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S&P 500 Index Additions and Cash Holding Decisions

Existing research discusses the sources of abnormal market performance of newly added S&P 500 firms and suggests that the Index addition might cause changes in the corporate governance and firm financial characteristics. We examine the relation between cash holdings and firm characteristics after S&P 500 addition and propose that both firm characteristics and capital market perception change after Index addition. In contrast to size, cash held by S&P 500 additions persistently decreases before and following inclusion. Although S&P additions still have larger Q compared to their peers, Q is significantly lower after their inclusion, and results are robust to the selection of data frequency and the choice of a benchmark group. The trend reversal cannot be explained with the level/changes in cash flows and size, which are also included in the estimation model. Furthermore, our instrumental variable estimates suggest that R&D, as a proxy of investment opportunities, demand even larger than previously expected liquidity buffers.