22/06/2016 - 12:23

ASX rules cut growth off at the base

22/06/2016 - 12:23


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The ASX has upset the WA corporate advisory market by proposing tighter listing requirements that will allegedly boost investor confidence by providing ‘enhanced guidance about the standards expected of an ASX-listed company’. 

The new ASX listing requirements could increase the barriers to innovation.

The ASX has upset the WA corporate advisory market by proposing tighter listing requirements that will allegedly boost investor confidence by providing ‘enhanced guidance about the standards expected of an ASX-listed company’. 

The implication is that some small IPOs are assuming an unwarranted respectability under the present rules, thereby exploiting unsuspecting unsophisticated investors.

On the other hand, critics of the changes claim the new rule changes will increase regulatory burden and thereby stifle innovation and productivity.

The critics are right and it’s important to understand why. Regulation itself is not an issue. Well-defined property rights – essential for smooth trading – generally require a substantial regulatory infrastructure to monitor and enforce. Deep and liquid free markets are far from free-for-alls.

The issue is the misplaced assumption that the governance of IPOs is principally about protecting shareholders against managerial opportunism. The reverse is true for IPOs involving innovative businesses.

The persons most deeply invested in a new entrepreneurial venture are the original owners-managers, whose ongoing investments of time, effort, and attention are essential to success. When an entrepreneur requires capital to develop an innovative project or initiate a high-risk venture such as minerals exploration, they face the risk of control being wrested from them by investors once the project is proved commercially viable and can be operated independently of them.

Researchers such as Stewart Myers of MIT, one of the most influential corporate finance theorists of modern times, point out that firms whose future value depends on human effort and risk taking by key managers go public to reduce the bargaining power of outside investors by diffusing their voting control.

For innovative entrepreneurs, IPOs solve the problem of obtaining development capital from outside investors while minimising their risk of losing control (and associated rewards) when a payoff is imminent.

This perspective makes sense of an otherwise pointlessly extravagant aspect of many IPOs –  the amounts raised are remarkably small given the substantial fixed and ongoing costs of a public listing. I’ve come across IPOs that raised less than $2 million and incurred well over $200,000 in direct listing expenses. One can easily envisage cheaper capital raising solutions, but it is difficult to think of ones that also effectively protect the return to the entrepreneurs’ human capital from being appropriated by investors once commercial success is assured.

There is a fashionable view that the micro-capitalisation IPO sector is populated by a disproportionate number of snake-oil peddlers who prey on the gullibility of naïve mum and dad investors. The reality is that small-time amateur punters are not the principal support base of the micro-cap sector; the sector relies far more on reasonably savvy investors with an appetite for the risk-reward tradeoff offered in this market.

As a class, retail investors lose far more in the big-ticket IPOs that would easily meet the ASX’s proposed new criteria than they do in the micro-cap IPOs that the ASX proposes to ban.

The ASX is a commercial, for-profit entity that quite reasonably expects to be allowed to run its business in a way that bests suits its interests. It is true that lifting standards to entry to a club improves the reputation of those already in the club. This is not a trivial consideration, particularly if the ASX believes this outcome may make it more attractive to a potential bidder and this is the desired objective. A long rump of small companies with highly volatile share prices may not be worth their listing fees if they put off potential bidders.

Nevertheless, the critics’ point that the new rule changes will increase the barriers to innovation and productivity has a sound basis.

Entrepreneurs with projects that fall below the ASX’s increased size thresholds will be barred from accessing one capital raising method that protected their interested and that demonstrably passed the market test of effectiveness.  A lot of seed capital is lost in the micro-cap market, but it’s from tiny acorns that might oaks grow. 

It’s a shame the ASX is proposing rule changes that will reduce the ground on which those seeds might thrive.



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