Today’s stock market is nearly transaction cost-free and overrun by trading schemes that can displace individual investors. While competition reduces trading costs for investors, it can have negative consequences for IPOs.
Tick size, or the price increment in which stock prices are quoted, can be a penny or less. Retail commissions are down to $5 a trade. These two factors have had a big impact on the ability to create high-quality sell-side research for smaller companies. The result is that the median market capitalization of companies covered by equity research analysts has steadily increased, and the number of investment banks acting as bookrunners, or lead managers, on small-cap IPOs has steadily decreased. In fact, many middle-market institutional sales desks have closed.
Many agree that a realignment of economic incentives to market participants in the public markets is needed. As such, the U.S. Securities and Exchange Commission is currently seeking comment on a tick size pilot program which would test how the stocks of small-cap companies — those with a market capitalization below $750 million — would respond if the tick size increased to a nickel. If enacted, this program could provide small-cap IPOs with improved access to capital, increased sell-side research and aftermarket trading, and hopefully, more investment banks and new investors interested in their IPOs.
Those who oppose the reforms, such as some large retail brokers, are afraid to draw the SEC’s attention to their trading practices. Others fear reforms would make trading in small-cap stocks more expensive for retail investors.
For retail investors – who comprise about 80 percent of the small stocks – this would bring institutional investors back into small-cap stocks, helping both increase stock prices, reduce volatility and provide much needed expansion capital.
To small-cap companies, this would mean access to the capital needed to grow their businesses and invest in innovation.
In this and our two prior posts, we have covered the effects of the Sarbanes-Oxley Act, the JOBS Act and Tick size on the IPO market, which we believe, have created a “one size fits all” U.S. stock market, where only big brands and big stocks can sustain adequate visibility with investors.
So, should the aspirational IPO wait for the government to fix everything or should it work within the current regulatory environment and establish a presence with Investors?