PLAYING IT SAFE
Creative entrepreneurs will choose to sell their ideas to bigger firms to avoid today’s regulatory quagmires
BY DOUG FRENCH

Doug French, associate editor of Liberty Watch: The Magazine is an executive vice president of a Nevada bank. He is the 2005 recipient of the Murray N. Rothbard Award from the Center for Libertarian Studies. Other stories by Doug French

While the financial press crows about the new highs being set by the Dow Jones Industrial Average, the politics of envy are in high gear. In this post-Enron age, the rule makers in Washington are doing their best to make headlines and win votes claiming to make investing safe again for the average dim-witted shareholder. 

But what these regulations really do is drive entrepreneurial talent away from public companies, reducing competition for large firms. Wealth is less widely distributed, corporate boards are made stupider, and petty bureaucrats are elevated to management positions, ultimately leaving shareholders with fewer and poorer performing investment choices. 

First there was the Sarbanes-Oxley Act of 2002, which provides for a thicket of self-monitoring rules. “The closer you look at Sarbanes-Oxley, the more you realize it is perfectly designed to crush new business creation,” writes Michael Malone in The Wall Street Journal online. The average cost of implementing Sarbanes-Oxley is $3.5 million, according to Malone. This isn’t a big deal for big companies, but a deal killer for start-ups.

The demonization of stock options also puts the kibosh on innovative start-up companies. The Financial Accounting Standards Board has implemented rules that force companies to expense the value of stock options that are used to attract talent from top to bottom in new and existing organizations. These regulators point to the Frank Quattrones of the corporate world as reason to implement the new rules. 

But while the regulators haven’t stopped executives from receiving options, they have very effectively made it too expensive to hand out options to all rank-and-file workers. The number of millionaires working at (or retired from) Microsoft is legendary. More average Joes and Janes were made wealthy through stock options than by any other means in recent years. As Malone points out: “The great stories are not about a Steve Jobs becoming a billionaire, but about his secretary becoming a millionaire.” 

Millions of man-hours are now being spent scouring option records at public companies in a witch-hunt to determine if executives received the benefit of beneficial option pricing. These “unproductive vultures of corporate democracy and securities regulation,” as Thomas G. Donlan of Barron’s so appropriately labels them, should cease and desist. They do nothing but harm to shareholders and the U.S. economy. 

The typical investor can buy shares of a company with a simple phone call or the click of a mouse. That same investor can sell the shares just as quickly. This passive investment requires nothing of the investor but money. The shareholder didn’t create anything, but owns “a ticket to ride on the ship that others have built, others navigate, others load, others steer,” Donlan explains. 

Now, the shareholder rights’ movement has spurred the Security and Exchange Commission (SEC) into implementing disclosures that will lay bare the pay of CEOs and other highly-compensated officers of publicly-traded companies. Union activists have agitated for these changes. The Home Depot’s recently resigned CEO Bob Nardelli is the AFL-CIO’s newest scapegoat. Nardelli was criticized for taking $210 million in compensation with him when he left the company and also making too much money while he was there, a time when the stock price didn’t perform well. However, Nardelli tripled the dividend during his tenure, and shareholder equity was nearly doubled. 

Now the incoming chairman of the House Financial Services Committee, Massachusetts Democrat Barney Frank, says he thinks shareholders should approve executive compensation plans. What business do shareholders have of weighing in on how much CEOs should be paid, just because they got a hot tip from their friend at the country club to buy a few shares? And the goons and bureaucrats who run the AFL-CIO and CALPERS (California’s state employee pension fund) clearly have political agendas that conflict with their fiduciary duties. 

The result of all of this is fewer companies going public and more public companies being bought out by private equity firms. During the dot.com boom, more than 450 high-tech companies went public in just two years. Through the first three quarters of 2006, the Wall Street Journal’s Malone points out that only 37 companies sold stock to the public, despite the buoyant stock market.

Ultimately, creative entrepreneurs will choose to sell their ideas to bigger firms to avoid the regulatory quagmire that going public now presents. In turn, the remaining large firms will be run by average-compensated, low-talent managers, who will avoid taking business risk, but instead will play it safe appeasing regulators and providing below-average returns to shareholders.