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A Market-Based Alternative to Corporate Governance

November 22, 2020

Within the public company structure, firm ownership and control are separate. This disconnect can misalign the interests of the two parties. As a result, owners often clamor for good corporate governance procedures. But what constitutes good corporate governance? Do widely touted governance measures actually add value and lead to better market performance?

We propose a market-based alternative for determining effective corporate governance policies. We go on to highlight the value that may result from such an approach.

What Is Good Corporate Governance?

Governance policies such as staggered boards, separation of the Chairman and CEO positions, and the dual share class structure have been widely debated. However, the empirical evidence concerning their efficacy has been mixed. [1]

We believe that a market-based approach may help to better measure the efficacy of corporate governance policy.

Governance-Based Index Funds

Governance-based index funds could provide investors with access to synthetic governance. Funds could be constructed to include or exclude companies with certain governance policies.

Currently, many of the large index families, such as S&P, MSCI, & FTSE, are excluding or limiting dual share class companies from their families of broad-market indices.

A bespoke index may be constructed to include only dual share class companies. Such an index exists in the form of the North Shore Dual Share Class Index.

We believe that such indices offer potential benefits in the marketplace.

Potential Benefits of Corporate Governance Indices

First, they may provide a solution to the inability of index funds to exercise market discipline by selling the stock of companies with bad corporate governance. Because an asset manager can offer a “good governance” fund in which governance is an investment criterion, asset flows into that fund may have the effect of reducing the cost of capital for the fund’s portfolio companies.

Second, governance funds may offer a market-based mechanism to evaluate the effect of corporate governance empirically. If, as many large institutional investors claim, certain bad governance features are value-decreasing, good governance funds should outperform their broad-based peers and attract inflows from investors.

Finally, synthetic governance may provide a mechanism to enhance management accountability by providing passive investors a mechanism to subject the governance choices of their portfolio companies to capital market discipline.

By providing a simple and low-cost investment strategy based on governance provisions, governance index funds may allow capital flows to select which governance features are value increasing. As such, we believe that corporate governance index funds are a market-based alternative to regulation, a tool for enhancing the market discipline of firm-specific governance choices.

Potential Benefits of the Dual Share Class Structure

One widely debated corporate governance policy Is the dual share class structure. We believe that this corporate structure allows a firm’s founders or knowledgeable insiders to implement its long-term vision while insulating it from short-term market pressures.

How may the argument of whether the dual share class structure may be value-adding or decreasing?

The North Shore Dual Share Class ETF (DUAL)

The North Shore Dual Share Class ETF (DUAL) seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the North Shore Dual Share Class Index. The index is designed to track the performance of dual-class companies incorporated in the United States.

DUAL may be instrumental in evaluating whether the dual class structure is value-adding, as we believe, or not.

DUAL may provide investors with an attractive vehicle to gain exposure to the potential benefits of dual share class companies.


[1] Ahn, Byung Hyum; Fisch, Jill E; Patatoukas, Panos N. & Solomon, Steven Davidoff, Synthetic Governance

Exchange Traded Concepts, LLC serves as the investment advisor. The Fund is distributed by SEI Investments Distribution Co. (1 Freedom Valley Drive, Oaks, PA 19456), which is not affiliated with Exchange Traded Concepts, LLC, North Shore Indices, or any affiliates. Check the background of SIDCO on FINRA’s BrokerCheck.

Carefully consider the Fund’s investment objectives, risk factors, charges and expenses before investing. This and additional information can be found in the Fund’s full or summary prospectus, which may be obtained by visiting ( dualetf.com). Investors should read it carefully before investing or sending money.

Investing involves risk, including possible loss of principal. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from social, economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Narrowly focused investments, investments in smaller companies, and those in commodities typically exhibit higher volatility. Issuers in energy-related industries can be significantly affected by fluctuations in energy prices and supply and demand of energy fuels.

There is no guarantee the fund will achieve its stated objective. Indices are unmanaged and do not include the effect of fees. One cannot invest directly in an index. The fund is non-diversified.

Shares are bought and sold at market price (not NAV) and are not individually redeemed from the Fund. Brokerage commissions will reduce returns. Market price returns are based upon the midpoint of the bid/ask spread at 4:00 PM Eastern time and do not represent the returns you would receive if you traded shares at other times. The first trading date is typically several days after the fund inception date. Therefore, NAV is used to calculate market returns prior to the first trade date because there is no bid/ask spread until the fund starts trading.

Dual Share Class Companies create unique risks. Dual Share Class Companies allow for a concentration of voting power in the hands of company insiders through a disproportionate allocation of voting rights among stockholders, which may negatively affect common stockholders in a variety of ways. For example, a company’s owners may use such power for personal benefit, while passing on financial risk to common stockholders. Further, Dual Share Class Companies allow entrenchment of management in the company, which may prevent common stockholders from being able to address issues relating to mismanagement of the company, such as share dilution, increased company debt, and financial underperformance relevant to the market. Investing only in a portfolio of Dual Share Class Companies may impact the Fund’s relative investment performance depending on whether such investments are in or out of favor in the market. A portfolio of Dual Share Class Companies may underperform a portfolio that includes companies with traditional ownership structures.