Keeping Up with the Joneses and the Real Effects of S&P 500 Inclusion

The S&P 500 index is the most visible and prestigious broad-based stock index in the U.S. Being included in it means joining an exclusive club that confers prestige on its members, as, for instance, many articles noted when Tesla was included in the index. If there is a “keeping up with the Joneses” effect for corporations, we would expect them to change their policies to fit with their peers once they joined the club. This effect has been studied for individuals but not for corporations, and S&P 500 inclusion offers a good opportunity to do so.

Joining the S&P 500 is fundamentally different from joining most other indices because of the central role the index plays in U.S. capital markets. Firms included in the index receive more attention. When a firm joins the S&P 500, for example, Google searches of the company increase in the following month.  No such increase occurs when the firm joins the Russell 1000 index. In addition, attention to the SEC filings of a firm increase following its inclusion in the S&P 500 index.

When a firm joins the index, the “keeping up with the Joneses effect” implies that the firm would put more weight on the behavior of its index peers than before. There is a large literature on peer effects in finance and how they may reflect social learning or social utility, including mimicking or herd behavior. Our setting is different from that discussed in this literature because we predict a change in the importance a firm gives to a subset of peers. We explore whether a firm’s corporate policies are influenced more by index peers after it becomes a member of the S&P 500 than before. We find that firms that join the index access the SEC fillings of index peers substantially more often. Further evidence that the included firm has joined a prestigious club is that they increase the number of board members with experience at an S&P 500 company and change the peer group for managerial compensation to include more S&P 500 firms. Both effects are strong.

We also investigate whether firms added to the index change their investment policies to be more similar to those of their index peers. We find that, on average, S&P 500 firms invest less than other firms, controlling for given characteristics, and we would therefore expect added firms to reduce their investment. We show that this is the case. Further, we would expect investments by included firms to change more in correlation with their S&P 500 peers. We find strong evidence supportive of this prediction. Next, we turn to payout policies. On average, S&P 500 firms repurchase more stock than do other firms. When a firm is added to the index, its repurchases increase by 1.8 percent of total assets, on average. We further show that the repurchases of an added firm correlate more with the repurchases of index peers after inclusion.

A possible explanation for the peer effects we document is that they are driven by investors rather than by management and the board of the included firm. As a firm is added to the index, we show that it usually acquires more passive investors and loses blockholders. Overall, however, the firm does not experience an increase in institutional ownership. The increase in passive ownership implies that the firm has more investors that invest in it because it belongs to the S&P 500 than because of its fundamental characteristics. This increase in passive ownership could prompt the firm’s stock price to move more in correlation with its index peers, but we find no such effect.

The change in stock ownership could affect how investors expect the firm to act. There are two possible theories of change in investor behavior that could explain the peer effects we document. The first is that investors, including institutional investors, believe that firms in the index must behave in a certain way and influence management to behave accordingly. The second possibility is that inclusion increases common ownership and therefore changes the objective that investors want the firm to pursue. There is no good way to differentiate the first theory from one where the peer effects are driven by management and the board without a push from investors. The second theory is easier to assess. The main prediction of common ownership theories is that an increase in common ownership reduces competition. We therefore investigate whether we can identify an impact of index inclusion on competition. We find no such impact.

In sum, we find that joining the prestigious club of the S&P Index leads a firm to change its corporate policies, draws more attention to the firm, and prompts the firm to pay more attention to its index peers. In addition, its compensation peers include more S&P 500 firms, and its board has more members with experience at S&P 500 companies. Investment, external financing, and payouts also correlate more with index peers after inclusion. These effects are consistent with the “keeping up with the Joneses” effect.

This post comes to us from professors Benjamin Bennett at Tulane University; René M. Stulz at The Ohio State University, the National Bureau of Economic Research, and the European Corporate Governance Institute; and Zexi Wang at Lancaster University. It is based on their recent article, “Keeping Up with the Joneses and the Real Effects of S&P 500 Inclusion,” available here.