Index Membership and Small Firm Financing
49 Pages Posted: 23 Dec 2015 Last revised: 26 Oct 2020
Date Written: October 3, 2017
This paper investigates the extent to which index membership affects small firm financing. Using a regression discontinuity specification around the lower cutoff of the Russell 2000 small-cap index, we find that index membership causes small firms to transition away from bank financing in favor of seasoned equity offerings. These effects are concentrated in the year following Russell 2000 additions and do not reverse immediately upon deletions. Liquidity, the elasticity of demand for equity, and analyst coverage also significantly increase following Russell 2000 additions, but do not significantly decrease following deletions. Finally, firms added to the Russell 2000 obtain lower spreads and have fewer covenants on the bank loans that they do initiate. Our findings are consistent with index membership mitigating the financing frictions of small firms by improving their information environment through increased investor awareness.
Keywords: Bank Borrowing, Seasoned Equity Offering, Regression Discontinuity, Index Membership, Russell 2000 Index
JEL Classification: G32, G21, G24
Suggested Citation: Suggested Citation