Assumed to be a proxy for the large-cap market and tracked by over $13 trillion in investment assets, the S&P 500 Index enjoys a quasi-official status with the Securities and Exchange Commission. The Commission permits public companies and mutual funds to use the Index to benchmark their financial performance in regulatory filings. Companies that are part of the Index must do so.
That is what makes a 2017 decision by the administrators of the Index problematical. In the wake of the controversial IPO of Snap, which included the issuance of 200 million shares with no voting rights, S&P administrators decided to exclude all new dual-class companies from candidacy for inclusion in the S&P 500 Index. Oddly, the decision did not apply to existing S&P 500 member companies with dual-share structures, such as Meta, Alphabet, Visa, Berkshire Hathaway, and twenty-eight others.
As a result of the S&P’s decision, as of December 2021, fifty-five dual-class stocks have been disqualified from joining the S&P 500 Index. In a recent paper, Vincent Deluard of the Stone X Group, found that between July 2017 and 2021, a cap-weighted composite of the fifty-five exiled companies outperformed the S&P 500 by 15%. Including them in the Index would have added 70 basis points to the returns of the 500 Index. Deluard estimates that the loss to investors since the 2017 “exclusion decision” to the end of last year was approximately $93 billon.
The recent Nasdaq sell off has for now narrowed this divergence. Nevertheless, the trends are obvious. Deluard found that in 2021 and 2022, sixty-two percent of US IPOs opted for a multiple share structure. If that continues, it will steadily reduce the relevance of the Index as a measure of the large-cap market, while granting a wholly unmerited opportunity for companies and funds to claim they are “beating the market” in comparison to an increasingly obsolete index.
Made in the heat of the Snap controversy, the 2017 “exclusion decision” was an unfortunate foray by the S&P 500 Index into corporate governance matters. If the decision is not reversed, it may be time for investors, governance professionals, and, particularly, the Commission, to reconsider their assumptions about the role that the S&P 500 Index plays in benchmarking corporate and fund performance.