Friday, September 17, 2010

Casino Capitalism

Need a job in this tough economy? Maybe you need to do an IPO, an Initial Public Offering of stock in a company. A recent study by accounting and consulting firm Grant Thornton details a fairly clear link between jobs growth and a healthy IPO market. Since 2001, the U.S. equity market has averaged only 126 IPOs per year.

I wrote in the June 18, 2010 post “ETF Elephant in the Room” about potential for considerable disintermediation of capital away from direct investing in companies to indirect investment through Exchange Traded Funds. My conclusion was more or less intuitive. It is not possible for the number of new ETFs that are in the planning stages to sell shares without taking capital away from operating companies.

The link between IPOs and job creation may not be so obvious. However, the Grant Thornton line of reasoning is also intuitive. Smaller businesses - even ones large enough to elbow their way into the public company scene - are by far and large responsible for job creation. When such companies do not have access to capital, it stands to reason that employment will not expand.

The Grant Thornton bean counters also conclude that our capital markets have become dysfunctional through uncoordinated regulatory changes that have not kept pace with technological innovations. The investment-centric capital market we knew in the before the 1980s has been replaced by a high-frequency trading model that fails to allocate capital, instead rewarding successful gaming strategies with little or no link to fundamental corporate performance. They termed it Casino Capitalism.

Some investors might point to Sarbanes-Oxley as the root of the public company difficulties. However, the Grant Thornton folks reached further back in history to the Manning and Order Handling Rule passed in 1996. The group concluded that this sweeping set of changes coupled with the penetration of on-line brokerage in the 1990s and decimalization of trading in 2005, led to the demise of the investment banking bracket that staged and supported small company initial public offerings - the very type of company that would ultimately create new jobs. The lack of an IPO market as an exit strategy has also eroded the ability of venture capital to support some of the most risky start-ups - also would-be employers.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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