SOX and private equity

There has been much talk about the huge Kinder Morgan management buyout. Today’s WSJ says, “let's hope this event isn't lost on Congress, whose regulatory fervor is one reason many companies are fleeing the U.S. public capital markets.” And yes, this is a problem.

The WSJ notes that there are now 250 buyout firms controlling $800 billion in capital, up $175 billion in new money last year, taking private firms like Toys "R" Us and Hertz.

I've often noted here (see my Sarbanes-Oxley archive) the SOX archive), and discussed in my book with Henry Butler, The Sarbanes-Oxley Debacle. SOX's role in driving firms from the US public markets -- not just small and foreign firms, but now big firms. Whatever the benefits to the firms from escaping these regulatory costs, corporate executives must see some advantages of removing themselves as potential targets of plaintiffs' lawyers, federal regulators and prosecutors.

The WSJ also asks today whether it really matters that more firms are going private. The answer they give is that

it's troubling that the current trend is being driven as much by regulatory excess as market opportunity. U.S. capital markets have long been a national strength and a source of wealth creation. To the extent that broad shareholder ownership has also spread the wealth, it has been good for social mobility and boosted public support for free markets.

Sounds familiar. As Butler and I say in our book:

The liquidity, risk-bearing and informational advantages of public ownership potentially make them more valuable than they would be if they were closely held. To be sure, this does not mean that all firms should be public, but it does suggest it may be socially costly to, in effect, put a tax on public ownership.

See also my blog post on this last January.

One specific cost of too many private firms is that buyouts create a lot of debt.  This is good to the extent that it forces managers to be careful with cash. But debt also carries bankruptcy risk if things go south, and bankruptcy is expensive.

Moreover, I'm confident that we'll see that some excesses accompanied the boom in private equity, as they do every boom. In other words, there is some Enron of private equity waiting to happen.

When the scandal breaks, the politicians and the journalists will have their usual fun decrying the horrors of private equity.  Watch for the Private Equity Reform Act of 2007.  Everybody by then will have forgotten how all this was created by SOX, the child of the last scandal.