Significant shifts in the stock ownership patterns of publicly traded companies have occurred over the past forty years. Of particular interest is the dramatic growth in the size and number of fully indexed companies, where ownership is so widely held that classical agency theory may no longer be meaningfully applicable. Largely unnoticed and poorly documented, the shift in the United States towards ever larger fully indexed corporations, which Bob Monks has called “drone corporations”, or “corporate drones”, appears to be accelerating rapidly among the most powerful and influential US companies, bringing an entirely new context to bear on the concept, “too big to fail.”
For purposes of the current brief an “indexed company” is one whose ownership is so widely distributed that no single shareholder holds a principal position, which is defined by the SEC as 10% or more. In most cases the largest single position is likely to be less than half that amount, or it may be held by a shareholder this itself also widely held, such as a mutual fund company or a passive index fund; in the most extreme cases the largest single position may be less than one percent of the shares outstanding.
These screens were applied to the companies that comprise the S&P 500 index, identifying the fully indexed companies in this group by excluding any companies where:
Just ten years ago, in July of 2003, the first year for which GMI Ratings (formerly The Corporate Library) collected the necessary ownership data to make such an assessment possiblei, indexed companies comprised just 36 percent of the S&P 500 by count, but already accounted for 51 percent of the total S&P 500 market cap. By July of 2012 the count had grown to 54 percent of the S&P 500, and accounted for 64% of its total market cap. Furthermore, while the average market cap of all S&P 500 companies rose from just under $16 billion in 2003 to more than $26.5 billion in 2012, the average market cap of an S&P 500 indexed company rose from $22.5 billion to $30.5 billion. The fully indexed company has not only become the dominant form among large cap US corporations, but these companies continue to grow, in size, in number, and in power.
These screens are intended to exclude any companies where there were one or more vested owners, or more specifically shareholders whose holdings were of sufficient size and importance to warrant an active level of monitoring and participation in the affairs of the corporation. Exactly the same screens were applied for each of the two time periods under review, but closer examination of a few specific companies highlights the dynamic nature of this target group. In the case of Wells Fargo, for example, which Warren Buffett has begun to steadily increase his holdings, will soon approach the threshold for being excluded from this group, while Apple, since the death of Steve Jobs, is headed in the opposite direction.
The rise of the modern index fund is clearly a major contributor to this development, but so too are the emergence of high speed, high volume digital trading standards, including modern derivative practices, and a steady trend towards the creation of ever larger and increasingly global corporate empires.
While there are many smaller companies that meet this definition as well, the current brief is focused on the indexed companies that were identified as part of the S&P 500 as of July 15, 2012, as shown in Table 1 in the attached supporting data files.
Indexed companies effectively “resolve” the agency problems inherent in the public corporate form by effectively removing vested owners from the agency equation, and by elevating the power and authority of the CEO and board accordingly. Absent the constraining influence of active, i.e. informed and involved, owners, and particularly in the context of CEO-selected and CEO-dominated boards, the elevation of the indexed company CEO in status and power has been considerable, and the normal ties between power and accountability effectively eliminated. In the absence of vested owners, the indexed company CEO and board asserts degree of power and authority that was previously associated with controlled companies, which are the polar opposite of the indexed company with regards ownership.
Surprisingly, given their prominence and growing dominance of the US equity markets, while certain individual indexed companies have performed quite well, in terms of average investment returns to shareholders over the five year period between July, 2007 and July, 2012, the 269 indexed companies that comprise a majority of the S&P 500 as of July 2012 have consistently under-performed their non-indexed counterparts.
The Summary Table at the end of this brief compares the indexed versus non-indexed S&P 500 companies as of July, 2012, and supports a number of equally surprising conclusions:
Looking even further afield, and comparing these groups using data from other readily available sources yielded even more startling possibilities:
The fully indexed companies are not only becoming larger and more dominant, they have also begun to exhibit a number of characteristics, and engage in corporate behavior, which could ultimately have a very negative impact on the health and well-being of the US equity markets. In his book, Citizens DisUnitedv, Bob Monks takes an even closer look at this trend and its implications in this larger context, and identifies those key shareholders who could make all the difference in reversing it.
The rise of the fully indexed corporation appears to have escaped the attention of most academic researchers, and perhaps even a majority of investors. Based on the findings of this preliminary brief and its supporting data, and the even more far reaching conclusions highlighted in Citizens DisUnited, certain questions seem particularly important:
Ric Marshall, Chief Analyst at GMI Ratings
The views and opinions expressed in this brief are entirely my own.