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Anita Anand and Adriana Robertson are professors at the Faculty of Law and are cross-appointed to the Rotman school of management at the University of Toronto.

The news that a whistleblower had contacted U.S. regulators alleging manipulation of the VIX, a volatility index at the heart of the recent market turmoil, highlights near-universal reliance on information that stock-market indexes provide.

While the VIX is not itself a stock market index – it is constructed from the implied volatility of S&P 500 index options – the fact that it is designed to track the expected volatility of another index only reinforces the centrality of indexes in the modern economy.

Other uses of stock-market indexes abound: Investors rely on them to evaluate the returns on their investment portfolios. Firms use them to assess their own performance. Mutual-fund managers' compensation is often tied to whether they outperform a given index. In short, stock market indexes are responsible for driving trillions of investment dollars.

While stock market indexes are ubiquitous, very little is known about their internal workings. As with credit-rating agencies before the most recent financial crisis, they are completely unregulated and their level of transparency is highly variable. Major index providers, such as the FTSE, MSCI and S&P (which produces the TSX Composite Index) publish detailed documents that set forth the bases on which stocks are included and excluded from the index, the weighting methodology, rules for rebalancing and information on how decisions relating to the index are made. But both within and across index providers, the disclosures are highly variable, as is the level of transparency of indexes, generally.

Much of the past research on indexes has focused on the stock price implications of changes in index composition. Several scholars have documented evidence of significant price effects when securities are added to or removed from an index. Generally, when a security is added to an index, its price jumps, resulting in positive abnormal returns. Conversely, when a security is deleted from an index, its price falls, resulting in negative abnormal returns. While these results are robust across a wide array of markets, what is missing from the existing literature is a comprehensive examination of the decision-making processes employed by these indexes.

In this time of financial-market volatility, we decided to take on this question and are analyzing 900 indexes used as benchmarks for U.S.-equity mutual funds. While our work is continuing, we are identifying a phenomenon which we term "index heterogeneity." That is, these indexes are heterogeneous across a number of metrics, including: how stocks are selected for inclusion or exclusion; the timing of these decisions; the data employed in making these decisions; the weighting of the stocks selected for the index; and governance structures within index providers themselves. Most importantly, there is no consistency in terms of the disclosure provided by stock market indexes, let alone the rules by which they are governed.

Thus an overarching characteristic among almost all stock market indexes is that decision making occurs in a "black box," lacking transparency. If an index mentions its governance at all, it typically provides a vague reference to a committee that oversees the index. Unlike boards of public corporations, whose governance practices are mandated, the committee can be and often is comprised of non-independent persons with "extensive experience in global equity markets."

Because indexes make decisions that have significant effects on financial markets, we must ask whether regulators should examine their governance and at least set baseline requirements for disclosure.

This issue has become increasingly salient as index providers make decisions that impact the governance of companies seeking to be listed on major exchanges. Following the Snap IPO, two major index providers, S&P and FTSE, announced changes in their rules regarding firms that issue multiple voting shares.

This is different from the emergence of corporate governance indexes (CGIs) which are specific indexes that allow or encourage companies to differentiate themselves on the basis of their governance. Major indexes are simply stating to firms that "you will not be included in our indices if you exhibit a certain type of governance." The fact that investors are demanding – and companies seem to be paying attention to – these statements, is evidence of the power that these indexes wield.

The issue is not simply whether stock market indexes should exercise influence over company governance. Rather, we should be concerned about the way in which indexes make these decisions in the first place. In other words, what about the governance of the indexes themselves? Given the extent to which the market relies on the information that indexes provide, do stock market indexes warrant greater regulatory oversight? Is mandated disclosure for stock market indexes a reform worth pursuing?

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