American Business Goes Galt 2

Overregulation is killing the public company.

The first article in this series explained two fundamental ideas which power our economy.  Limited-liability corporations mean that people can invest money without worrying that the business will mess up and cost them every penny they have, as with a partnership.  Partnerships have to be paranoid and profoundly careful - the partners split the profits when times are good, but they're individually and collectively liable for all debts if the business gets in trouble.

The risk of being totally wiped out makes it hard for a business to find enough partners to grow big enough to operate internationally.  Limited liability made it possible to find a great many more investors.

Stock exchanges are the other innovation that powers our economy.  An exchange allows investors a convenient place to buy and sell stock in limited liability companies.  This makes it possible for businesses to readily raise capital to expand.  Investors can easily trade in and out of businesses as their financial circumstances dictate.

All these activities must be subject to regulation, of course.  Big businesses are so complex that fraud would be too easy without strict requirements for auditing the books and reporting the results.  Regulation is a constant battle between the regulatory agencies who seek more power, politicians who seek opportunities to extract campaign contributions in return for getting regulators to back off, accountants and lawyers who want businesses to be required to pay them to shuffle more paper, and businesses who don't want government looking over their shoulders.

Every financial crisis results in more laws which are designed to keep it from happening again.

The Enron bankruptcy, for example produced mark-to-market and the Sarbanes-Oxley law.  These changes hugely increased accounting and reporting requirements.  These wonderful new rules also failed to help auditors catch Bernie Madoff or a host of other crooks.

The crash of 2008 produced the Dodd-Frank law, whose complexities are still being digested.  It's too early to know what the economic costs of Dodd-Frank will be, but based on the known costs of the changes that came out of Enron, the results won't be good for job creation.

Unintended Consequences

Regulatory changes generally have unintended consequences.  Mark-to-market was a contributing factor in AIG being given billions of dollars of taxpayer money.  When the mortgage market collapsed, nobody would buy mortgages from AIG.  Since there was no market, their value was zero by mark to market rules.  This was a "significant change."

AIG had to follow the reporting rules and say that they'd had a huge loss on paper - even though they hadn't actually lost any real money.  Everyone assumed that AIG was going to go under, so the government bailed them out.

The money didn't go to AIG itself; it was used to pay off businesses such as Goldman Sachs which had lent money to AIG or bought mortgages from them, including a great many foreign banks that American taxpayers don't even care about as much as they might American ones.  Goldman and others believed, partly on the basis of mark to market, that most of the mortgages AIG had written were no good.  Having bought those mortgages from AIG, the banks wanted the government to buy back their exposure.

Creditors usually lose money in such bailouts, but Goldman's political clout was so great that they got 100 cents on the dollar.  In the end, the bailout turned out not to be needed - AIGs mortgages were sound and kept being paid.  The great AIG panic was all for nothing - it was an artifact of regulation.

In addition to mark-to-market, the Enron bankruptcy also brought us Sarbanes-Oxley which added another layer of complexity to the reporting requirements of public companies.  I've a friend who climbs poles and fixes wires for our electric utility.  Before the new accounting requirements were put in place, he reported the number of bundles of wire ties he used.  After their accountants were required to report in more detail, he and his colleagues had to report on the use of individual wire ties, which cost a fraction of a cent each.

Is all the extra detail worth the cost to the utilities' customers?  Probably not - but apparently it's the law, or at least the way the regulators have interpreted the law.

Driving Businesses From The Public Stage

Sarbanes-Oxley has been in place long enough that we're beginning to see results.  The Economist reports:

Mark Zuckerberg, Facebook’s young founder, resisted going public for as long as he could, not least because so many heads of listed companies advised him to. He is taking the plunge only because American law requires any firm with more than a certain number of shareholders to publish quarterly accounts just as if it were listed. Like Google before it, Facebook has structured itself more like a private firm than a public one: Mr Zuckerberg will keep most of the voting rights, for example.

The number of public companies has fallen dramatically over the past decade—by 38% in America since 1997 and 48% in Britain. The number of initial public offerings (IPOs) in America has declined from an average of 311 a year in 1980-2000 to 99 a year in 2001-11. Small companies, those with annual sales of less than $50m before their IPOs—have been hardest hit. In 1980-2000 an average of 165 small companies undertook IPOs in America each year. In 2001-09 that number fell to 30. Facebook will probably give the IPO market a temporary boost—several other companies are queuing up to follow its lead—but they will do little to offset the long-term decline.  [emphasis added]

History shows that the highest rate of job creation comes after smallish new companies go public.  When companies put off raising money in a new IPO or sell out to bigger companies instead of taking on the burdens of being public, job growth suffers.  As one business writer put it, "Every time an engineer joins Google, a startup dies."

Another Economist article explains how our economy is being suffocated by regulation:

Many lawmakers seem to believe that they can lay down rules to govern every eventuality. Examples range from the merely annoying (eg, a proposed code for nurseries in Colorado that specifies how many crayons each box must contain) to the delusional (eg, the conceit of Dodd-Frank that you can anticipate and ban every nasty trick financiers will dream up in the future).

Sarbanes-Oxley, a law aimed at preventing Enron-style frauds, has made it so difficult to list shares on an American stockmarket that firms increasingly look elsewhere or stay private. America’s share of initial public offerings fell from 67% in 2002 (when Sarbox passed) to 16% last year, despite some benign tweaks to the law. A study for the Small Business Administration, a government body, found that regulations in general add $10,585 in costs per employee. It’s a wonder the jobless rate isn’t even higher than it is.

The Death of Public Companies

What's even more disturbing than new companies not being formed is that established public companies are disappearing.  The burdens of being public have become so costly that many firms are finding it profitable to buy back all their stock, de-list the companies from the stock exchanges, and take them private.

This makes our economy a lot less transparent - private companies file fewer reports than public firms.  It's harder for investors to know what's going on and easier to engage in quiet lobbying.  Private companies can't raise capital by selling shares, but unregulated markets are springing up to match private firms with investors.

Once again, our lawmakers have demonstrated that wealthy people can rearrange their affairs to get around whatever barriers government puts in their path.  It's the little guy who loses out when a company bails out of the New York Stock Exchange, where anyone can buy shares, and instead ownership privately to the well-heeled members of the country club.

We don't yet know what damage Dodd-Frank will do, but anything that makes the banking system less responsive to new circumstances is bad for growth.

The bottom line is that the more government taxes or regulates an activity, the less of that activity occurs.  Increasingly severe burdens have been placed on investment and job creation; businessmen have responded by moving jobs and money offshore and by taking companies private.

Ayn Rand envisioned a world where individual genius businessmen could collapse an economy by "going Galt" and simply declining to do what they do best.  In reality, the world economy isn't based on a handful of geniuses but rather on the collective wisdom and investments of millions of players large and small.  It turns out the basic principle of "going Galt" still works, though - not as individuals, but as companies, which are pulling out of the American game in disgust.

The next article in this series discusses a company which didn't pull out.  They went the IPO route reluctantly because they more or less had to - but investors won't benefit.  Another triumph for regulation!

Will Offensicht is a staff writer for and an internationally published author by a different name.  Read other articles by Will Offensicht or other articles on Business.
Reader Comments

Don't you mean Ayn Rand, not Any Rand?

May 23, 2012 9:40 PM

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May 23, 2012 9:59 PM

Excellent history lesson.It's a shame that capitalism and how it works is not taught in the schools and universities. If it were we would not have to worry about teachers unions and liberal university professors. Could it be that that is the reason why our chidren are so ignorant of our economic system? Perhaps Romney should consider this as a plank in his platform.

May 26, 2012 2:42 PM
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