Strategic Adjustment of Capital Structure: Evidence from S&P 500 Index Additions

48 Pages Posted: 25 Mar 2019

See all articles by Eunpyo Hong

Eunpyo Hong

George Washington University

Min Hwang

George Washington University - Department of Finance

Jiyoon Lee

George Washington University - Department of Finance

Date Written: March 6, 2019

Abstract

We examine the capital structure of firms that are newly added to the S&P 500 index. Leverage gradually decreases during the two-year pre-addition period and then increases during the two-year post-addition period, resulting in a U-shaped trend. This trend is more pronounced in financially weak firms and firms facing intense competition for index addition. This U-shaped leverage trend also exists among firms that compete for addition to the index but not among similar firms that do not compete for addition. The sharp shift in the direction of the leverage trend after addition is attributable mainly to increases in debt issuance and cannot be explained by mechanical mean reversion of leverage or changes in the cost of capital. The overall results are consistent with firms' strategically reducing leverage to improve financial health prior to index revisions. The post-addition reversion of leverage suggests that the pre-addition-period improvement in financial health is temporary, and is consistent with the existence of a target capital structure.

Keywords: S&P 500 index, capital structure, target leverage

JEL Classification: G30, G32

Suggested Citation

Hong, Eunpyo and Hwang, Min and Lee, Jiyoon, Strategic Adjustment of Capital Structure: Evidence from S&P 500 Index Additions (March 6, 2019). Available at SSRN: https://ssrn.com/abstract=3263539 or http://dx.doi.org/10.2139/ssrn.3263539

Eunpyo Hong

George Washington University ( email )

2023 G Street
Washington, DC 20052
United States

HOME PAGE: http://https://sites.google.com/site/eunpyohong19

Min Hwang

George Washington University - Department of Finance ( email )

2023 G Street
Washington, DC 20052
United States

Jiyoon Lee (Contact Author)

George Washington University - Department of Finance ( email )

2023 G Street
Washington, DC 20052
United States

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