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1. Introduction
This paper makes two contributions. First, it provides an explanatory choice model that explains the S&P 500 index inclusion decision. Typically, Standard & Poor's (S&P) must choose among several eligible firms that satisfy its explicit criteria. The paper examines several fundamental financial performance and risk measures that plausibly constitute implicit inclusion criteria. These are incorporated into a model that differentiates well between the included firms and those eligible but not added (ENA). Thus, S&P appears to select firms with stronger intrinsic financial positions based on traditional fundamental analysis. Second, it investigates whether the identified implicit criteria provides information that is not already impounded in price, and therefore can help explain the positive abnormal returns attached to index inclusion. I find that although the S&P committee may have some foresight into future firms' performance, this does not constitute a significant disclosure that would affect price at inclusion, rather it is consistent with wanting to ensure positive and persistent operating performance after inclusion.
S&P claim that "company additions to and deletions from an S&P equity index do not in any way reflect an opinion on the investment merits of the company" ([32] Standard and Poor's 2002, p. 1), yet researchers have consistently documented significant and permanent abnormal returns around S&P 500 (hereafter index) inclusion announcements (e.g. [31] Shleifer, 1986; [25] Lynch and Mendenhall, 1997; [8] Chen et al. , 2004). The "information hypothesis" argues that new S&P 500 index additions convey favourable information about the added firms to the market, which is reflected in the abnormal and permanent stock price reaction around the index inclusion announcements. [22] Jain (1987), [12] Dhillon and Johnson (1991), [11] Denis et al. (2003) all provide indirect evidence in favour of the information hypothesis. None of these studies, however, has specifically examined the uncertainty concerning the selection criteria, nor have any identified the information that is ostensibly revealed at inclusion announcements. In this paper, by identifying variables that explain the inclusion decision, I also identify variables that are candidates to capture the information explaining the attendant abnormal returns if the information hypothesis is correct that the inclusion choice conveys information not previously impounded in price. Alternatively, the variables that explain the inclusion choice may reflect information fully impounded in...