Corporate Governance by Index Exclusion

The Harvard Law School Forum on Corporate Governance and Financial Regulation 2019-06-12

Posted by Scott Hirst (Boston University) and Kobi Kastiel (Tel Aviv University), on Wednesday, June 12, 2019
Editor's Note: Scott Hirst is an Associate Professor of Law at the Boston University School of Law, and Director of Institutional Investor Research at the Harvard Law School Program on Corporate Governance. Kobi Kastiel is Assistant Professor of Law at Tel Aviv University, and a Research Fellow at the Harvard Law School Program on Corporate Governance. This post is based on their recent article, forthcoming in the Boston University Law Review. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here), and The Perils of Small-Minority Controllers (discussed on the Forum here), both by Lucian Bebchuk and Kobi Kastiel, and the keynote presentation on The Lifecycle Theory of Dual-Class Structures.

Investors have long been unhappy with certain governance arrangements adopted by companies undertaking IPOs, such as dual-class voting structures. Traditional sources of corporate governance rules—the Securities and Exchange Commission, state law, and exchange listing rules—do not constrain these arrangements. As a result, investors have turned to a new source of governance rules: index providers.

Our recent article, forthcoming in the Boston University Law Review, provides a comprehensive analysis of index exclusion rules, their likely effects on insider decision-making, and their ability to serve as investors’ new gatekeepers. We show that efforts to portray index providers as the new sheriffs of the U.S. capital markets are overstated. Index providers face complex and conflicting interests, which make them reluctant regulators, at best. This reluctance to regulate is clearly reflected in the dual-class exclusion rules they adopted. We also analyze, theoretically and empirically, the efficacy of index exclusions in preventing disfavored arrangements and show that their efficacy is likely to be limited, but not zero (as some scholars argue). We conclude by examining the lessons from this important experiment and the way forward for corporate governance.

A more detailed overview of our analysis follows:

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