A Costly Mistake for Investors, US Capital Markets, and Growth: Evidence from the Exclusion of Dual-Class Stocks from Popular Indices

Abstract

On July 31, 2017, S&P Dow Jones Indices announced it would no longer add companies with multiple share classes to its flagship S&P 500 index. This decision was designed to protect index fund investors against unequal voting rights structures, but it has already lowered investors’ returns and will eventually reduce the dynamism of the US economy and capital markets.

The companies which have been rendered ineligible for index inclusion by the August 2017 decision significantly outperformed the S&P 500 index with only marginally higher volatility. Companies with dual-class shares, which are disproportionately ran by their founders, spend more on research and development and tend to grow faster than companies with one vote / one share structures. Over the past 20 years, a market cap-weighted composite of stocks with multiple share classes outperformed the Russell 3000 index by 38.8%.

The exclusion of dual class stocks from popular indices created costly side-effects for investors, capital markets, and society at large. Because the S&P 500 index is the benchmark for the most popular target-date funds, index funds, and ETFs, most Americans will have fewer assets in retirement than if they had invested in a total market fund. Most index fund investors will also miss the growth of innovative technology IPOs, which increasingly favor dual share class structures.

European and Asian exchanges have already amended their listing requirements to attract high-growth dual class stocks. S&P Dow Jones’ exclusion decision creates risk that could potentially push human, intellectual, and technological capital from the U.S. to strategic rivals.

Keywords: open-end investment management companies, index, sec, securities, s&p 500, index effect, index funds, ETFs, Growth, IPOs, Innovation, anomalies, 401-Ks, pensions

JEL Classification: J26, J32, G1, G11, G18, G2, G28, G23, G30, G38