120  The Stock Market Is Smarter Than You Think Growth often means adding more business units and expanding geographi- cally, which lengthen the chain of command and involve more people in every decision. Smaller, nimbler companies can well end up with lower costs. Whether size helps or hurts, whether it creates scale economies or disecono- mies, depends on the unique circumstances of each company. Myths about Market Mechanics Conventional wisdom has long held that companies can capture benefits for their shareholders without any improvements to underlying cash flows by having their stock included in a key market index, listing it in multiple mar- kets, or splitting their stocks. True, a company from an emerging market in Asia securing a U.S. listing or a little-known European company joining a leading global stock index might secure some appreciable uplift. But well- functioning capital markets are entirely focused on the fundamentals of cash flow and revenue growth. Index Membership Becoming a member of a leading stock market index such as the S&P 500 or FTSE 100 appeals to managers because many large institutional investors track these indexes. Managers believe that when institutional investors rebal- ance their portfolios to reflect the change of index membership, demand will shift dramatically, boosting the share price. Anecdotal evidence appears to confirm this view. In 2001, Nortel, Shell, Unilever, and four other companies based outside the United States were removed from the S&P 500 index and re- placed with the same number of U.S. corporations. The departing companies lost, on average, nearly 7.5 percent of their value in the three days after the announcement. The stock prices of the new entrants—including eBay, Gold- man Sachs, and UPS—increased by more than 3 percent in the same period. But empirical evidence shows that such changes are typically short-lived. On average, share prices of companies excluded from a major stock index do indeed decrease after the announcement. But this fall is fully reversed within one or two months.31 Surprisingly, the evidence on the impact of index inclusions appears less conclusive; several publications report that price increases occurring immedi- ately after an inclusion are only partly reversed over time.32 We analyzed the effect 31 H. Chen, G. Noronha, and V. Singal, “The Price Response to S&P 500 Index Additions and Deletions: Evidence of Asymmetry and a New Explanation,” Journal of Finance 59, no. 4 (August 2004): 1901–1929. 32 See also, for example, L. Harris and E. Gurel, “Price and Volume Effects Associated with Changes in the S&P 500: New Evidence for the Existence of Price Pressures,” Journal of Finance 41 (1986): 815–830; and R. A. Brealey, “Stock Prices, Stock Indexes, and Index Funds,” Bank of England Quarterly Bulletin (2000): 61–68. Myths about Market Mechanics  121 on share price of 103 inclusions and 41 exclusions from the S&P 500 between De- cember 1999 and March 2004.33 As Exhibit 7.14 shows, new entrants to the index experienced only a short-lived increase in share price: statistically significant posi- tive returns disappeared after only 20 days, and all effects largely disappeared after 45 days. As investors adjust their portfolios to changes in the index, share prices of new entrants initially increase but then revert to normal once portfolios are rebalanced. For 41 companies ejected from the S&P 500 over the same period, we found similar patterns of temporary price change. The pressure on their prices following exclusion from the index lifted after two to three weeks. Cross-Listing For years, many academics, executives, and analysts believed companies cross- listing their shares on exchanges in the United States, London, and Tokyo could realize a higher share price and a lower cost of capital.34 Cross-listed shares would benefit from more analyst coverage, a broader shareholder base, improved liquidity, higher governance standards, and better access to capital. But our analysis does not find any significant impact on shareholder value from cross-listings for companies in the developed markets of North America, Western Europe, Japan, and Australia.35 We found no decline in share price when companies announced a delisting from U.S. and UK stock exchanges 33 For further details, see M. Goedhart and R. Huc, “What Is Stock Membership Worth?” McKinsey on Finance, no. 10 (Winter 2004): 14–16. EXHIBIT 7.14  Effects of Inclusion Disappear after 45 Days 20 15 10 5 0 –5 –10 –15 –20 –25 –20 –15 –10 –5 0 5 10 15 20 25 30 Effective date Announcement date, 1–5 days 35 40 45 50 55 60 Average Median Quartile 1 Day relative to effective date Cumulative abnormal return, % Quartile 4 34 See, for example, C. Doidge, A. Karolyi, and R. Stulz, “Why Are Foreign Firms That List in the U.S. Worth More?” Journal of Financial Economics 71, no. 2 (2004): 205–238; and M. King and U. Mittoo, “What Companies Need to Know about International Cross-Listing,” Journal of Applied Corporate Finance 19, no. 4 (Fall 2007): 60–74. 35 For further details, see R. Dobbs and M. Goedhart, “Why Cross-Listing Shares Doesn’t Create Value,” McKinsey on Finance, no. 29 (Autumn 2008): 18–23.