State of Innovation

Patents and Innovation Economics

Jack Kemp: Anticipates My Book on SOX

In 2002 Jack Kemp wrote a prescient article on Sarbanes Oxley, entitled Criminalizing Corporate Behavior.  He correctly predicted,

 The greatest harm caused by Sarbanes-Oxley, though, will be to small firms that are pushed over the edge into oblivion or nascent public firms that are never born because of legal fees, accounting fees and other exorbitant costs piled on by the regulators!

This is exactly what has happened under SOX.  Since it was passed, the number of companies going public has dropped by over seventy percent.  The US is the only major country in the world with fewer public companies today than it had a decade ago.  The average cost of complying with SOX is over $4M per year per public company.  Sarbanes Oxley has failed to achieve any of its stated objectives.  Its proponents said it would increase investor confidence in the stock market, eliminated accounting fraud, and decrease the cost of raising capital.  I doubt that anyone would say they have more confidence in the stock market today than they had ten years ago.  It clearly did not stop accounting fraud or reduce the cost of raising capital.

Jack Kemp explained the media lies used to pass Sarbanes Oxley.

First, instances of corporate fraud and misconduct are quite rare, occurring in less than one-quarter of 1 percent of all companies. Second, contrary to how the media portrays corporate scandals, accounting fraud and sweetheart financial deals are not the result of too little government intervention into the marketplace and insufficient government oversight of an unfettered capitalist system.

Political opportunists exploit the media fiction to play the politics of envy and convince the public that stringent, far-reaching government action is required to stop this “epidemic” of corporate criminality. Rather than a dispassionate examination of the problem, Congress hurriedly enacts ill-advised legislation like the Sarbanes-Oxley Act, which essentially criminalizes accounting mistakes and poor management.

The political demagogues who have used the collapse of Enron, Global Crossing and a few other high-profile business failures as an excuse to criminalize corporate mistakes and poor management ignore the fact that over the last two years there have been more than 70 major bankruptcies in the communications industry, with at least 23 more expected. There have been more than $100 billion in corporate defaults and $7 trillion worth of losses in asset values. A few of these bankruptcies may have resulted from accounting shenanigans, and a few more may be explained by poor business judgment, but with bankruptcies running through an entire industry, and indeed, an entire sector of the economy, the evidence is clear that we confront a problem beyond telecom monopolies or greedy and shady corporate executives. Moreover, in 2001 more than 60 percent of all corporate defaults were outside the telecom sector.

By focusing on accounting scandals and criminalizing corporate mistakes, we divert attention away from the fact that in most cases it was excessive taxation, deflationary monetary policy, and overbearing regulatory policy that undermined companies and entire industries that otherwise were thriving and had a bright future. Political demagogues who play the politics of fear and envy confuse cause and effect when they blame catastrophic business failure on accounting gimmicks. In fact, it was usually the prospect of catastrophic business failure brought on by horrible government policy that created the pressures to cut corners, engage in accounting irregularities and commit outright fraud.

Congressman Kemp debunks the nonsense that the late 90s were a bubble created by the Federal Reserve.  He correctly points out that the Federal Reserve actual caused deflation, which resulted in the collapse of so many productive companies and the recession of 2000.  If you don’t believe me look at chart of the price of gold.  Its price declined from $400 per ounce in 1996 until 2001 when it hit a low of $271 and did not get back to $400 and ounce until 2004.  Unfortunately, the myth of a Federal Reserve created bubble in the late 1990s serves the agenda of both groups on the right and on the left.

Jack Kemp’s prescience on Sarbanes Oxley was amazing.  It’s too bad we did not listen to him and avoid all the pain of the last decade.

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August 11, 2012 Posted by | -Economics, Innovation, sarbanes oxley | , , , , , | Leave a comment

SOX: Shooting Ourselves in the Head

Hear is an excellent article, IT’S OFFICIAL: The IPO Market Is Crippled — And It’s Hurting Our Country  in the Business Insider, on the damage we have done to our capital markets.  The article starts out by showing that many of our biggest companies went public when they were very small.  At the time there were numerous underwriters and often the main inventors were individual investors.  For instance, the article explains:

As recently as 1986 Adobe had an IPO raising $6M.   None of these companies could have gone public in today’s environment even adjusting for inflation.  Virtually all the buyers at the time were individuals and there was a robust “over the counter” after market for young companies.

The article then explains that a company has to have a market valuation of $250M or more to be viable in today’s market.  My estimates are higher.  The article points out that a major reason for this change in the market is because of Sarbanes Oxley or SOX, which imposes onerous accounting requirements on companies.  The article then discusses some attempted solutions to this problem.  (I have suggested an alternative in my post Circumventing Sarbox and the IPO drought)

This has been a disaster for the venture capital industry.  As a result, VCs are looking for companies that can exit by M&A at earlier states.  VCs are also not investing in capital intensive companies.

Unfortunately, the article calls for half measures of curtailing but not eliminating SOX.  They suggest this course of action despite the fact that they do not single benefit provided by SOX.  The authors point out that:

The number of annualU.S.issuers listing IPOs onU.S.exchanges has declined since 1996 from 756 to a low of 36 in 2008 and 50 in 2009 and 120 last year according to Dealogic.  By contrast, there have been 346 Chinese issued IPOs listed onChinaexchanges in 2010 even though the U. S. GDP is 3x larger thanChina’s.

This is just one more example of how were are exporting our innovation and jobs overseas.

The insane thing about our securities laws is that in the U.S. you have to hire a lawyer to invest in a non-public company, but you can blow your money in Vegas, Atlantic City, etc freely.  One activity creates jobs and wealth and creates value.  The other is a less than zero sum that destroys wealth.

May 6, 2011 Posted by | Uncategorized | , , , , , , , | Leave a comment

More Evidence Sarbox is Hurting Our Economy

AWall Street Journal article discusses how a number of European companies are delisting from US stock exchanges.  The article points out that cost of complying with US law is outweighs any benefits derived by being listed on a US stock exchange.  It also explains that the cost of Sarbanes Oxley is increasing, despite earlier predictions that the cost of SOX would decline over time.  The new financial reform bill does nothing to address these problem.  In fact the present financial reform bill, at over 1400 pages, is going to make it more difficult for start-ups to raise money and more costly to go public in the US.

May 20, 2010 Posted by | -Economics, Innovation | , , , , , , | 1 Comment

Voices on the Net a Session with JJ

I had an excellent interview with JJ on a Session w/JJ on Voice on the net.  For the full interview click here.

April 28, 2010 Posted by | Innovation | , , , , , , , , | Leave a comment

Study Shows Strong IP Key to VC Back Company Success

An article in IAM (Intellectual Asset Management), reports (please read the full article) on a study on the relationship between the success of venture backed companies and their intellectual property portfolio.  The study states

Success in the venture capital industry is an exit: an acquisition of, or an initial public offering (IPO) by, a portfolio company. Analysis shows that across all sectors a significantly higher percentage of venture capital backed winners (companies that have been acquired or have gone public) have patent portfolios as opposed to losers (companies that are out of business).

Winners are many times more likely to hold intellectual property than losers. Although the presence of intellectual property portfolios is not perfectly correlated to success or failure, this indication alone should support executive and investor focus on the role of intellectual property in their decisions and actions.

While having intellectual property increases the probability of success, those who manage intellectual property will have an even higher probability of success. In certain sectors, such as healthcare, data demonstrates the value of higher quality portfolios. In other sectors, such as telecommunications or information technology, the effect is less prominent – although still clearly and demonstrably present.

IAM summarizes it this way:

In fact, according to the metrics applied by IP Vision, 86% of the VC-backed winners (ie, companies that are acquired or go to an IPO) they identified had strong as opposed to typical intellectual property assessments. In other words, while a healthy IP position may not guarantee that a start-up technology company is going to be successful, it is going to find it a whole lot harder to succeed if it does not have one. And ,crucially, it is not just ownership of IP that is important, it is understanding the IP that is key.

The article also explains

[A] healthy IP position may not guarantee that a start-up technology company is going to be successful, it is going to find it a whole lot harder to succeed if it does not have one. And,crucially, it is not just ownership of IP that is important, it is understanding the IP that is key.

If you want to learn how to create strong intellectual property portfolio see my post IP Strategy Document That Amazes Investors .

March 12, 2010 Posted by | Business Models, Innovation | , , , , , , , | Leave a comment

Grant Thorton on the IPO Crisis

Grant Thornton has prepare a paper entitled Market Structure is Causing the IPO Crisis .  Here is my understanding oftheir position.  The IPO market, especially for small IPOs started to decline before Sarbanes Oxley.  The Manning Rule and Order Handling Rule and decimalization decreased the margin for handling illiquid securities by brokerage houses.  Finally, online brokerage accounts have killed quality research and encouraged speculation.

The things that effect the IPO market are the cost of going public, the return for going public, the alternatives to going public, and the willingness of an investment bank to take you public (might be part of the cost).  While not stated explicitly in the report, they seem to imply that there is little incentive for investment banks to take small companies public or to create a market in their securities after the fact.  If true, I think this would contribute to the IPO downturn, but I do not think they have stated their case very strongly. Continue reading

January 22, 2010 Posted by | -Economics, -Legal, Innovation, Uncategorized | , , , , | Leave a comment

Sarbanes Oxley Update

According to the Brenner Banner article Where Have All the Public Companies Gone, since, 1997  “the number of listings (of public companies) has declined by almost 40%. This is especially remarkable as listings on other global stock exchanges have increased: the number of listed companies in Hong Kong has almost doubled.”  The article states that Grant Thornton says this is not due to Sarbanes Oxley, but the advent of online trading.  I do not find this credible.  Online trading should effect all the other stock exchange also.

January 18, 2010 Posted by | -Economics, Innovation | , , | 1 Comment

The Death of Venture Capital – Video

There has been a lot of discussion about whether the Venture Capital Model is dying. Some suggest that there is just too much money in venture capital other suggest that it is just a cyclical downturn. However, the evidence does not support this.  Click here to see the video

January 12, 2010 Posted by | -Economics, Innovation, Patents | , , , , , , , , , , , | Leave a comment