By Telis Demos
The keepers of the Dow Jones Industrial Average have made it
clear that companies that do business in the U.S. but are
incorporated overseas aren't eligible for the stock-market
benchmark. The new definition will preclude companies that have
moved abroad through tax-lowering inversion deals from being in the
blue-chip index.
A committee overseeing the Dow index this month adopted new
language in its methodology requiring member companies to be
incorporated and headquartered in the U.S. In addition, the U.S.
must be a company's biggest revenue-generating country.
While those criteria were historically understood, they hadn't
been formally written down as the benchmark's rules, said David
Carlson, director of U.S. and Canadian equity indexes at S&P
Dow Jones Indices, which oversees the Dow index.
"Considering this is one of the oldest indices, and always
considered to be a purely U.S. index, we wanted to maintain that
legacy," said Mr. Carlson, who added the move had been in the works
for some time. S&P Dow Jones Indices is a part of McGraw Hill
Financial Inc.
The Dow tracks 30 stocks from different sectors, ranging from
drug maker Merck & Co. to media company Walt Disney Co. The
stocks are selected and criteria are set by a committee that
doesn't use a quantitative method but instead looks at the
reputation, growth and prominence of the companies. Wall Street
Journal editors are among the committee's members, as is Mr.
Carlson.
The new language comes at a sensitive time, as a number of large
U.S. companies are in the process of incorporating outside the U.S.
through mergers that allow them to cut their corporate tax rates.
In such deals, known as inversions, a U.S. firm buys an overseas
company and relocates its legal home to a lower-tax country such as
the U.K. or Ireland.
Since 2009, at least 35 U.S. companies have relocated overseas
for tax purposes, according to a study by S&P Capital IQ. Only
25 did so in the preceding eight years, the study found.
The Dow Jones Industrial Average methodology also states that
companies must be in the S&P 500 index, a broader benchmark of
the U.S. market, to be considered for inclusion. Although the
S&P 500 also is limited to U.S. companies, it doesn't
disqualify companies that move their legal headquarters abroad if
they continue to meet other criteria.
At present, 24 companies in the S&P 500 are headquartered
outside the U.S., and four more are incorporated overseas but still
have main offices in the U.S., according to S&P Capital IQ.
Seven companies in the S&P 500 have recently announced
inversion deals, according to S&P Capital IQ. None are in the
Dow.
One Dow constituent that recently considered an inversion was
Pfizer Inc. The drug maker's bid this year to buy U.K.-based
AstraZeneca PLC was rebuffed, and in recent weeks it explored a
tax-lowering takeover of Ireland-based Actavis PLC, the Journal
reported Tuesday.
The Dow's move to explicitly exclude non-U.S.-based companies
could in theory have share-price implications for companies that
choose to do inversions, as some index funds may be forced to sell
those stocks.
The Dow, however, has $33 billion in assets tied to the index,
compared with the S&P 500, which has about $1.9 billion.
The Dow's move comes as other index providers have decided to
make it easier to retain companies that reincorporate overseas.
Most of the major index providers "have methodologies that make
sure [companies] won't suddenly be excluded from American indices
and moved to [foreign] ones," said Spencer Bogart, an analyst at
ETF.com, which tracks indexes and exchange-traded funds.
"Inversions won't have any real impact" on stock ownership.
Mat Lystra, senior research analyst for Russell Investment
Group's stock indexes, said the company--whose indexes include the
Russell 3000 index of small-capitalization companies-- in 2010
adopted more flexible criteria for determining a company's home
country.
Before the change, he said, "incorporation was the only thing we
looked at. But it's not sufficient anymore. Where to incorporate
has become a strategic decision for a company.
"We're trying to parse out companies where it is just a
strategic decision, like an inversion, but also want to acknowledge
when a business and its operations have changed," he said.
Write to Telis Demos at telis.demos@wsj.com
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