Index Creation, Information Changes, and Financing

Abstract

We analyze how financing responds to shifts in passive demand when firms are added to equity indexes. Using a worldwide sample of index launches and changes to index methodologies, we show that firms issue more debt and become more leveraged when they are added to indexes. Although there is more information production, as measured by an increase in analyst following and news coverage, index additions do not improve stock price informativeness. The findings are consistent with active investors producing additional information, which just about offsets the increased noise in stock prices due to greater inelastic demand. The additional information benefits debt investors, with bonds becoming more liquid, ratings improving, and yield spreads declining. As a result, indexed firms increase their reliance on public debt. We also find that the debt response is stronger in countries with weaker information environments, consistent with information changes driving debt responses. We find no support for corporate governance changes producing the financing responses around index additions.

Keywords: index membership, leverage, information, stock price informativeness, cost of debt

JEL Classification: G14, G15, G32