Description:
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 and is primarily driven by debt policies. This leverage trend 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 temporarily prior to index revisions