WeWork Reveals the Downside of Sarbanes-Oxley

(Bloomberg Opinion) -- Big pieces of economic legislation tend to unleash the full power of unintended consequences. Consider Sarbanes-Oxley, the bipartisan law passed in 2002 in the wake of the accounting scandals at Enron Corp. and WorldCom Inc. It did what it was intended to do, which was ensure companies gave accurate accounts of their finances. But it has also led to debacles such as WeWork.

The simple idea behind Sarbanes-Oxley is that public companies require an extra layer of accounting checks that private ones do not in order to protect average investors, who are exposed to all the downside caused by managements who reaped an asymmetric payoff by going public. Because Sarbanes-Oxley made the initial public offering process difficult and expensive, companies responded by staying private longer.

Some research suggests Sarbanes-Oxley has had no bearing on the number of companies going public or the valuation at which they go public, but I have a tough time taking that seriously. Despite the stock market reaching record highs, last year only saw 190 IPOs in the U.S. raising $40.2 billion, according to data compiled by Bloomberg. In 2000, there were 306 that raised $53.5 billion. Also, the number of publicly traded companies has shrunk from more than 8,000 in 1996 to less than 4,000 currently.

I was an equities trader at the time Sarbanes-Oxley became law, and the unintended consequences were not so hard to predict. It was all everyone on the trading floor talked about – and it’s what we are seeing now. The result of companies waiting longer to go public is that when they do, valuations are much higher. The sole purpose of an  IPO has become a liquidity event for the founders and early investors, with venture capital firms have ended up capturing most of the growth.

What’s left is a highly unappealing investment for the public. In this way, Sarbanes-Oxley actually exacerbated wealth inequality. You could have bought Amazon.com Inc. at a $2 billion valuation in 1997 and rode it all the way up to $1 trillion. Uber Technologies Inc. went public in May as a fully-valued stock -- and then some. Its shares are down about 35% from the IPO.

As successful as it is, Amazon was subjected to the quarterly dissection of its results very early on in its public life. People -myself included - moaned quite a bit about its amazing ability to generate losses, but ultimately the stock market decided to take a long view. There is no discipline imposed when a private company has money shoveled into it at successively higher valuations.

Being public isn’t fun, with the regimen of quarterly earnings, having to deal with research analysts, the obligatory deference to Wall Street and the activists breathing down your neck. It’s much more fun to be private and ultimately sell shares at the highs to anyone who is gullible enough to buy them.

As for WeWork, no company surpasses it in terms of excess, bizarre behavior, related-party transactions and conflicts of interest – the type of creature generally associated with a market top. But if it went public at, say, a $2 billion valuation instead of something in excess of $50 billion, it is likely that none of that craziness would have happened because WeWork would have been subject to the quarterly earnings scrutiny very early on.

So yes, in a way, Sarbanes-Oxley is how we got WeWork as well as many other intractable business models. It also is a big reason for rising wealth inequality. It should be repealed, or at least, the expensive parts of it, because the current system doesn’t protect investors, it fleeces them. I could not have created a more unfair system if I tried.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of "Street Freak" and "All the Evil of This World." He may have a stake in the areas he writes about.

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