Market Capitalization Changes For S&P 500 Inclusions And Exclusions

A Regression Analysis

Research Paper (postgraduate) 2015 20 Pages

Business economics - Investment and Finance




1. Introduction

2. Theoretical background
2.1 Hypotheses

3. Dataset

4. Regression analysis
4.1. Inclusions

5. Limitations

6. Recommendations for further research

7. Conclusion

8. Sources


Previous research has already proven that firms which get included in or excluded from the S&P 500 index experience stock price changes that ultimately result in market capitalization changes. The causes of these changes has extensively been examined, but a consensus on the true cause has not yet been reached. In this paper the market capitalization effect is examined by making a distinction between the reasons for inclusions and exclusions. It is argued that expected events, like bankruptcy and index-downgrading, have lower price effects than unexpected events, which include mergers and acquisitions. By usage of a regression analysis it is concluded that there is no difference in price effects between the individual reasons for inclusions and exclusions. However, when the reasons are grouped into unexpected and expected events there is a significant effect for the inclusions. Firms which expectedly enter the index experience lower market capitalizations changes than firms which unexpectedly entered the index. This effect could not be proved for exclusions.

1. Introduction

The composition of the S&P 500 index is constantly changing. Firms get excluded from the index when their performance decreases, they are acquired by another firm, the firm spins off part of its operations, and for several other reasons. A growth in market capitalization or mergers might cause a firm to be included in the index. These firms which get included in or excluded from the S&P 500 index often experience stock price changes. Many researchers investigated this effect and they have come up with several reasons for these price changes, they will be discussed in the rest of the paper.

However, there does not seem to be a constant price effect; while the effect is large for one firm, it might be relatively small for another. So, what determines the differences between the price effects for these firms? The reason for the inclusion or exclusion might be a significant factor for these effects. This paper examines the different reasons for S&P 500 inclusions and deletions and explores the differences between the price effects related to these reasons.

First, the theories proposed by several academics are discussed. Secondly, the reasons for S&P 500 changes are examined and used to form the hypotheses of this research. Thirdly, the dataset is discussed and the frequency distribution of the different reasons is reviewed. Fourthly, the hypotheses are tested using a regression analysis. Furthermore, the limitations of the research are explained and recommendations are given on future research. Finally, the results of the research are summarized and followed by a conclusion.

2. Theoretical background

Companies that are added to the S&P 500 index will experience positive price effects, while companies that are delisted from the index will suffer from negative price effects (Lynch & Mendenhall, 1996). Three hypotheses try to define the cause of this effect.

The information hypothesis claims that announcements of S&P 500 index additions often provide non-public favourable information about the added firm which leads to a permanent price increase. Baran and King (2014) found that information asymmetry decreases for inclusions, but the asymmetry increases for deletions. This means that the information about firms which are part of the S&P 500 is more public than the information about firms who are not part of the index.

The price pressure hypothesis however pleads for a temporary increase in price because of higher demand. The demand increases because investors have to add the firm to their portfolio, in order to duplicate the market portfolio. Lastly, the downward sloping demand curve hypothesis argues for a long-term price effect. When there are no perfect substitutes for a stock its demand curve will indeed be downward sloping (Cai, 2007).

Chen et al. (2006) were unable to find evidence for any of these hypotheses and presented a new potential cause: changes in investor awareness. They argue that investors are already familiar with firms which get delisted from the S&P 500 index, these well-known firms will therefore suffer from mild and temporary price decreases. First-time additions to the index are however paired with large price increases since investors did not know of the profitableness of these firms beforehand. The data which Chen et al. (2006) gathered confirmed their hypothesis; investor awareness leads to significant price increases after additions but smaller price declines after deletions.

This asymmetric price effect can be examined in more detail. Zhou (2011) made a distinction between pure or new-entry additions and upward or re-entry-additions. Firms which were never listed in a S&P index and enter such an index are categorized as pure additions while firms which were already listed in a S&P index and get promoted to the S&P 500 are categorized as upward additions. According to the investor awareness hypothesis pure additions lead to greater price effects than upward additions. Zhou (2011) found evidence for this hypothesis and also concluded that the model can be applied to deletions.

While the research described above made distinctions between pure additions versus upward additions and first-time additions versus second-time additions, no distinction was made between the reasons for these additions. In this paper the additions and deletions will be paired with a specific reason for this event.

2.1 Hypotheses

There are several reasons for a firm to be included in or excluded from the S&P 500, Table 1 provides an overview. The main difference between these reasons is their time-intervals. While you can predict that a firm will go bankrupt based on their recent results, mergers and acquisitions can happen unexpected. Negotiations about a merger may start at an early stage but this information is often private. The information will only become public when the two merging firms have agreed on the merger conditions.

Table 1

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Reasons for S&P 500 inclusions and exclusions

When investors know that a firm is likely to enter the S&P 500 in the near future they could already start investing in their stock, anticipating on a price increase. The price effect on the actual day of inclusion of this firm will therefore be lower than the price effect for firms which unexpectedly enter the index. For inclusions; a small price change occurs for the ‘market capitalization growth’ reason, since this is an expected event. Acquisitions, mergers, spin-offs and S&P rule changes are however unexpected and a large price change will occur in these situations. For exclusions; bankruptcy, delisting, and index downgrading are expected events and cause a small price decrease while mergers, acquisitions, spin-offs and rule changes are unexpected and cause a large price decrease.

To be more thorough this research does not investigate just the price change but the change in market capitalization, which is the price of the stock multiplied by its volume. This reasoning leads to the following two hypotheses:

H1: The market capitalization effect on or around the date of inclusion of a stock which gets included in the S&P 500 index is higher for firms which enter because of acquisitions, mergers, spin-offs and rule changes than for firms which enter because of market capitalization growth.

H2: The market capitalization effect on or around the date of exclusion of a stock which gets excluded from the S&P 500 index is higher for firms which leave because of mergers, acquisitions, spin-offs and rule changes than for firms which leave because of bankruptcy, delisting, and index downgrading.

3. Dataset

The initial dataset of this research consisted of 1,017 firms. This led to data on 450 inclusions and 473 exclusions. Note that there is not data for every firm in the dataset: some firms never left the index, for other firms valuable information could not be found.

The frequency distribution is shown in the next tables. A firm often entered because something happened to a firm which was in the index. This is depicted by an ‘X’ after the reason. For example, ‘AcquiredX’ means that the firm entered the S&P 500 because another firm got acquired and therefore left the index.

The reasons for inclusions were divided into four categories: mergers, new rules, growth and other:

Table 2

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Frequency distribution for inclusions

Table 3

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Clarification of ‘other’ category for inclusions



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Maastricht University
finance S&P500 stocks stock market portfolio



Title: Market Capitalization Changes For S&P 500 Inclusions And Exclusions