The JOBS Act and the Costs of Going Public

• Published date: 01 September 2017
• Date: 01 September 2017
• DOI: http://doi.org/10.1111/1475-679X.12172

DOI: 10.1111/1475-679X.12172

Journal of Accounting Research

Vol. 55 No. 4 September 2017

Printed in U.S.A.

The JOBS Act and the Costs

of Going Public

SUSAN CHAPLINSKY,

∗KATHLEEN WEISS HANLEY ,†

AND S. KATIE MOON

‡

Received 5 September 2014; accepted 19 February 2017

ABSTRACT

We examine the effects of Title I of the Jumpstart Our Business Startups Act

for a sample of 312 emerging growth companies (EGCs) that filed for an

initial public offering (IPO) from April 5, 2012 through April 30, 2015. We

find no reduction in the direct costs of issuance, accounting, legal, or under-

writing fees for EGC IPOs. Underpricing, an indirect cost of issuance that in-

creases an issuer’s cost of capital, is significantly higher for EGCs compared to

other IPOs. More importantly, greater underpricing is present only for larger

firms that are newly eligible for scaled disclosure under the Act. Overall, we

find little evidence that the Act in its first three years has reduced the measur-

able costs of going public. Although there are benefits of the Act that issuers

appear to value, they should be balanced against the higher costs of capital

that can occur after its enactment.

JEL codes: D82; G24; G32; G38; M41

Keywords: IPOs; JOBS Act; disclosure; regulation; underpricing

∗Darden Graduate School of Business, University of Virginia; †College of Business and

Economics, Lehigh University; ‡Leeds School of Business, University of Colorado.

Accepted by Douglas J. Skinner. We thank two anonymous referees, Leah Baer, Scott

Bauguess, Phil Berger, Alex Butler, Laura Field, Rachita Gullapali, Shan He, Jonathan Jona,

Jay Ritter and the seminar and conference participants at Columbia University, Lehigh Uni-

versity, Northeastern University, the Securities and Exchange Commission, the University of

Melbourne, the University of Nebraska–Lincoln, the University of New South Wales, the 2015

Colorado Summer Accounting Conference, and the 2015 Entrepreneurial Finance and In-

novation Conference for helpful comments. Alexandra Phillips and Ravali Paidipati pro-

vided valuable research assistance. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

795

Copyright C, University of Chicago on behalf of the Accounting Research Center,2017

796 S.CHAPLINSKY,K.W.HANLEY,AND S.K.MOON

1. Introduction

In April 2012, the Jumpstart Our Business Startups (JOBS) Act was signed

into law with the goal of reducing the regulatory burden of small firms

seeking to raise capital in the United States. Title I of the law addresses the

initial public offering (IPO) process and attempts to reverse a decade-long

decline in the number of IPOs, especially smaller IPOs, in the United States

(Gao, Ritter, and Zhu [2013]).1As described in the IPO Task Force Report

[2011], an influential study that served as a blueprint for the Act, “This

dearth of emerging growth IPOs and the diversion of global capital away

from the U.S. markets—once the international destination of choice—have

stagnated American job growth and threaten to undermine U.S. economic

primacy for decades to come.”

Although several reasons have been advanced to explain the decline in

small IPOs (e.g., Weild and Kim [2010], Gao, Ritter, and Zhu [2013]), the

IPO Task Force Report attributed it primarily to the cumulative effects of

a “regulatory cascade” that followed the tech bubble collapse in 2000, and

to changing market practices that eroded investor interest and the trading

environment for small firms. These effects are believed to have increased

the costs of going public without commensurately increasing the benefits of

being a public company. As articulated by Keating [2012, p. 8], “Sarbanes-

Oxley and other regulations have imposed unacceptably high compliance

costs on emerging growth companies seeking to go the IPO route in terms

of both dollars spent and time wasted.”

The JOBS Act (the Act) seeks to remedy these burdens by reducing the

required disclosure and compliance obligations during the IPO process

and the first five years of being a public company. Its passage was viewed

by supporters and critics alike as the most significant relaxation of IPO and

public reporting requirements in recent memory.2Title I of the Act permits

“emerging growth companies” (EGCs)—generally, firms with less than $1

billion in revenues in their most recently completed fiscal year—to phase

in the public reporting and compliance obligations (“public on-ramp provi-

sions”). Among the provisions directly related to the costs of preparing for

an IPO, EGCs can choose to solicit pre-filing interest from investors about

an offer (test the waters), confidentially file their registration statement

with the U.S. Securities and Exchange Commission (SEC), and scale back

1In addition to Title I, the JOBS Act contains several other sections that, for example,

increases the number of shareholders from 500 to 2,000 before public reporting requirements

become effective and that authorizes “crowd funding.”

2See “Congress Passes the JOBS Act,” Schiff Hardin, nationallawreview.com, March 31,

2012. Supporters of the law believed it would reduce burdensome regulation and modern-

ize security regulations. Critics, such as The New York Times, charged that it would turn back

years of security legislation designed to protect investor interests, describing it as “a terrible

package of bills that would undo essential investor protections, reduce market transparency

and distort the efficient allocation of capital.’’ (“They Have Very Short Memories,” The New

Yor k Ti me s editorial, March 10, 2012).

THE JOBS ACT AND THE COSTS OF GOING PUBLIC 797

financial and executive compensation disclosure in their IPO filing. In ad-

dition, after the IPO, EGCs can continue to report reduced executive com-

pensation disclosure, and delay the onset of Sarbanes-Oxley (SOX) and

the Dodd-Frank Act governance requirements until the fifth anniversary of

going public. Thus, the Act intends to reduce the costs of preparing regis-

tration materials and of meeting the ongoing compliance requirements of

being a public company.

Both the disclosure and compliance provisions of the Act potentially re-

duce the scope and credibility of information disclosed to investors at the

time of the IPO and for as long as the firm remains an EGC.3In this study,

we investigate the potential effects of reduced disclosure under the Act on

the direct and indirect costs of going public. If the Act is successful in re-

ducing the costs of preparing to go public, it should result in lower direct

costs of issue, such as accounting, legal and underwriting fees. Information

at the time of the IPO, however, is believed to be particularly valuable to in-

vestors in reducing information asymmetry (Benveniste and Spindt [1989],

Sherman and Titman [2002], Leone, Rock, and Willenborg [2007], Hanley

and Hoberg [2010]). If, at the same time, reduced disclosure at the time of

the IPO and thereafter results in a loss of transparency for investors, the Act

could be associated with an unintended increase in indirect costs, e.g. the

firm’s cost of capital, as measured by the underpricing of the firm’s shares

on the first trading day.

Our work is related to an extensive literature on the effects of dis-

closure on capital costs. Studies of regulations that enhance disclosure

generally find benefits in terms of lower costs of capital or higher eq-

uity values when disclosure results in a greater transparency of informa-

tion (see Verrecchia [2001], Dye [2001], and Healy and Palepu [2001]

for a review of the literature). Consistent with this, Bushee and Leuz

[2005] and Greenstone, Oyer, and Vissing–Jorgensen [2006] find that

positive stock returns are associated with the imposition of required fi-

nancial disclosure on over-the-counter (OTC) traded companies. More

recently, the Securities Offering Reform of 2005 afforded well-known sea-

soned issuers greater latitude in communicating with investors in advance

of an offer.4Shroff et al. [2013] and Clinton, White, and Woidtke [2014]

document a significant increase in pre-offering disclosures after the reform

3Henceforth, we refer to both types of provisions, disclosure and compliance, collectively as

“reduced (or scaled) disclosure.” For the compliance provisions, the delay in SOX governance

requirements reduces the external vetting of the firm’s financial reporting procedures, which

may, in turn, reduce investors’ confidence in the firm’s financial disclosures. Also, the “say

on pay” requirement is intended to encourage both shareholders and boards of directors to

become better informed and more involved in evaluating the firm’s executive compensation

practices.

4A well-known seasoned issuer or WKSI is a firm that has an outstanding minimum $700

million in worldwide market value of voting and nonvoting equity held by nonaffiliates or has

issued in the last three years at least $1 billion aggregate amount of nonconvertible securities

other than common equity, in primary offerings for cash, not exchange.