following is a biography of Rick:

Rick is author of the excellent investment blog “Value Discipline,” founder of “Value Architects Asset Management”, and is a regular guest commentator on (please see "Is Burlington Northern the New Coke?" for his last guest commentary).  Prior to his current role, Rick has been a professional portfolio manager for institutional investors for over 25 years.  You can view a more complete profile of Rick on his blog.  You can also email Rick at the following address should you have any questions or thoughts for Rick after reading his commentary.  Rick is a very genuine teacher of the financial markets and treats it very seriously.  Case in point: Rick has also been responsible for running the education program for the CFA Society in Toronto (which is the third largest CFA society in the world besides the New York and London Societies) and had also been involved with grading CFA examinations.

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

Political economists say that capital sets towards the most profitable trades, and that it rapidly leaves the less profitable non-paying trades. But in ordinary countries this is a slow process…In England however…capital runs as surely and instantly where it is most wanted, and where there is most to be made of it, as water runs to find its level.-Bagehot (1873)

Walter Bagehot was a British journalist and businessman who wrote extensively about economic topics in the 19th Century. He was describing the allocation of capital in the English economy.

Most of us give little thought to just how an economy allocates capital efficiently, that it really doesn't matter to us. Capital is supposed to be invested in sectors expected to have high returns, and withdrawn from sectors with poor prospects as Bagehot describes. Clearly, the growth of the nation is accelerated if capital is directed to “winners” rather than “losers” in the allocation of precious resources.

The role of a stock exchange goes beyond just being a “casino” for us to transact. The raising of equity capital plays an important role in financing the nation's business and this would be far less efficient if there were no secondary markets and no trading. Secondary markets exist to provide liquidity for our investments but also serve as a barometer for expectations. Investment bankers utilize the determination of secondary markets to price deals. Consequently, capital formation to a large degree depends on healthy markets and stock exchanges. Financial markets improve growth because they improve the allocation of capital.

Though everyone is thrilled not to have endured a second coming of the Great Depression, there is a serious depression in capital formation that is occurring, largely because of the demise of exchange listings. An excellent report by Grant Thornton, “A Wake-up Call for America” addresses some of these concerns. I think the issue is of sufficient gravity, that it deserves recognition in a Marketthoughts post

A Wake-up Call for America link-

The peak year for US listings was 1997-surprisingly, not during the peak of the Internet bubble. Since this peak year, the number of US stock exchange listed companies has declined by nearly 39%. Since 1991, the number is down by more than 22% and down 53% when allowing for inflation-adjusted GDP growth.

This is NOT a global phenomenon. The US is seriously lagging other industrialized nations in the formation of listed companies.

Number of Listings


Percentage Change 1991-2008


Number of Listings


Percentage Change Peak - 2008





GDP Adjusted




GDP Adjusted





































The decline in the number of listings is disturbingly large. This is especially true for smaller cap companies. Why is this occurring? If the market structure is failing to support the micromarket for individually listed companies, how can it serve investors? How can it be efficient? How can in facilitate the formation of capital? In short, it can't.

Yet, it is so fundamental to economic health. Increased access to equity capital, and a market structure that supports not only issuers but also investors would result in improved productivity, improved job growth, and support to economic growth through capital gains and taxes.

A lot of people blame Sarbanes-Oxley. The Sarbanes-Oxley Act (SOX) was passed in 2002 after a string of high profile corporate scandals. The law's main goal was to improve the quality of financial reporting and to increase investor confidence. The Securities and Exchange Commission (SEC) was put in charge of enforcing the law. In 2003, SEC implemented Section 404 of SOX, which requires companies to put in place and periodically test procedures that monitor the internal systems ensuring accurate financial reports. Section 404 requires that managers report their findings in a special management's report, and an outside auditor attests to the management's assessment of the company controls.

These procedures are intended to help companies detect fraudulent reporting early and deter financial fraud, directly improving the reliability of financial statements. Section 404 and its practical application have been under intense attack from business groups and lawmakers. In 2005, the Duke University/CFO Magazine Business Outlook Survey put increased regulation as one of the top concerns of US corporations, third after competition and health care costs. The SEC's own Advisory Committee on Smaller Public Companies recommended renewed Section 404 exemptions for small firms because of the high costs of compliance.

Sarbanes Oxley in my opinion does play a role here. Some academic research seems to attribute some negative effects to this legislation. Cohen at Northwestern  for instance, finds that Sarbanes Oxley altered the structure of managerial compensation owing to an increase in managerial risk aversion, and reduced research and development spending and capital investments. Not exactly encouraging for future growth.

The principal source of concern about SOX is the increased compliance fees, of which the auditing fees are an easily measurable component. The Financial Executives International organization surveyed 217 large companies. The self-reported average one year increase in the audit fees due to SOX Section 404 was approximately $1.3 million. The survey also suggests that the cost of internal and external people hours (excluding fees paid for auditor attestation) was $3.1 million, thus exceeding the direct audit fees. For a small company seeking equity of $20-$50 million, this is a meaningful cost.

Even for fairly large companies, de-listing from the US has been occurring with increasing frequency. Historically, the ADR has been an important instrument for foreign firms seeking access to U.S. capital markets. Indeed, in 2006, a record 52.6 billion ADRs valued at $1.5 trillion traded on major U.S. exchanges. However, over the period 2001 to 2006, the number of exchange listed ADRs outstanding dropped from approximately 610 to 478. Over the same period, the number of non-U.S. exchange listed firms worldwide increased from 27,110 to 34,630.

But the Grant Thornton study suggests that the root cause of “The Great Depression in Listings” is not just SOX, but a whole array of regulatory changes that were meant to lower trading costs. This has had the unintended consequence of stripping economic support for other value components of the investment brokerage industry such as quality sell-side research, capital commitment to support trading, and sales.)

The Great Depression in Listings began with the advent of online brokerage and the Order Handling Rules. The peak of the Dot-Com Bubble and the adoption of Sarbanes-Oxley came much later.
Source: Grant Thornton – A Wake-Up Call for America

The small IPO is essentially extinct. The venture capital market is threatened as the number of venture-funded IPOs is at an all time low, and the average time to market from first venture investment to IPO has more than doubled. The revitalization of the venture-backed IPO market is critical to U.S. economic recovery and to the ongoing viability of America's competitiveness. Consulting firm Global Insight estimates that in 2008 public companies that were once venture-backed accounted for more than 12 million U.S. jobs and $2.9 trillion in revenues, which equates to 21 percent of U.S. GDP. Further, it is estimated that 92 percent of job growth at these companies occurs once the company enters the public markets.

The National Venture Capital Association (NVCA) in April of this year created a proposal to address some of these issues, called The Four Pillars.

  1. Ecosystem Partners- The “four horsemen” boutique investment banks of the 1990s (Alex Brown, Hambrecht & Quist, Montgomery Securities, and Robertson Stephens), which specialized in IPOs of venture-backed companies, no longer exist. As well, there is a void in quality auditing services available for smaller companies. The NVCA is attempting to develop new “Ecosystem Partners” to replace these firms.

  2. Enhanced Liquidity Paths- The distribution system that connects sellers and buyers of venture-backed company new issues is broken. There are many drivers behind this disconnect including mismatched expectations in terms of issue size, the lack of sell side analysts, and the propensity of hedge funds to buy and sell stock quickly.

  3. Tax Incentives- The NVCA advocates a capital gains tax rate that is globally competitive and preserves a meaningful differential from the ordinary income rate. The Association asserts that venture capitalists who are successful in building new companies should continue to be taxed at a capital gains rate for any carried interest that is earned over the long term. The Association also intends to explore the possibility of a onetime tax incentive for buyers and holders of IPOs as well as increasing the holding rate for capital gains status to two or more years.

  4. Regulatory Review- From Sarbanes Oxley (SOX) to the Global Settlement to Regulation FD, small venture-backed companies have been faced with costly compliance and increasing obstacles to enter the public markets as a result of regulations intended for larger multi-national corporations. One size does not fit all.

But as the Grant Thornton study demonstrates, the demise of new listings and the de-listing of some existing listings began well before the onset of SOX. Here are some of the reasons cited:

  1. Online Brokerage- I know of very few people who use a traditional broker. The advent of online brokerage in the mid 90's resulted in the disintermediation of the retail salesman. The retail salesman depended on the availability of good research product to service his accounts. Execution only online trading resulted in the demise of many research departments at worst, or at best, a focus on institutional business in large cap names that traded a lot.

  2. Order Handling Rules- New order handling rules by which electronic crossing networks were required to link with a registered exchange or NASDAQ allowing exchange members of NASD members to execute ECN orders inside the public bid and offer. This reduced spreads which eroded the economics that enabled capital commitment, sales, and research support.

  3. Decimalization- This eroded spreads, which impacted the economics of brokerage firms that focused on small cap securities.

  4. Sarbanes Oxley- We have already described the compliance costs and their impact on smaller firms

  5. Global Research Settlement- The loss of investment banking-derived compensation for analysts led to a focus on trading of large cap names which contributed to declines in small cap stock coverage by analysts, IPOS, and new listings.

The Grant Thornton study also refers to the advent of “casino capitalism.” “Black Pools”- trade execution venues used by institutions to trade away from traditional exchanges contribute to diminished transparency. Short-term high frequency traders have replaced long-term quality investors for companies. Some 8000 hedge funds are responsible for 30% of trading volume, yet have little regulatory oversight.

It is stunning to look at how far the US is falling behind other countries in the expansion of global markets as far as listings.

Number of Listings

Number of Listings


% Change 1991-2008


Number of Listings


% Change






GDP Adjusted




GDP Adjusted



















Deutsche Borse









Borsa Italiana


















Hong Kong









The U.S. listed markets - unlike other developed markets - have been in steady decline, with no rebound, since 1997.
Source: Grant Thornton – A Wake-Up Call for America

From an investor standpoint, the microcap (below $250 million) segment of the market may have valuations that are significantly lower than private market valuations. They may look like extreme bargains on paper. But with a lack of research coverage, and little following, there are few catalysts to realize value. Small stocks need research, sales, and capital support to sustain reasonable valuations and liquidity.

The capital crisis of 2008 has only exacerbated this trend. According to Integrity Research a consulting firm that focuses on Wall Street research providers, 40% of sell-side research analysts lost their jobs in 2008. More than one quarter of sell-side reports for small cap names (25.7%) announced that a sell-side analyst was discontinuing coverage. The drop in liquidity, the drop in transparency, and the increased costs (management has to take over the burden of meeting with investors) results in higher costs. In a brief screening of Russell 2000 index companies, 600 had coverage by fewer than three analysts. Get outside the Russell 2000 and you will find the majority of companies have no coverage at all, even with market caps of over $100 million.

As you can see, there is much to be gained for the economy by improving the state of our capital markets. The notion of taking a business public has provided excitement and incentive for entrepreneurs to take entrepreneurial risk and has provided additional capital to small businesses to drive and exploit the economics of great new ideas and products.

Let's hope that some of the suggestions made in the Four Pillars are taken up. When issuers go public, capital is freed up for reinvestment in private enterprise. Once companies can secure public equity funding, it is easier to attract credit to fuel expansion further.

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