Can Regulation Save the Junior Equity Market? Lessons from Canada's CPC Program
"Exploring how effective regulation can revitalize junior equity markets and foster small business growth."
The health of a nation's economy heavily depends on the existence of a vibrant junior equity market. However, in recent years, the number of initial public offerings (IPOs) in the United States, particularly those under US$50 million, has significantly decreased. This decline has made it harder for smaller companies to secure the necessary equity capital, which has slowed their growth and resulted in millions of lost jobs, according to a study by Weild and Kim (2009).
Several factors contribute to this downturn, including changes in market structure, excessive regulation, insufficient analyst coverage for junior companies, and a shift in the economy that has reduced the profitability of smaller firms (see Jegadeesh and Kim 2010; Weild and Kim 2010; Gao, Ritter, and Zhu 2013). Regardless of the cause, there is a growing consensus that the current U.S. regulatory environment is not conducive to financing for nascent companies.
The United States is not alone in facing challenges in the public financing of junior companies. Since the 1980s, European countries have struggled to develop thriving junior equity markets, with limited success. While these markets initially attracted new listings, they eventually suffered from illiquidity in both primary and secondary markets, as noted by Rasch (1994). These challenges underscore the need for effective regulatory frameworks that balance investor protection with the needs of growing companies.
How Canada's CPC Program Revitalized Its Junior Equity Market
To determine whether it's possible to develop a regulatory framework that can create or maintain a viable junior equity market, this study examines Canada's Capital Pool Company (CPC) program, a regulated blind pool program. Canada initiated this program in response to junior equity market fraud in a blind pool offering in 1986.
- Increased Completion Rates: More than 93.6% of CPCs complete their qualifying transaction (QT) and become regularly listed companies.
- Long-Term Viability: 72.2% complete their QT and remain listed for five years following this transaction or are delisted due to amalgamation, takeover, or graduation to a more senior exchange.
- Improved Underwriter Quality: An increasing percentage of higher-quality underwriters are willing to take CPCs public, especially since the program expanded to Canada's major provinces.
- Reduced Fraud Incidence: The adoption of the CPC regulations significantly lowered the incidence of fraud in the Canadian junior equity market.
Key Takeaways: Balancing Growth and Investor Protection
The success of the CPC program demonstrates that it is indeed possible to develop an effective regulatory regime for listing blind pool companies, which protects investors and enables small companies to raise capital and grow their businesses. Future studies should explore these methods to provide more insight into this increasingly important research area. It remains uncertain whether the CPC regulations can be adopted in other countries, but when the program was initially restricted to investors in Alberta, many experts questioned its broader applicability. Within 16 years, the program expanded across Canada and attracted international listings, illustrating its adaptability and success.