Thoughts on S&P's decision to exclude non-voting stock from indexes
This week the company that maintains the S&P 500 index announced that they will start excluding companies from their indexes that issue multiple classes of shares. So newer issues of stock from companies like Snap Inc. (SNAP) - that do not have voting rights - will not be included in many popular indexes. This follows similar statements from FTSE Russell and MSCI earlier in the year. These announcements highlight a couple of key reminders for investors. First, there is a significant human element even with indexes that claim to be strictly rule-based. Second, although index providers and professionals agree that corporate governance matters, there is no consensus on how to encourage better practices while still maintaining indexes that represent public companies.
Human Element in Indexing
In the past, stock index providers used significantly different approaches in the construction (selection of stocks) and maintenance (addition/removal of stocks) of their published indexes. Over the past decade or two, index advisory boards and other stakeholders have made various choices that have made indexes like the Russell 1000 and S&P 500 much more similar than prior decades. For example, MSCI phased into using free-float adjusted indexes starting in 2001 (which reduces exposure for stock shares not freely traded in the markets) and S&P followed suit a few years later. Russell indexes have been float-adjusted since their inception.
Yet there are still differences that can affect the composition and performance of indexes that claim to represent the same market – such as US Large Cap stocks. For example, when determining whether to add or remove a stock from an index, S&P has a committee that typically meets monthly to make the determination; MSCI has a quarterly review; and Russell makes the change once a year in June.
One of the Vanguard Group’s initiatives, the “one-share, one-vote” idea, is generally a good one; however, there are many other issues involved in governance - illustrating that voting rights are only part of the picture. The makeup and responsibilities of the board of directors, incentive compensation, transparency, and management succession are just a few other matters governance touches on. While voting makes a big impact, its efficacy as a stand alone principle is questionable when large shareholders like Vanguard appear to rubber stamp votes on important concerns like CEO pay anyway.
Companies that are already in S&P indexes and have different share classes, like Alphabet (formerly Google), and Warren Buffett’s Berkshire Hathaway, will stay in the indexes. However, I wonder how accurately indexes like theirs will represent the overall market going forward. I tend to agree with many other professionals – including those from DFA – on the multiple share class issue: That as publicly available information, shareholder rights will be reflected in stock prices, and that a lack of voting rights alone does not warrant excluding a stock from investment.