S&P denies allegations it sells index inclusion

Can companies buy their way into the S&P 500? That's the explosive allegation made by a recent NBER paper — one that's strenuously denied by S&P itself.

Why it matters: According to S&P's own calculations, some $13.5 trillion is indexed or benchmarked to the S&P 500. That's well over $100,000 per U.S. household. Any question as to the integrity of the index has to be taken seriously.

The intrigue: Three researchers, including former Asian Development Bank chief economist Shang-Jin Wei, now at Columbia University, spent two years examining additions to the S&P 500, and whether they could be explained using published criteria.

• They found that when a firm purchases a credit rating from S&P (but not when it purchases a credit rating from rival Moody's), its chances of being added to the S&P 500 are higher.

The other side: S&P says there's simply no mechanism whereby that could happen; that its ratings and indices arms are two separate companies that don't talk to each other.

• For the record: “S&P Dow Jones Indices and S&P Global Ratings are separate businesses with policies and procedures to ensure they are operated independently of one another," said the company in a statement. "Our Index Governance segregates analytical and commercial activities to protect the integrity of our indices.”
• David Blitzer, who led S&P's index committee for much of the period covered in the paper, told the FT that he was "prohibited from speaking to anyone in S&P Ratings without legal counsel present" and that he wouldn't have even known if a company had hired S&P Ratings to rate its bonds.

The big picture: S&P Dow Jones Indices is something of a black box when it comes to decisions as to which companies belong in the S&P 500, and when they should be admitted.

• Published criteria for inclusion can feel arbitrary — Tesla was excluded from the index for years, for instance, because it wasn't consistently profitable enough. And most hot recent IPOs are also excluded from the index because of their dual-class share structures.
• The index therefore isn't the 500 largest companies listed in the U.S. — in fact, most of the time it isn't even 500 companies. S&P has significant discretion when it comes to which companies it includes in the index, although the researchers and S&P disagree on just how much S&P exercises that discretion.

Between the lines: The paper shows that companies step up their purchases of S&P ratings when vacancies appear in the index, or when they become large enough to qualify for inclusion. They don't act in a similar manner with respect to Moody's ratings.

• The evidence suggests that companies believe that purchasing a rating will increase their chances of getting into the index — whether or not that's actually the case.

The bottom line: The paper has not yet been peer reviewed, but it undoubtedly raises serious questions, many of which could be fixed by S&P moving to a much more automatic and much less discretionary methodology for composing its flagship index.