Anil K. Kashyap is Stevens Distinguished Service Professor of Economics and Finance at the University of Chicago; Natalia Kovrijnykh is Associate Professor of Economics at Arizona State University; Jian Li is Assistant Professor of Finance at Columbia Business School; and Anna Pavlova is Professor of Finance at London Business School. This post is based on their recent paper.
Since the 1980s economists have known that when stocks are added to the S&P 500 index their prices rise. There are now many theories that aim to explain this fact. Yet almost all of the related research has focused on how indices influence asset prices, with much less attention paid to other possible implications. In The Benchmark Inclusion Subsidy, we look at the repercussions of index inclusion for corporate decisions.
Asset management practices affect corporate decisions
Most fund managers’ performance is judged against benchmarks. Because the asset management industry is estimated to control more than $100 trillion worldwide, this means that there is a huge pool of money where the people making investment decisions have strong incentives to favor buying stocks inside the index instead ones that are outside it. We construct a model to analyse the consequences of these incentives.
The model predicts that firms that are part of a benchmark have a different cost of capital than similar firms outside the benchmark. When a firm adds risky cash flows, say, because of an acquisition or by investing in a new project, the increase in the shareholder value is larger if the firm is inside the benchmark. Hence, a firm in the benchmark could accept a project that an otherwise identical non-benchmark firm would not. This runs contrary to standard corporate finance theory. In the special case where there are no fund managers—as is standard in corporate finance—investors always value equivalent cash flows of benchmark and non-benchmark firms in the same way.
Keynote Address by Commissioner Lee on Climate, ESG, and the Board of Directors
More from: Allison Herren Lee, U.S. Securities and Exchange Commission
Allison Herren Lee is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent Keynote Address at the 2021 Society for Corporate Governance National Conference. The views expressed in the post are those of Commissioner Lee, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.
“You Cannot Direct the Wind, But You Can Adjust Your Sails” [1]
Good morning and thank you for the invitation to speak today at the Society for Corporate Governance 2021 National Conference. I’m impressed with your full and informative agenda over the next few days, and I appreciate the important work you do in supporting company boards and executives.
I also appreciate your engagement in the SEC’s policymaking process, including your recent letter in response to the request for public input on climate change disclosures. In fact, we’ve received thousands of comments in response to that request, but we hardly need that statistic to understand that the subject of climate risk and our financial markets, and ESG more broadly, is top of mind in board rooms and c-suites around the globe.
Increasingly, boards of directors are called upon to navigate the challenges presented by climate change, racial injustice, economic inequality, and numerous other issues that are fundamental to the success and sustainability of companies, financial markets, and our economy. This call, welcomed by some and eschewed by others, is attributable in part to the large and growing influence that corporations hold over the social and economic well-being of people and communities everywhere. A study from 2018, for example, showed that 71 of the top 100 revenue generators globally were corporations while only 29 were countries. [2] In other words, corporations—in many cases U.S. corporations—often operate on a level or higher economic footing than some of the largest governments in the world. That is a dynamic worthy of reflection—and one that drives home the weighty consequences and obligations associated with some corporate decisions.
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