S&P Global (SPGI 1.47%) made headlines when it decided that multiclass shares were unfit for its most prestigious indexes, a decision that increasingly appears to be aimed at making an example of Snap (SNAP 2.00%), which employs a multiclass share structure that concentrates corporate voting power in the hands of its insiders. While I consider myself an advocate for shareholder rights and the importance of good corporate governance, I can't help but feel that S&P Global's decision is somewhat arbitrary and inconsistent with previous changes to its indices. Here are three reasons I'm on Snap's side, despite its dual-class share structure.
1. Multiclass share structures are neither new nor rare
While S&P Global may be making an example of Snap, the dual-class share structure it employs isn't exactly rare among publicly traded companies. In fact, roughly 10% of publicly traded companies have a multiclass share structure that gives one share class more voting power than another.
The list of multiclass stocks includes high-performing companies like Berkshire Hathaway, Nike, Workday, Facebook, among countless others. Of course, it also includes some losers, including Snap and Blue Apron, which have performed poorly since their public debuts.
Realistically, though, an index and the funds that track it aren't supposed to pick winners or losers -- they're supposed to simply own a broad swath of stocks.
Image source: Snap.
2. Inconsistencies in the index
Drawing the line at Snap seems arbitrary. If dual-class share structures are a bad thing, it makes sense to me that companies that employ such a structure should be thrown out of the indices in wholesale, rather than enforcing the rules on new additions. Previous changes to S&P indices haven't allowed for grandfathering companies that have already joined an index.
When S&P Global made the decision to disallow business development companies (BDCs) from its leading indices in 2014, it didn't grandfather in the companies that were already in the index. Instead, it kicked them out immediately, and barred them from inclusion in the future.
The decision to disallow business development companies from its indexes was, in my view, driven by the marketing department more than anything else. An obscure SEC rule requires BDCs' expenses to be reported in an index fund's expense ratio, inflating their reported fees and making them less attractive for investors who only do modest due diligence into a fund's true management expense ratio. Of course, grandfathering dual-class companies into index funds has no such disadvantage when it comes to reported expense ratios, so it's easier for S&P Global simply to allow companies that are already in its indexes to stay in, even if its inconsistent with how it decides which companies are allowed in, and which aren't.
If Snap and Facebook both decided to employ dual-class share structures before S&P Global decided to disallow them from its most well-known indices, it isn't clear to me why only one company is allowed in.
3. Index funds rarely vote against corporate management, anyway
It's not inconceivable that, at some point, index funds will control roughly half of all stock assets under management. Already, the big three index fund giants -- BlackRock, Vanguard, and State Street -- own more than 13% of many S&P 500 companies' shares, and thus exert 13% of the voting control at most S&P 500 companies.
As assets continue to flow into index funds, it's very possible that the three largest index fund managers end up with control over most corporate governance matters. With 13% of the vote in many S&P 500 components, they are already the most influential voting block on issues ranging from board-member selection to auditor ratification.
If S&P Global wants to make a big deal of corporate governance, it may want to look at the fund managers who pay it millions of dollars in fees each year to license its indices. A study published in 2017 reveals that the big three index fund managers vote alongside company management on more than 90% of shareholder votes, and they are even more likely to vote with management when activist investors come along.
A first telling observation is that only a small fraction of the opposition of the Big Three against management occurs in proposals where management recommends voting against (BlackRock 6 percent; Vanguard 2 percent; State Street 5 per cent). Proposals that management recommends to oppose are typically issues put on the agenda by activist shareholders. This implies that the Big Three ally with management against such shareholder proposals -- in fact, the ability to repel unwelcome activist investors may be an important part of the potential influence of the Big Three over management
It's probable that there may come a day when companies face a difficult choice: Employ a multiclass structure to give 100% voting control to insiders, or list with a single share class and thus entrust the "big three" index fund managers with de facto voting control.
While giving a handful of insiders complete control over corporate governance matters may be a bad thing, I'm not exactly sure that giving control to just three asset managers is really that much better.
