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Index Membership and Small Firm Financing

62 Pages Posted: 23 Dec 2015 Last revised: 23 Sep 2016

Charles Cao

Pennsylvania State University

Matthew Gustafson

Pennsylvania State University - Smeal College of Business

Raisa Velthuis

Villanova University - Department of Finance

Date Written: September 22, 2016

Abstract

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 because it improves the 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

Cao, Charles and Gustafson, Matthew and Velthuis, Raisa, Index Membership and Small Firm Financing (September 22, 2016). Available at SSRN: https://ssrn.com/abstract=2707337 or http://dx.doi.org/10.2139/ssrn.2707337

Charles Cao

Pennsylvania State University ( email )

Department of Finance
Smeal College of Business
University Park, PA 16802
United States
814-865-7891 (Phone)
814-865-3362 (Fax)

HOME PAGE: http://www.personal.psu.edu/qxc2/cao.html

Matthew Gustafson (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

East Park Avenue
University Park, PA 16802
United States

Raisa Velthuis

Villanova University - Department of Finance ( email )

United States

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