So if Sarbanes-Oxley didn't cause the IPO drought, what did?

Chances are you've gotten used to the old saw that Sarbanes-Oxley makes it cost prohibitive for small companies to go public on the U.S. markets. But I've always thought the languishing market for initial public offerings wasn't so simply explained. A recent study by David Weild and Edward Kim (no relation) of Grant Thornton, noted in IBD, has added some important nuance to the debate. They argue that the ills of the IPO market go further back than commonly thought. Specifically, the number of IPOs in a single year from 2000 to the present never exceeded the number of IPOs of any year in the 1990s, not even 1991, a recession year. 

The real lack of liquidity stems from the new stock trading "democratization" rules that led to decimalization and other spread-crimping changes. Recall that regulators were bent on making trading cheaper and breaking the tyranny of churned retail accounts. They have certainly done that, and there's been a big move toward fee-only retail accounts. In many ways, this movement has been a good thing.

But perhaps, there have also been some unintended consequences.

The fact is that the broker community used to have an incentive to hawk small-cap stocks and IPOs, they made huge commissions, which were hard to defend frankly. When those commissions evaporated so did a lot of the incentive to trade small cap stocks, especially new issues. At the institutional level, similar analysis holds. The idea of making markets just isn't that compelling unless you can make more money.

The whole small cap stock-support infrastructure was gutted. All of this makes sense, but you have to wonder what would now incent more liquidity in these stocks? Any ideas? I'd hate to think that the IPO drought is permanent. - Jim