Audit Analytics recently released a new report, Initial Public Offerings: Recent Trends in Corporate Governance Risks. Leveraging our extensive databases, the report provides a deeper look at the risks that initial public offerings offer to investors, regulators, and other financial statement users.
The costs of going public are often cited as a reason companies avoid a public offering. In response to these discussions, over the last decade, the SEC and Congress have focused on making public markets more attractive to companies by scaling some disclosure requirements and reducing regulatory burdens. In this report, we seek to examine IPOs in the context of reporting quality and determine whether reducing regulatory burden is beneficial to stakeholders.
The regulatory action is most pronounced and lasting for smaller entities, and interestingly, these entities appear to carry the highest risk.
This is seen when examining ineffective internal controls.
While overall, the percentage of IPOs with ineffective internal controls over financial reporting (ICFR) has risen in the last decade, this increase is most pronounced among small IPOs.
Developing effective ICFR can be costly, and many private companies must complete extensive work to establish an internal control system before conducting an IPO. While some companies can successfully install an effective control system or remediate existing material weaknesses in their controls due to the influx of capital from the IPO process, some cannot or do not.
Smaller IPOs have greater growth potential than larger IPOs. Devoting the influx of capital to ICFR in the years surrounding an IPO might divert resources from expanding operations, or exploring new market opportunities – areas that more established IPOs might have saturated.
This might explain why, despite seeing the largest improvement in ICFR controls following the IPO year, small IPOs exhibit the highest percentage of ineffective internal controls year-over-year.
Over the last decade, significant regulatory changes have been enacted to make participation in the public markets more attractive to private entities. Many of these actions have focused on reducing the barriers to entry that private entities face in the transition to listing on the public market.
IPOs present significant opportunities to market participants, but these opportunities come with significant governance risks. Having a clearer view of the risks IPOs present allows market participants and regulators to make more informed decisions about balancing growth opportunities with investor and investment protection, and ultimately helps the overall market operate more efficiently.
In this recently released report, we explore the costs of going public by measuring the effects on a company’s audit fees, examine how the infusion of new capital impacts a newly public company’s ability to continue as a going concern, and analyze the quality of financial controls and reporting as measured by ineffective internal controls and restatements.
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