企业长寿：指数更替与企业绩效

GLOBAL FINANCIAL STRATEGIES www.credit-suisse.com

Corporate Longevity Index Turnover and Corporate Performance February 7, 2017

S&P 500 Index Authors 12% 60

Michael J. Mauboussin 10% 50 [email protected]

Source: Jeremy Siegel and Credit Suisse.

Firms follow an “inexorable and irreversible movement towards the equilibrium of death.”

Kenneth Boulding1

Corporate longevity is an important consideration for investors as they assess valuation, position sizing within a portfolio, and the magnitude of sustainable competitive advantage.

Turnover in the S&P 500 Index, a proxy for longevity, correlates to an index of innovation reasonably well but correlates to M&A activity even better.

The trend for turnover in the S&P 500 and Fortune 500 is rising, but not dramatically. That turnover comes in waves better describes the data.

Investors who compare their results to a benchmark need to appreciate how that benchmark changes. While most investors consider index funds to be passive, the indexes themselves vary quite a bit over time.

The average total shareholder returns over the following year for the companies the committee removed from the S&P 500 but that continued to trade trounced those of the companies the committee added. The committee sells low and buys high.

Introduction

Clark Kerr, the former president of the University of California, noted that of the Western institutions established by 1520, only 85 existed almost a half millennium later. These include the Roman Catholic Church, the British Parliament, several Swiss cantons, and 70 universities. Each of these institutions represents a group of people who come together for a common purpose. Few companies, however, live a long time and those that do are generally in the beverage or hospitality business.2 Why do cities and universities grow old and companies die young? Further, is the rate of corporate longevity shrinking, stable, or expanding?

Corporate longevity is relevant for investors for a number of reasons. First, researchers frequently use longevity as a proxy for the rate of innovation. Short corporate lives are associated with rapid innovation or what the economist Joseph Schumpeter called the “perennial gale of creative destruction.”3 Corporate lives are more fleeting if innovation is accelerating, which has implications for portfolio construction and the pattern of value creation. We will show that while there is a link between innovation and longevity, the level of mergers and acquisitions (M&A) explains longevity even better than innovation does.

Longevity also plays an important role in determining the size of the investable universe. The population of public companies rises with spin-offs and initial public offerings (IPOs) and falls with M&A and delistings as the result of bankruptcy. Because M&A has exceeded IPOs in the last two decades, the population of listed companies in the U.S. has dropped to levels last seen in the 1970s.

Finally, investors generally measure the returns for active money managers versus a benchmark index. These indexes change their composition as index committees add and subtract companies. Comparing the results of an active investment manager to a benchmark index makes sense because investors consider the returns of an index fund as an opportunity cost. Just as companies must earn a return on investment in excess of the opportunity cost of capital to create value, investment managers must beat their benchmark to add value.

There is a general sense that the rate of change is accelerating and that corporate longevity is shrinking. This assertion appears frequently in the business press. Our research shows a more nuanced picture. Indeed, a common measure of corporate longevity, turnover of the companies in the S&P 500, shows that longevity has lengthened in recent years. Here is a summary of the research:

Exhibit 1: Studies on Corporate Survival Study Sample Survival CS Global Financial S&P 500 Implied survival of 24 years (1958-2016)

Strategies CS Global Financial Fortune 500 Implied survival of 16 years (1955-2015)

Strategies Stangler and Fortune 500 Implied survival of 16 years (1955-2011)

Arbesman Daepp, Hamilton, Typical half-life of 10 years, regardless of North American public companies West, and Bettencourt age or business sector (1975-2009) Global public companies with Roughly one half survive 10 years (1965- CS HOLT $250M-plus market cap 2015)

Survival of roughly 75 percent for 1 year U.S. Census All U.S. establishments and 50 percent for 5 years (1977-2014)

Dunne, Roberts, and More than 250,000 U.S. Survival of roughly 65 percent for 5 years Samuelson manufacturing firms and 20 percent for 10 years (1963-1982) Source: Credit Suisse. See endnotes for full list of sources.

The S&P 500 had a market capitalization of $20.6 trillion as of January 31, 2017, which represents about 80 percent of the available U.S. market capitalization. The S&P 500 is a good proxy for the overall market because of its size.4 More than $7.8 trillion worth of mutual funds are benchmarked to the S&P 500, with index assets making up 28 percent of that amount.5 Almost one-half of all actively-managed U.S. equity mutual funds, which control about 60 percent of total assets under management, use the S&P 500 as a benchmark.6

We examine the turnover in the composition of the S&P 500 to understand the causal drivers of additions and removals. We consider whether turnover in the S&P 500 is a reasonable proxy for innovation in light of these results. While we see an association between S&P 500 turnover and an index of innovation, M&A appears to have a larger influence on the changes than the innovation index does.

While researchers have analyzed the pattern of entry and exit, we go beyond this and analyze the characteristics of the companies coming and going. Specifically, we examine the total shareholder returns (TSR) for the three years before and the three years after a company is added to, or dropped from, the S&P

500. We also look at the cash flow return on investment (CFROI®) for the same population to gauge the quality of the businesses.

We find that the companies the committee adds to the S&P 500 have trailing TSRs and CFROIs that are above average. The companies the committee removes fall into one of two camps. Those that exit as the result of M&A have strong past TSRs and high CFROIs. Those that exit as the result of failure, or other factors, have weak TSRs and low CFROIs.

One intriguing finding is that in the 12 months following an action, the companies the committee removes from the S&P 500 but that continue to trade vastly outperform the companies the committee adds. This is consistent with regression toward the mean. The committee generally adds companies that have done well and have high embedded expectations, and removes companies that have done poorly and have low expectations. The stocks with low expectations go on to outperform the stocks with high expectations.

The population of the S&P 500, while economically large and significant, only represents a fraction of the broader economy. As a result, we also examine the Fortune 500 to see whether the turnover of the S&P 500 is consistent with that of other big companies. The Fortune 500 is a list of the largest companies in the U.S. measured by revenue. It includes private companies for which there are data. We also look at longevity for smaller companies via academic research and data from the U.S. Census Bureau.

The rate of change we see for the Fortune 500 is generally consistent with that of the S&P 500. For small companies, the entry rate is approximately 12-14 percent per year and the exit rate is about 10-12 percent.

This means that for an economy that starts with 100 companies, around 12-14 new companies will enter each year and 10-12 will leave. The result is modest growth in the number of companies. There is substantial birth and death among young companies.

®  CFROI is a registered trademark in the United States and other countries (excluding the United Kingdom) of Credit Suisse Group AG or its affiliates.

The main question is, “Why do companies die?” Some die because of obsolescence, but most depart gracefully through M&A. The companies that the S&P 500 committee discards that continue to trade appear to present a small, but lucrative, investment opportunity.

What Causes S&P 500 Turnover?

Exhibit 2 shows the turnover in the constituents of the S&P 500 Index from 1958 to 2016. We use data from FactSet for 1991 through 2016 and from Jeremy Siegel, a professor of finance at the Wharton School of the University of Pennsylvania, for the prior years.7 Over this span, the average annual turnover rate was 4.2 percent, which means there were approximately 20 changes per year. The removal of one company and the addition of its replacement constitute one change. Appendix A explains how we track deletions and additions.

Exhibit 2: Turnover in the S&P 500 Index, 1958-2016 12% 60

10% 50

Source: 1958-1990: Jeremy Siegel, “Long-Term Returns on the Original S&P 500 Companies,” Financial Analysts Journal, Vol. 62, No. 1, January/February 2006, 18-31; 1991-2016: FactSet, S&P Dow Jones Indices, Credit Suisse.

The trend line in the annual turnover rate rises gently from the late 1950s and early 1960s, when the rate of change was a modest 3 percent, to an average turnover rate of about 4 percent over the past 5 years.

Perhaps the most striking feature of exhibit 1 is that the turnover rate can swing wildly from year to year. For example, the annual turnover rate was as low as 2 percent and as high as 11 percent from 1991 through 2016.

What is the source of turnover? The high turnover in some periods, such as the dot-com bubble in the late 1990s or the financial crisis in 2008-2009, makes sense and may be indicative of changes in the underlying economy. But in most instances, the turnover tells us little about creative destruction.8

For instance, the huge spike in 1976 turnover was the result of the S&P committee removing 40 industrial, transportation, and utility companies and replacing them with financial stocks. Starting around 1996, the S&P committee started to manage the index more actively. Through much of the index’s history, the committee only modified the list of companies when it had to remove a stock for reasons including bankruptcy or acquisition. But over the past 20 years, the committee has been more proactive in removing firms that fail to effectively represent the industry in which they compete, or that fail to characterize the U.S. market.9

As a case in point, the index committee removed 7 companies in 2002 due to their “lack of representation.”

This distinction most commonly refers to companies with market capitalizations at the low end of range for the index. In that same year, the committee replaced 7 non-U.S. companies because they failed to meet the selection criteria at that time. This is despite the fact that some of the companies had been in the index and its predecessors for 60 years. Without the change in methodology, 14 of the 23 total changes in 2002 would have been unlikely.

This example reveals that the S&P committee’s more active approach to managing the index explains about one-third of the turnover over the past 20 years. Exhibit 3 shows the hypothetical turnover for the S&P 500 assuming the S&P committee managed the index from 1996 to 2016 in the same way as it did from 1958 to1995. We assume the committee would not have removed companies for “lack of representation,” low market capitalizations, failing to meet certain profit criteria, or being domiciled outside the U.S. We also exclude the 40 changes in 1976 that were purely to change the industry makeup of the index.

Without these changes, the gentle rise in turnover in exhibit 2 gives way to a nearly flat trend line. So what looks like evidence of creative destruction at first glance may simply be more proactive index management.

Exhibit 3: Hypothetical Turnover in the S&P 500 Index, 1958-2016 12% 60

10% 50

Source: Credit Suisse.

The change in the S&P committee’s approach to managing the index reveals the limitation of using turnover as a simple proxy for innovation. Yet there is a good fit between “The Shift Index,” a measure of innovation developed by consultants at Deloitte, and turnover in the S&P 500. Exhibit 4 shows the correlation between the change in the Shift Index and the turnover in the S&P 500 from 1994 through 2015. The correlation coefficient (r) is 0.65. The Shift Index has three component indexes. The “foundation index” captures public policy, infrastructure penetration, and technology performance. The “flow index” reflects virtual and physical flows, as well as amplifiers such as social media. The “impact index” takes into consideration markets, firms, and people. The Shift Index combines these components in an attempt to quantify economic change.10

Exhibit 4: The Shift Index and Turnover in the S&P 500 Index, 1994-2015 S&P 500 Index Shift Index

Source: Deloitte analysis (see: https://dupress.deloitte.com/content/dam/dup-us-en/articles/3407_2016-Shift-Index/DUP_2016-Shift-Index.pdf); FactSet; S&P Dow Jones Indices; Credit Suisse.

The question is whether anything explains turnover better than the Shift Index. To answer this, we examine why the committee removed stocks from the S&P 500. Appendix B provides a detailed discussion of the basis for additions to, and removals from, the index. Additions must meet specific criteria, but the committee has a fair amount of discretion in the decision to remove a company.

The grounds for removal fall into one of three categories: “M&A,” “Failure,” and “Other.” M&A includes mergers, acquisitions, and companies that go private. We exclude other strategic deals such as spin-offs to shareholders or other forms of dividing a company.

Failure primarily includes companies the committee dropped from the index following a bankruptcy filing or for failure to maintain a sufficient market capitalization.10

“Other” consists mostly of two groups. First are companies that realized a large decline in market capitalization for reasons unrelated to performance, including special dividends or spin-offs. Second are companies that the committee eliminated for having a domicile outside the U.S.

For 2000 through 2016, we categorize each removal from the index based on the information that S&P provides. This reveals that M&A, not failures, drives the majority of turnover in the index. Exhibit 5 shows that more than half the removals are the result of M&A, while only one-third are from failure. The other category is just over one-tenth of the sample. Most failures are the consequence of a decline in market capitalization, not bankruptcy. See Appendix C for a full log of these changes and the reasons for each removal.

Exhibit 5: Reasons for Removal from the S&P 500 Index, 2000-2016

Source: FactSet; S&P Dow Jones Indices; Credit Suisse.

Exhibit 6 compares U.S. M&A volume to index turnover from 1990 to 2016. There is a strong relationship between the two, with a correlation coefficient (r) of 0.79. We see that index turnover over the last 27 years peaks at the same time as M&A peaks in the late 1990s, again crests around the M&A wave in the mid- 2000s, and accelerates in recent years alongside resurgent M&A.

An extensive body of research links M&A activity to a wide variety of factors, including stock prices, business sentiment, financing costs, tax rates, industry shocks, and even behavioral pressures on management teams.11 While the rate of innovation certainly plays a role in M&A as well, it appears to be one among a handful of essential drivers.

Exhibit 6: S&P 500 Turnover and U.S. M&A Volume, 1990-2016 U.S. M&A Volume 2.5 S&P 500 Turnover 12%

Volume (Trillions of 2015 U.S Dollars)

10% 2.0

8%

Source: Thomson Reuters; S&P Dow Jones Indices; Credit Suisse.

These categories reveal the limitations of simply associating turnover with creative destruction. For example, it is inaccurate to say that a company “failed” if the S&P committee removed it following a divestiture that shrunk the company’s market capitalization below a threshold level. Likewise, it is hard to say that creative destruction was the reason the committee removed a company after it was acquired for its strong growth and profitability.

The Characteristics of Companies Added to, and Removed from, the S&P 500

The next step of our study was an analysis of the characteristics of the companies the committee added and removed from the S&P 500 Index. We focused on two measures. The first is three- and one-year total shareholder return (TSR), relative to the S&P 500, before the change and one and three years following the change. TSR is the return an investor earns for a stock given the change in price and assuming that all dividends are reinvested.

The second measure is the three- and one-year cash flow return on investment (CFROI) before the change and one and three years following the change. CFROI is a measure of the return a company earns on the cash it invests in its business. Because CFROI is adjusted for inflation, you can compare it over time without fear of distortion. Appendix D provides detail on the sample sizes of the various categories.

Exhibit 7 summarizes our observations about TSR.12 The S&P committee tends to add companies that have realized strong past stock returns. The companies added from 2000-2016 had an average relative TSR of 23 percent per year for the 3 years before inclusion, and 41 percent for the year prior to inclusion. The median returns, while more modest, are similarly high. The committee’s behavior is consistent with other investors: They buy high.13

Exhibit 7: Trailing and Future TSRs for Additions and Removals from the S&P 500, 2000-2016 TSR Relative to S&P 500 -3 Year +3 Year

Source: FactSet and S&P Dow Jones Indices.

The companies the committee removed had three-year returns that lagged the S&P 500 and one-year returns that were essentially equal to the index. Naturally, the TSRs reflect the reason the committee had to drop a company. (See exhibit 8.) For example, the companies that left as the result of M&A had average relative returns of 4 percent per year for three years and 28 percent for one year.

Companies that failed fared poorly prior to exclusion. Those companies had average relative TSRs of -32 percent per year for three years and -41 percent for one year. Companies that left the index for other reasons had returns roughly in line with that of the S&P 500. For each type, the median returns prior to removal are similar to those for the mean. Companies that were acquired had excellent relative TSRs, those that failed had poor TSRs, and the other companies performed about in line with the market.

Exhibit 8: Trailing and Future TSRs for Types of Removals from the S&P 500, 2000-2016 TSR Relative to S&P 500 -3 Year +3 Year

Source: FactSet and S&P Dow Jones Indices.

However, the past is not prologue. Exhibit 9 shows that the average TSRs over the following year for the companies the committee removed but that continued to trade trounced those of the companies the committee added.14 One year after a change, the average relative TSR for the companies the committee added was -2 percent while the relative TSR for the companies removed was 28 percent. Despite the sharp divergence in the first year, the disparity does contract over three years. These results are consistent with prior research examining changes to the S&P 500 and Dow Jones Industrial Average.15 The S&P 500 Index committee buys high and sells low.

Exhibit 9: Relative TSRs Following Addition and Removal from the S&P 500, 2000-2016

Source: FactSet and S&P Dow Jones Indices.

Exhibit 10 shows the results for CFROI. The committee adds companies to the S&P 500 that have CFROIs well above the average. For the three years prior to addition these companies have an average CFROI of 15 percent, while the CFROI is an even higher 16 percent for the year prior to addition. These figures compare to an average CFROI of 9.2 percent for all U.S. companies during that period. The S&P 500 committee adds companies that have stock market returns and quality that are well above average.

The CFROIs of the deleted companies are the mirror image: They are below average. The mean CFROI for the three years prior to removal was 10 percent, and the CFROI in the year before removal was an even lower 8 percent. But, the average CFROIs for the removed companies belie the results based on why they were removed.

Exhibit 10: Trailing and Future CFROIs for Additions and Removals from the S&P 500, 2000-2016

Source: FactSet; S&P Dow Jones Indices; Credit Suisse HOLT®.

Companies removed as the result of M&A had trailing three-year average CFROIs above the rest of the market. (See exhibit 11.) This is consistent with prior research that suggests firms with large free cash flows are attractive takeover targets.16 Companies removed because of failure had CFROIs below the average. The CFROIs for these companies in the one year and three years following removal, at around five percent (medians), are subpar businesses.

Exhibit 11: Trailing and Future CFROIs for Removals from the S&P 500, 2000-2016 CFROI -3 Year +3 Year

Source: FactSet; S&P Dow Jones Indices; Credit Suisse HOLT®.

The S&P 500 committee adds stocks of companies that have achieved good recent TSRs and that are of above-average quality. Those companies continue to earn high CFROIs, but their stocks, on average, generate TSRs roughly in line with the market in the one and three years following addition.

There are two tales for the companies that the committee removes. The stocks of companies that are involved in M&A, which is a majority of removals, have TSRs and CFROIs that are well above the market prior to leaving the S&P.

The stocks of the companies categorized as failures, slightly below one-third of our sample, have abysmal TSRs prior to removal but superb TSRs after removal. The quality of these businesses, as measured by CFROI, is substandard throughout the period we measure.

The stocks of the smallest group, companies categorized as “other,” have average quality prior to removal and earn TSRs roughly equivalent to that of the market before removal and better than the market after removal.

Evidence from the Fortune 500 Corroborates the S&P Experience

The S&P 500 includes many large companies in the Unites States and accurately reflects the broad stock market. To expand our analysis of longevity, we also examined the changes in the Fortune 500 over time.

Published annually by Fortune magazine, the list includes the 500 largest U.S. companies ranked by revenues. Because it includes public, private, and mutual insurance companies, the Fortune 500 is a more complete list of America’s largest companies.17 We estimate that roughly 315 companies are in both the S&P 500 and the Fortune 500.

Exhibit 12 shows annual turnover in the Fortune 500 since 1955, the year Fortune first published the list. We see a pattern of turnover that is consistent with that of the S&P 500. On average, there are 32 changes per year, representing turnover of roughly 6 percent, above the S&P 500 at about 4 percent. Similar to the S&P 500, we see evidence of a modest rise in turnover. But the trend is down over the past 30 years.

Exhibit 12: Fortune 500 Turnover 12% 60

10% 50 Trend line

Source: Fortune and Credit Suisse.

Exhibit 13 presents another view of longevity for the companies on the list.18 We select five starting years— 1955, 1965, 1975, 1985, and 1995—and track what number of the original 500 companies for those years remain on the list annually for subsequent years.19 For example, 362 of 500 companies on the 1955 list remained there 10 years later. After 15 years, only 294 of the 500 were still on the list. After 35 years, just 170 of the 500 made the list. The steeper the slope of the line’s decline, the more rapidly companies disappear from the list. The lines that start at more recent dates do appear to drop faster, showing that there is indeed acceleration in turnover for the Fortune 500. It’s harder to remain among the ranks of the largest companies today than it was in past generations.

Exhibit 13: Fortune 500 Longevity 500 1955

Number of Original Companies Remaining

Source: Fortune and Credit Suisse.

Exhibit 14 shows that Fortune 500 turnover, similar to S&P 500 turnover, tracks the M&A cycle closely.

However, the correlation is not as high for the Fortune 500 as it is for the S&P 500. Since 1990, the annual turnover for the Fortune 500 had a correlation (r) to U.S. M&A volume of 0.58, which compares to 0.79 for S&P 500 turnover.

Exhibit 14: Turnover for the Fortune 500 and S&P 500 and U.S. M&A Volume U.S. M&A Volume 2.5 12% S&P 500 Turnover

Volume (Trillions of 2015 U.S. Dollars)

Source: Fortune; Thomson Reuters; S&P Dow Jones Indices; Credit Suisse.

Broadening the Sample—From Big to Small

We have focused on big corporations because they reflect the overall economy and represent a large fraction of the investable universe. Investors focus on those companies with good reason. In the U.S. today, there are 5.1 million total firms and only roughly 4,400 stocks trade on major exchanges.21

Timothy Dunne, Mark Roberts, and Larry Samuelson, a trio of economists, did a sweeping study of corporate longevity, including entry and exit rates. Their analysis of more than 250,000 U.S. manufacturing firms showed that roughly 35 percent of firms that enter an industry exit within 5 years, and that about 80 percent of entrants exit within 10 years.22

Exhibit 15 shows the rate of entry and exit for U.S. establishments across all industries from 1977-2014, using the U.S. Census’s Business Dynamics Statistics (BDS). Most studies on corporate demography use establishments, a rough proxy for firms, as the unit of analysis because that is the way the Census Bureau collects and reports the data.

A useful way to think about entry and exit is to imagine an industry with 100 firms today. Based on the average annual rates over the past decade, roughly 12-14 new firms will enter the industry and 10-12 firms will leave in one year. This leads to modest growth in the total number of firms on average. Because entry rates typically exceed exit rates, the number of establishments in the U.S. increases over time.

The most recent data disclosed by the BDS show that approximately 25 percent of establishments fail within the first year and just over one-half fail within five years.23 Mortality rates are high for young companies and decline for companies that reach adolescence.

Exhibit 15: Establishment Entry and Exit Rates, 1977-2014 (United States)

18% Entry Rate

Source: U.S. Census Bureau; Center for Economic Studies; Business Dynamics Statistics; Credit Suisse.

Why Companies Die (and Cities and Universities Live)

Imagine an ant colony with a nearby source of food. Foragers find the food source and use chemical signals to tell the other ants where to go to find the food. Call this exploitation. But some ants leave the chemical trail and wander around seemingly aimlessly. Call this exploration. Why would an ant ever leave the main trail to the food? If another rich food source appears, the colony wants to have a mechanism to find it. Ant colonies balance exploitation with exploration. But it gets even better: The rate of exploration is roughly correlated with the rate of change in the environment.

Our speculation is that a similar model can help explain why companies die. Successful companies generally have a core source of profits. For many reasons, corporate leaders tend to dedicate too many resources to exploitation of profits and not enough to exploration. Commonly, exploration requires a different structure than exploitation, causing companies to stumble. The best companies are those that can skillfully balance exploitation and exploration.24

By contrast, cities and universities have less pressure to optimize, and hence are more capable of evolving and skirting failure. From a societal point of view, the rise and fall of individual companies may be healthy. But for an individual who is involved with a company on the decline, the pain is real.

Conclusion

Corporate longevity is important for investors for a handful of reasons. First, if longevity is contracting then investors need to rethink valuation, position sizing within a portfolio, and the magnitude of sustainable competitive advantage. Our analysis shows that while turnover in the S&P 500, a proxy for longevity, is reasonably well correlated to an index of innovation, the turnover is even better correlated to M&A activity.

That innovation and M&A are linked makes sense, but we also know that other factors, including capital availability, stock prices, and the institutional imperative, influence M&A waves.

On balance, turnover for the S&P 500 and Fortune 500 is rising, but not at a dramatic rate. A better description is that turnover comes in waves. Further, changes in criteria contaminate the turnover results.

Another reason that investors need to understand longevity is to assess the risk of failure for stocks within their portfolio. This is especially pertinent for investors in value and small capitalization stocks. About one-third of the removals from the S&P 500 over time have been companies we categorize as failures. These companies have poor TSRs and below-average CFROIs. Since these stocks are often inexpensive, they can represent value traps. The data also show that young companies, which are generally small and private, tend to have a higher mortality rate than companies that make it to adolescence.

Finally, investors who have their results compared to a benchmark need to appreciate how that benchmark changes. While most investors consider index funds to be passive, the indexes themselves change quite a bit over time. Note that the S&P beats roughly 60 percent of active managers in an average year and does so without any trading, macro forecasting, or limits on position or sector size.

The S&P 500 committee presents a very attractive trading strategy. Using historical numbers, investors who bought the stocks that the committee removed from the S&P 500 (that still traded) and who sold short the stocks entering the S&P 500 would have earned a tidy excess return. It appears the S&P 500 committee behaves in a way that many investors do: It buys high and sells low.

Appendix A

Methodology for tracking deletions from, and additions to, the S&P 500

Deletion: Stock’s CUSIP is not a part of index in Year (t0) but that CUSIP was a part of index in Year (t-1) Addition: Stock’s CUSIP is a part of index in Year (t0) but that CUSIP was not a part of index in Year (t-1)

Because many companies change their stock tickers and names following structural transformations such as acquisitions and break-ups, or even for purely cosmetic reasons, we need a way to identify changes to the index that are not based solely on a company’s ticker or name. So, to identify additions and deletions to the index, we compare the CUSIPs of all members in one year to the CUSIPs in the following year. A stock’s CUSIP allows us to trace a stock’s lineage even if it has changed its name or ticker.

Determining the changes in the index range from the simple to the complex. For our period of analysis, some CUSIPs, such as that of Johnson & Johnson, were in the index every year and were tied to the same ticker and corporate name the whole time. Then there were examples like the CUSIP for Apple, Inc., which was tied to Apple Computer until the company changed its name in 2007. And finally, there were more complex examples that not only demonstrate the dynamic elements of our economy, but also show how the S&P committee tries to capture and reflect such change.

A merger is a good example. In December 1999, Monsanto and Pharmacia & Upjohn agreed to merge and form Pharmacia Corporation. In March 2000, S&P announced that it was going to remove Monsanto and Pharmacia & Upjohn from the S&P 500 Index and replace them with Pharmacia Corporation and Linear Technology. While this appears to be two changes to the index (i.e., two add/remove events), we only count it as one because Monsanto’s CUSIP lived on in the combined entity. So, the only change is the replacement of Pharmacia & Upjohn (71694110) with Linear Technology Corporation (53567810).

Removed: Monsanto Company (71713U10) and Pharmacia & Upjohn (71694110)

Added: Pharmacia Corp (71713U10) and Linear Technology (53567810)

Treatment of Multiple Share Classes

We do not count the inclusion of additional trading lines of a company’s stock as a change in the index. In March 2014, S&P revised how they treat companies with more than one class of common stock. Historically, companies could only be represented once in the index. The new methodology allows for multiple trading lines of a company’s stock to be included in the index provided the lines meet certain requirements for liquidity and materiality. So, while there are still only 500 companies in the S&P 500, the index can now have more than 500 share lines. There are 505 share lines in the index as of February 6, 2017.25

Determining Fiscal Years When Calculating Trailing and Future CFROIs

With knowledge of the month and year of the S&P’s announcement, we estimate the most recent fiscal year for which results would have been known. That fiscal year constitutes the trailing “-1 year,” and we base the other measurement periods off of that.

Appendix B

Here’s a look at how S&P constructs and oversees the index. The criteria for additions are more straightforward than the grounds for removal. While the committee has some discretion in the companies they select, additions must satisfy a list of criteria for eligibility including standards for market capitalization, liquidity, domicile, public float, and earnings quality. Here are the attributes as of January 2017:26

Universe: Domiciled in the U.S.

Market Capitalization: $5.3 billion or greater.

Public Float: A minimum of 50 percent of shares outstanding available for trading.

Financial Viability: Positive reported earnings in the most recent quarter and over the most recent four quarters (in aggregate).

Liquidity and Price: Highly tradable stocks with active and deep markets. More specifically, “the ratio of annual dollar value traded to float-adjusted market capitalization should be 1.00 or greater, and the stock should trade a minimum of 250,000 shares in each of the six months leading up to the evaluation date.”

The grounds for removal, except in the case of M&A, are not as clear. For example, the committee may leave alone an index constituent that violates one of the criteria for addition, as meeting all the criteria is not necessary for continued membership. Through much of the index’s history, the S&P committee only modified the list of companies when it had to remove a stock for reasons including bankruptcy or acquisition. But over the past 20 years or so, the committee started to manage the index more actively by removing firms that no longer effectively represented the U.S. market or the industry in which it operated.

S&P’s primer on methodology reveals a tension between a passive and an active approach. On the one hand, S&P states that “turnover in index membership should be avoided when possible.” On the other hand, S&P says it intends the index “to reflect the U.S. equity markets and . . . the U.S. economy” and to include “leading companies in leading industries.” The S&P 500 Index does not simply include only the largest companies in the U.S., though, and many of its constituents are not in the top 500 as measured by either market capitalization or sales. To meet the goal of having the top companies, some turnover is clearly inevitable and prompts the S&P committee to continually revise the index.

Appendix C

Exhibit 16 is a log of all the changes in the S&P 500 Index from changes on one day, it generally does not necessarily pair a specific

Exhibit 16: Changes to S&P 500 Index, 2000-2016

10/12/2000 10/16/2000 Power-One Inc Unicom Corp 10/16/2000 10/23/2000 BroadVision Inc PaineWebber Group 10/25/2000 11/1/2000 NiSource Inc Columbia Energy Group 10/31/2000 11/1/2000 EOG Resources Eastern Enterprises 11/14/2000 11/21/2000 Forest Laboratories Seagate Technology 11/15/2000 11/16/2000 Starwood Hotels & Resorts Armstrong World 11/20/2000 11/24/2000 Chiron Corp Fort James Corp 11/27/2000 11/30/2000 Calpine Corp Florida Progress 11/29/2000 12/11/2000 MetLife Inc Seagram Co. Ltd

2000-2016. When S&P announces multiple addition with a specific removal.

Removal Type Reason for Removal

M&A Acquisition by Motorola Failure Lack of representation Failure Lack of representation M&A Bought by Dominion Resources Failure Lack of representation M&A Merger with Monsanto Failure Lack of representation M&A Acquisition by BP Amoco M&A Acquisition by Tribune Company M&A Acquisition by Viacom M&A Acquisition by Investcorp M&A Acquisition by Alcoa M&A Acquisition by American Electric Power Failure Lack of representation M&A Acquisition by Pfizer M&A Acquisition by MGM Grand M&A Acquisition by Siemens Other Spins off large interest in MIPS Technologies M&A Acquisition by International Paper M&A Acquisition by AT&T Corp M&A Merger with Bell Atlantic Failure Lack of representation Failure Market cap changes M&A Merger with Qwest Other Spins off Stilwell Financial M&A Acquisition by Anadarko Petroleum Failure Lack of representation Other Spins off large interest in Palm M&A Acquisition by Northern States Power Failure Market cap changes Failure Lack of representation M&A Acquisition by Unilever M&A Acquisition by WPP Group M&A Acquisition by Tyco International M&A Acquisition by PECO Energy M&A Acquisition by UBS M&A Acquisition by NiSource M&A Acquisition by KeySpan Energy M&A Acquisition by Veritas Failure Lack of representation M&A Acquisition by Georgia Pacific M&A Acquisition by CP&L Energy M&A Acquisition by Vivendi M&A Acquisition by Citigroup Failure Lack of representation Failure Lack of representation Failure Lack of representation Failure Lack of representation

12/12/2000 12/21/2000 Fluor Corp. Massey Energy 12/19/2000 12/29/2000 Applied Micro Circuits Morgan (J.P.) & Co

11/27/2001 11/30/2001 Equity Residential Prop Tr National Service Ind 11/28/2001 11/29/2001 NVIDIA Corp Enron Corp 12/10/2001 12/14/2001 Jones Apparel Group Homestake Mining 12/12/2001 12/12/2001 Genzyme Corp Ralston-Ralston Purina Gp 12/27/2001 12/31/2001 Waters Corporation FMC Corp

11/13/2002 11/18/2002 AT&T Comcast Corp. Comcast Class A Special 12/4/2002 12/11/2002 Quest Diagnostics TRW Inc Removal Type Reason for Removal Failure Market cap changes Failure Market cap changes Failure Market cap changes Aetna (old) sells financials business, spins off U.S.

Other healthcare division, which becomes Aetna (new) M&A Acquisition by RJ Reynolds Other Spins off Fluor M&A Acquisition by Chase Manhattan

M&A Acquisition by AOL M&A Acquisition by El Paso M&A Acquisition by Dow Chemical M&A Acquisition by Firstar M&A Acquisition by FleetBoston Financial Corp. Other Splits into Ceridian and Arbitron Failure Market cap changes M&A Acquisition by Fifth Third Bancorp Other Spins off Roxio M&A Acquisition by Tyco International M&A Tender offer from Reed Elsevier M&A Acquisition by Johnson & Johnson Failure Market cap changes Failure Market cap changes Other Spins off large interest in Riverstone Networks Failure Market cap changes M&A Acquisition by PepsiCo M&A Acquisition by AIG Failure Market cap changes M&A Acquisition by First Union Corp Failure Lack of representation M&A Acquisition by Philips Petroleum M&A Acquisition by Chevron Failure Lack of representation M&A Acquisition by FirstEnergy Corp. Other Spins off Acuity Brands Failure Lack of representation M&A Acquisition by Barrick Gold M&A Acquisition by Nestle Other Spins off FMC Technologies

Failure Lack of representation M&A Merger with Westvaco M&A Acquisition by National Grid Group M&A Acquisition by Weyerhaeuser M&A Acquisition by Hewlett-Packard Failure No longer meets standards of inclusion Failure Lack of representation Failure Lack of representation Other Reorganization Other Not U.S. company Other Not U.S. company Other Not U.S. company Other Not U.S. company Other Not U.S. company Other Not U.S. company Other Not U.S. company M&A Acquisition by Amgen Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Merger with Philips AT&T spins off broadband unit, merges it w/ Comcast to M&A form AT&T Comcast M&A Acquisition by Northrop Grumman

10/25/2004 10/29/2004 Laboratory Corp of America Holdings South Trust Corp. 10/25/2004 10/26/2004 CIT Group AT&T Wireless 11/10/2004 11/30/2004 L-3 Communications Holdings WellPoint Health Networks

12/21/2004 12/28/2004 XTO Energy PeopleSoft Inc.

12/27/2005 12/30/2005 Viacom Inc. (New) Visteon Corp. 12/27/2005 12/30/2005 Whole Foods Market MBNA Corp.

Removal Type Reason for Removal

M&A Acquisition by IBM Failure Market cap changes Failure Allegations company violated securities laws M&A Acquisition by HSBC Holdings M&A Acquisition by Pfizer Failure Bankruptcy Failure Market cap changes M&A Taken private M&A Merger w/ IDEC becoming BIOGEN IDEC

M&A Acquisition by First Data Corp Failure Market cap changes M&A Acquisition by Bank of America M&A Acqusition by St. Paul Companies Other Sprint Corp eliminated Sprint PCS tracking stock M&A Acquisition by Manulife Financial Corp Failure Market cap changes M&A Merger with Regions Financial M&A Acquisition by JP Morgan Chase Failure Market cap changes M&A Acquisition by Royal Bank of Scotland M&A Acquisition by Wachovia M&A Acquisition by Cingular Wireless M&A Acquisition by Anthem Failure Market cap changes Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Acquisition by Oracle

Failure Market cap changes M&A Merger with Kmart (creating Sears Holdings) M&A Acquisition by Symantec M&A Acquisition by Crompton Corp M&A Taken private M&A Taken private M&A Acquisition by Sprint M&A Acquisition by Chevron Failure Market cap changes M&A Acquisition by Federated Department Stores M&A Acquisition by Washington Mutual M&A Acquisition by Procter & Gamble Failure Bankruptcy M&A Acquisition by SBC Communications Failure Market cap changes M&A Acquisition by Koch Industries Failure Market Cap changes M&A Acquisition by Bank of America

Failure Delisting by Nasdaq M&A Acquisition by Adidas-Salomon M&A Acquisition by Oracle M&A Acquisition by Cisco Failure Market cap changes M&A Acquisition by ConocoPhillips M&A Acquisition by Lincoln National M&A Acquisition by Duke Energy M&A Acquisition by Whirlpool M&A Acquisition by Boston Scientific M&A Acquisition by Novartis Failure Market cap changes M&A Acquisition by SuperValu M&A Acquisition by BASF M&A Acquisition by McClatchy

11/13/2006 11/16/2006 Cognizant Technology Solutions Alberto-Culver Co. (old) 11/15/2006 11/17/2006 Peabody Energy Corp HCA Inc.

11/21/2006 12/1/2006 DirecTV Group Inc. Freescale Semiconductor Inc. 11/22/2006 11/30/2006 IAC/InterActive Corp. Lucent Technologies 11/23/2006 11/30/2006 Questar Corp. North Fork Bancorp. Inc. 12/15/2006 12/19/2006 Terex Corp. Navistar International 12/20/2006 12/29/2006 Spectra Energy Corp. Parametric Technology

10/18/2007 10/26/2007 Titanium Metals Corp. Bausch & Lomb Inc. 10/18/2007 10/24/2007 NYSE Euronext Hilton Hotels 10/23/2007 10/25/2007 Jacobs Engineering Group Avaya Inc.

12/19/2007 12/28/2007 Washington Post Co. Temple-Inland Inc. 12/19/2007 12/31/2007 Total System Services Synovus Financial 12/20/2007 12/20/2007 Range Resources Corp. Tribune Co.

Removal Type Reason for Removal Failure Market cap changes Failure Market cap changes Other Cendant spins off Wyndham and Realogy M&A Acquisition by Anadarko Petroleum Failure Market cap changes M&A Acquisition by Wachovia M&A Acquisition by Regions Financial Failure Market cap changes M&A Acquisition by Thermo Electron Corp Other Splits up M&A Taken private M&A Taken private M&A Acquisition by Alcatel M&A Acquisition by Capital One Financial Failure Delisting by NYSE Failure Market cap changes

M&A Acquisition by AT&T M&A Acquisition by Motorola Failure Delisting by Nasdaq M&A Acquisition by Schneider Electric Acquisition by WPS Resources, which changes its name M&A to Integrys M&A Acquisition by Blackstone Group Other Market cap changes (after payout of special dividend) M&A Acquisition by Freeport-McMoRan Copper & Gold M&A Acquisition by CVS M&A Taken private M&A Taken private M&A Taken private M&A Taken private M&A Acquisition by AstraZeneca Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Merger with Bank of New York M&A Taken private M&A Taken private M&A Acquisition by National Grid Plc M&A Acquisition by Banco Bilbao Vizcaya Argentaria Failure Delisting by Nasdaq Other Spins off Teradata M&A Acquisition by Flextronics M&A Taken private M&A Taken private M&A Taken private M&A Taken private M&A Taken private M&A Taken private M&A Taken private M&A Taken private M&A Acquisition by Danaher M&A Acquisition by News Corp Other Splits up Other Spins out Total System Services M&A Taken private

10/16/2008 10/21/2008 NASDAQ OMX Group Inc. Dillard's Inc.

10/28/2008 10/30/2008 Wisconsin Energy Corp. MGIC Investment 10/30/2008 11/5/2008 J.M. Smucker Co. Terex Corporation 11/7/2008 11/10/2008 People's United Financial Inc. Unisys Corp.

11/10/2008 11/13/2008 DENTSPLY International Inc. Hercules Inc.

11/10/2008 11/13/2008 Wynn Resorts Ltd. Ashland Inc.

11/11/2008 11/12/2008 Cephalon Inc. General Growth Properties Inc. 11/17/2008 11/21/2008 Life Technologies Corp. Applied Biosystems Inc. 11/17/2008 11/18/2008 Stericycle Inc. Anheuser-Busch 11/26/2008 12/1/2008 The Dun & Bradstreet Corp. Liz Claiborne Inc. 11/26/2008 12/3/2008 Republic Services Inc. Allied Waste Industries Inc. 12/11/2008 12/18/2008 Equitable Resources Inc. Transocean Inc.

12/18/2008 12/22/2008 McAfee Inc. Barr Pharmaceuticals Inc. 12/23/2008 12/31/2008 FLIR Systems Inc National City Corp.

12/23/2008 12/31/2008 Owens-Illinois Inc Wachovia Corp. (New) 12/23/2008 12/31/2008 SCANA Corp Merrill Lynch

Removal Type Reason for Removal

M&A Taken private Failure Fails to meet consistent profit criteria M&A Acquisition by Toronto-Dominion Bank M&A Acquisition by JP Morgan M&A Acquisition by Ingersoll-Rand Failure Market cap changes Failure Market cap changes Failure Market cap changes Other Splits up M&A Acquisition by Bank of America Other Redomesticates to Switzerland M&A Taken private Other Splits up M&A Acquisition by Hewlett-Packard Failure Market cap changes (placed into conservatorship) Failure Market cap changes (placed into conservatorship) Failure Bankruptcy Market cap changes (too small even after acquisition by Failure Triarc)

M&A Acquisition by Liberty Mutual Group Failure Placed into receivership M&A Acquisition by Mars Failure Market cap changes Failure Market cap changes Failure Market cap changes Failure Market cap changes Market cap changes (too small even after acquisition by Failure Ashland)

Market cap changes (too small even after it acquired Failure Hercules)

Failure Market cap changes M&A Acquisition by Invitrogen forms Life Technologies M&A Acquisition by InBev Failure Market cap changes M&A Acquisition by Republic Services Other Redomesticates to Switzerland M&A Acquisition by Teva M&A Acquisition by PNC Financial Services Group M&A Acquisition by Wells Fargo M&A Acquisition by Bank of America

M&A Acquisition by Altria M&A Acquisition by Banco Santander Other Redomesticates to Switzerland Failure Market cap changes Failure Market cap changes Other Redomesticates to Switzerland Failure Market cap changes Other Redomesticates to Switzerland M&A Acquisition by Dow Chemical M&A Acquisition by CenturyTel Other Redomesticates to Ireland Failure Bankruptcy Other Redomesticates to Ireland Other Redomesticates to Switzerland Failure Market cap changes M&A Acquisition by Pulte Homes Failure Market cap changes Other Redomesticates to Ireland M&A Acquisition by Pfizer M&A Acquisition by Merck & Co.

Announced Implemented Addition Removal 12/11/2009 12/18/2009 Cliffs Natural Resources Inc KB Home 12/11/2009 12/18/2009 Mead Johnson Nutrition Co MBIA Inc. 12/11/2009 12/18/2009 Ross Stores Inc Dynegy Inc. 12/11/2009 12/18/2009 SAIC Inc Convergys Corp. 12/11/2009 12/18/2009 Visa Inc Ciena Corp. 12/15/2009 12/22/2009 Roper Industries Inc ENSCO Int'l

11/10/2010 11/16/2010 Ingersoll-Rand Plc Pactiv Corporation

10/11/2011 10/14/2011 TE Connectivity Ltd. Cephalon Inc. 10/24/2011 10/31/2011 Xylem Inc. ITT Corp. 11/18/2011 11/22/2011 Cooper Industries Janus Capital Group

12/14/2011 12/20/2011 TripAdvisor Inc. Tellabs Inc. 12/22/2011 12/30/2011 WPX Energy Inc. Compuware Corp

11/26/2012 11/30/2012 Dollar General Cooper Industries 12/5/2012 12/11/2012 Garmin Ltd. R.R. Donnelley 12/18/2012 12/21/2012 Delphi Automotive Titanium Metals 12/20/2012 12/31/2012 AbbVie Inc. Federated Investors Inc B Removal Type Reason for Removal Failure Market cap changes Failure Market cap changes Failure Market cap changes Failure Market cap changes Failure Market cap changes Other Redomesticates to U.K.

M&A Acquisition by Oracle M&A Acquisition by Berkshire Hathaway M&A Acquisition by Xerox M&A Acquisition by PepsiCo M&A Taken private M&A Acquisition by The Stanley Works M&A Acquisition by Baker Hughes Inc.

M&A Acquisition by ExxonMobil Inc.

Other Spins off QEP Resources M&A Acquisition by Merck KGaA M&A Acquisition by Schlumberger Ltd.

M&A Acquisition by Reynolds Group Holdings Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Acquisition by Pfizer Inc.

Failure Market cap changes Failure Market cap changes M&A Acquisition by Intel Corp.

M&A Acquisition by First Energy M&A Acquisition by CenturyLink M&A Acquisition by Sanofi-Aventis M&A Taken private M&A Acquisition by Alpha Natural Resources Acquisition by AMB Property (then renamed ProLogis M&A Inc.)

Failure Market cap changes M&A Acquisition by Bank of Montreal M&A Acquisition by Texas Instruments M&A Acquisition by Teva Pharmaceutical Industries Other Spins off Xylem Failure Market cap changes Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Acquisition by AGL Resources Failure Market cap changes Failure Market cap changes

M&A Acquisition by Exelon Corp.

M&A Acquisition by Express Scripts Failure Market cap changes M&A Acquisition by Lam Research M&A Acquisition by Kinder Morgan M&A Acquisition by Google Other Splits up M&A Acquisition by Duke Energy M&A Acquisition by United Technologies Other Below public float threshold Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Acquisition by Energy Transfer Partners M&A Acquisition by Eaton Corp.

Failure Market cap changes M&A Acquisition by Precision Castparts Failure Market cap changes

10/21/2013 10/28/2013 Transocean Ltd Dell, Inc.

10/28/2013 11/1/2013 Michael Kors Holdings Ltd NYSE Euronext 11/22/2013 11/29/2013 Allegion plc Penney J.C. Inc 12/4/2013 12/9/2013 General Growth Properties Inc Molex Inc 12/11/2013 12/20/2013 Alliance Data Systems Corp Abercrombie & Fitch Company 12/11/2013 12/20/2013 Mohawk Industries Inc JDS Uniphase Corp 12/11/2013 12/20/2013 Facebook Inc Teradyne Inc

10/27/2015 10/30/2015 Hewlett Packard Enterprise Co. Hudson City Bancorp, Inc. 11/9/2015 11/17/2015 Synchrony Financial Genworth Financial, Inc. Class A 11/12/2015 11/18/2015 Illumina, Inc. Sigma-Aldrich Corporation 11/23/2015 11/27/2015 CSRA, Inc. Computer Sciences Corporation 12/22/2015 12/28/2015 Church & Dwight Co., Inc. Altera Corporation Removal Type Reason for Removal

Failure Market cap changes M&A Merger with T-Mobile USA M&A Acquisition by Aetna Other Spins off WhiteWave M&A Taken private Failure Market cap changes Failure Market cap changes Other Deal results in public float below threshold M&A Taken private Failure Market cap changes Failure Market cap changes M&A Taken private M&A Acquisition by NYSE Euronext Failure Market cap changes M&A Taken private Failure Market cap changes Failure Market cap changes Failure Market cap changes

M&A Acquired by Thermo Fisher Scientific N/A N/A Failure Market cap changes Failure Market cap changes M&A Acquisition by Suntory Holdings Other Splits up M&A Acquired by Avago Technologies Failure Market cap changes M&A Acquisition by Actavis Failure Market cap changes N/A N/A Other Does not meet new market cap criteria Other Does not meet new market cap criteria Failure Market cap changes Other Does not meet new market cap criteria Other Does not meet new market cap criteria

M&A Acquisition by Medtronic M&A Taken private M&A Taken private Failure Market cap changes Failure Market cap changes Failure Market cap changes M&A Acquisition by Becton, Dickinson and Company M&A Acquisition by Actavis Other Spins off assets M&A Acquisition by Reynolds American Failure Market cap changes Other Merger with Rock-Tenn creates WestRock Co. Failure Market cap changes M&A Acquisition by Wisconsin Energy Corp.

M&A Acquisition by Dollar Tree Failure Market cap changes M&A Acquisition by AT&T N/A N/A N/A N/A N/A N/A M&A Acquisition by Danaher M&A Acquisition by Pfizer Failure Market cap changes M&A Acquisition by M&T Bank Failure Market cap changes M&A Acquisition by Merck KGaA Other Spins off SCRA M&A Acquisition by Intel

Cablevision Systems Corporation

10/24/2016 10/31/2016 Arconic Inc. Alcoa Inc. 11/29/2016 12/1/2016 Envision Healthcare Corp. Legg Mason, Inc. 11/29/2016 12/1/2016 Mid-America Apartment Communities Owens-Illinois, Inc. Source: FactSet; S&P Dow Jones Indices; Credit Suisse.

Removal Type Reason for Removal

Failure Market cap changes M&A Acquisition by ACE Ltd.

M&A Acquisition by Avago Technologies Ltd.

M&A Acquisition by Berkshire Hathaway M&A Acquisition by Weyerhaeuser Co.

Failure Market cap changes Failure Market cap changes M&A Acquisition by Exelon Corp.

M&A Acquisition by Schlumberger Ltd.

Failure Market cap changes N/A N/A Failure Market cap changes M&A Acquisition by Apollo Global Management M&A Acquisition by JAB Holding Company M&A Acquisition by Western Digital Corp.

M&A Acquisition by Charter Communications M&A Acquisition by Air Liquide SA Merges w/ foreign Coca-Cola bottlers, resulting in M&A foreign domicile M&A Acquisition by Shire plc M&A Acquisition by Altice NV M&A Acquisition by Emera Inc.

M&A Acquisition by Columbia Pipeline Group Inc. M&A Acquisition by Southern Co Merger with Tyco International forms Johnson Controls M&A International Merger with Johnson Controls forms Johnson Controls M&A International M&A Acquisition by Dell Corp.

M&A Acquisition by Marriott International Inc.

Failure Market cap changes Other Alcoa splits into Arconic and Alcoa Failure Market cap changes Failure Market cap changes

Appendix D

Exhibits 17 and 18 show the sample sizes for the data in exhibits 7-11. There were 428 total changes, so most of the calculations closely reflect the full sample. Because the removed companies were acquired or went bankrupt, there are no TSR or CFROI data in +one- and +three-years. The companies the committee removed for market capitalization declines or “other” generally have +one- and +three-year figures. For the -three- and +three-year calculations, we include only the companies that have data for the full three years.

Exhibit 17: Sample Size for S&P Changes TSR CFROI

Source: FactSet; S&P Dow Jones Indices; Credit Suisse HOLT®.

Exhibit 18: Sample Size for “Removal” Categories TSR CFROI

Source: FactSet; S&P Dow Jones Indices; Credit Suisse HOLT®.

Endnotes 1 Kenneth E. Boulding, A Reconstruction of Economics (New York: John Wiley & Sons, 1950), 38.

2 Clark Kerr, The Uses of the University: Fifth Edition (Cambridge, MA: Harvard University Press, 2001), 115. 3 Joseph A Schumpeter, Capitalism, Socialism and Democracy (New York: Harper & Row, 1942).

4 Ebenezer Asem and Shamsul Alam, “The Role of the S&P 500 Index Constituents in Tracking the U.S.

Equity Market,” International Journal of Economics and Finance, Vol. 4, No. 12, December 2012, 15-22. 5 See http://us.spindices.com/indices/equity/sp-500.

6 Martijn Cremers, Antti Petajisto, and Eric Zitzewitz, "Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation," Critical Finance Review, Vol. 2, No. 1, 2012, 1-48.

7 Jeremy Siegel, “Long-Term Returns on the Original S&P 500 Companies,” Financial Analysts Journal, Vol. 62, No. 1, January/February 2006, 18-31.

8 Richard Foster and Sarah Kaplan, authors of the book Creative Destruction, are among the most prominent proponents of the point of view that turnover reflects creative destruction. The authors examine the average tenure of a company in the S&P 500 over time and conclude that the rate of churn has accelerated. Their study spans from the late 1920s through the late 1990s. Because the S&P 500 wasn’t formed until 1957, they use the S&P 90 as a proxy in the early years. They show that turnover increased from about 1.5 percent in the 1920s and 1930s, an average lifespan of about 65 years, to nearly 10 percent in 1998, an average lifespan of 10 years.

Foster and Kaplan attribute this increase in the rate of change to Peter Drucker’s notion of the “Age of Discontinuity” and Joseph Schumpeter’s theory of creative destruction. These frameworks, the authors argue, show how markets promote discontinuity by having new, more innovative entrants replace old, weaker companies. See Richard Foster and Sarah Kaplan, Creative Destruction: Why Companies That Are Built to Last Underperform the Market—And How to Successfully Transform Them (New York: Random House, 2001).

9 Messod D. Beneish and Robert E. Whaley, “S&P 500 Index Replacements: A new game in town,” Journal of Portfolio Management, Vol. 29, No. 1, 51-60, Fall 2002.

10 “2016 Shift Index: The Paradox of Flows: Can Hope Flow from Fear?” Deloitte Center for the Edge, 2016.

See https://dupress.deloitte.com/content/dam/dup-us-en/articles/3407_2016-Shift-Index/DUP_2016- Shift-Index.pdf.

11 Peter Clark and Roger Mills argue that merger waves generally pick up steam alongside an improving economy, in large part because this increases the availability of financing. The authors attribute the biggest flurry of activity to behavioral factors, or what Warren Buffett likes to call the “institutional imperative.” CEOs see their peers doing deals and feel compelled to do deals of their own, even if valuations have already risen beyond levels that are attractive. See: Peter J. Clark and Roger W. Mills, Masterminding the Deal:

Breakthroughs in M&A strategy and analysis (London: KoganPage, 2013); Jarrod Harford attributes merger waves to industry shocks, an increase in capital liquidity, and a reduction in financing constraints. See Jarrod Harford, “What Drives Merger Waves?” Journal of Financial Economics, Vol. 77, No. 3, September 2005, 529-560. Researchers also demonstrate a link between merger activity and share prices. See Ralph L.

Nelson, Merger Movements in American Industry: 1895-1956 (Princeton: Princeton University Press, 1959), and Roger Clarke and Christos Ioannidis, “On the relationship between aggregate merger activity and the stock market: some further empirical evidence,” Economics Letters, Vol. 53, No. 3, December 1996, 349- 356.

12 To minimize the impact of the announcement on the stock price, we measure TSR as follows: For trailing returns, our ending point is one full day before the announcement (e.g., the trailing one-year return would be 366 days before the announcement through 1 day before the announcement). For future returns, our starting point is 1 day after the announcement.

13 Scott D. Stewart, CFA, John J. Neumann, Christopher R. Knittel, and Jeffrey Heisler, CFA, “Absence of Value: An Analysis of Investment Allocation Decisions by Institutional Plan Sponsors,” Financial Analysts

Journal, Vol. 65, No. 6, November/December 2009, 34-51; Andrea Frazzini and Owen A. Lamont, “Dumb Money: Mutual Fund Flows and the Cross-Section of Stock Returns,” Journal of Financial Economics, Vol. 88, No. 2, May 2008, 299-322; and Amit Goyal and Sunil Wahal, “The Selection and Termination of Investment Management Firms by Plan Sponsors,” The Journal of Finance, Vol. 63, No. 4, August 2008, 1805-1847. 14 Beneish and Whaley observed a similar pattern when they examined the trailing TSRs of stocks deleted from and added to the S&P 500 Index from 1996-2001. They found that stocks deleted from the index had average abnormal returns of -77 percent over the two years prior to removal, while stocks added to the index saw average abnormal returns of 290 percent for the two years prior to their introduction.

15 Kalok Chan, Hung Wan Kot, and Gordon Tang examined changes in the S&P 500 from 1962 to 2003 and found that added and deleted stocks both delivered strong long-term results and that the average abnormal return for the deleted stocks exceeded those of the added stocks. They attribute the positive results for added stocks to “increases in institutional ownership, liquidity, and analyst coverage, and a decrease in the long-term shadow cost,” and for deleted stocks to “a rebound in institutional ownership and liquidity after stock deletion.” They note that “the long-term operating performance declines for added stocks and increases slightly for deleted stocks subsequent to the year of stock addition or deletion (year t),” suggesting that “firms are added to the index during their peak performance stage and cannot sustain this performance in the long-run. In contrast, firms are deleted from the index during their worst performance stage but tend to recover somewhat in the long term.” See: Kalok Chan, Hung Wan Kot, Gordon Y.N. Tang, “A comprehensive long-term analysis of S&P 500 index additions and deletions,” Journal of Banking & Finance, Vol. 37, No. 12, December 2013, 4920-4930. Anita Arora, Lauren Capp, and Gary Smith found similar results for the Dow Jones Industrial Average. The authors examined all additions and deletions to the Dow since 1928, excluding changes due to M&A or due purely to a name change. They created two portfolios, one of added stocks and one of deleted stocks, and then tracked their performance, accounting for changes to the Dow over time. The authors found the deleted stocks, with annual returns of 15.9 percent, handily beat the added stocks, with annual returns of 11.5 percent. The authors conclude that the results are statistically significant and cannot be explained by Carhart’s four-factor model (CAPM, size, valuation, and momentum). See Anita Arora, Lauren Capp, and Gary Smith, “The Real Dogs of the Dow,” Journal of Wealth Management, Vol. 10, No. 4, Spring 2008, 64-72. 16 Michael C. Jensen, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers,” American Economic Review, Vol. 76, No. 2, May 1986, 323-329.

17 Full for a full description of how Fortune chooses the list, see: http://beta.fortune.com/global500/.

The years in our chart reflect the year of the financial results, not the year that Fortune published the list. For example, we count the 2016 Fortune 500 to be 2015 because the list published in 2016 largely reflects financial results for the year 2015. We exclude 1994 because Fortune changed its methodology that year, which led to a significantly high turnover number. To better represent changes in the U.S. economy, Fortune began to include service firms in its Fortune 500 list instead of listing them separately.

18 We follow the presentation of Dane Stangler and Sam Arbesman, “What Does Fortune 500 Turnover Mean?” Ewing Marion Kauffman Foundation, June 2012.

19 We are only able to track nine years following 1985 because Fortune changed its methodology in 1994 by expanding beyond industrial, energy, and manufacturing firms to include service firms as well. 20 Leslie Hannah, “Marshall's ‘Trees’ and the Global ‘Forest’: Were ‘Giant Redwoods’ Different?” in Naomi R. Lamoreaux, Daniel M. G. Raff and Peter Temin (eds.), Learning by Doing in Markets, Firms, and Countries (Chicago: The University of Chicago Press, 1999), 253-293.

21 U.S. Census Business Dynamics Statistics (September 2016 release containing data through 2014) and The World Bank (data through 2015).

22 Timothy Dunne, Mark J. Roberts, and Larry Samuelson, “Patterns of firm entry and exit in U.S. manufacturing industries,” RAND Journal of Economics, Vol. 19, No. 4, Winter 1988, 495-515 and Timothy Dunne, Shawn D. Klimek, Mark J. Roberts, and Daniel Yi Xu, “Entry, Exit, and the Determinants of Market Structure,” RAND Journal of Economics, Vol. 44, No. 3, Fall 2013, 462-487.

Brian Headd, Alfred Nucci, and Richard Boden, “What Matters More: Business Exit Rates or Business Survival Rates?” BDS Statistical Brief, U.S. Census Bureau, 2010.

24 Charles A. O’Reilly, III and Michael L. Tushman, Lead and Disrupt: How to Solve the Innovator’s Dilemma (Stanford, CA: Stanford University Press, 2016).

25 S&P Dow Jones Indices, “S&P Dow Jones Indices Announces Changes in Treatment of Multiple Share Classes in U.S. Indices and Revises Previously Announced Treatment of Google Stock Split,” March 11, 2014. See https://www.spice-indices.com/idpfiles/spice-assets/resources/public/documents/81745_multisharecgoogle2.pdf.

26 S&P Dow Jones Indices, “S&P U.S. Indices: Methodology,” January 2017. For the latest methodology, see http://www.spindices.com/documents/methodologies/methodology-sp-us-indices.pdf.

Sources for exhibit 1: Credit Suisse; Credit Suisse HOLT; Dane Stangler and Sam Arbesman, “What Does Fortune 500 Turnover Mean?” Ewing Marion Kauffman Foundation, June 2012. Madeleine I. G. Daepp, Marcus J. Hamilton, Geoffrey B. West, and Luís M. A. Bettencourt, “The mortality of companies,” The Royal Society Publishing, Vol. 12, No. 106, April 1, 2015; U.S. Census Bureau, Center for Economic Studies, Business Dynamics Statistics; Timothy Dunne, Mark J. Roberts, and Larry Samuelson, “Patterns of firm entry and exit in U.S. manufacturing industries,” RAND Journal of Economics, Vol. 19, No. 4, Winter 1988, 495- 515 and Timothy Dunne, Shawn D. Klimek, Mark J. Roberts, and Daniel Yi Xu, “Entry, Exit, and the Determinants of Market Structure,” RAND Journal of Economics, Vol. 44, No. 3, Fall 2013, 462-487.