IBEX 35 Inclusiones and Exclusiones

IBEX 35 Inclusiones and Exclusiones

Jay Dahya

Baruch College, CUNY

and

Laura Galguera García

University of Oviedo

March 29, 2012

Dahya is from Baruch College, The City University of New York, and García is from the University of

Oviedo. This paper has benefited from the helpful comments and suggestions of Andrew Ang, Yakov

Amihud, Stephen Brown, David Denis, Larry Glosten, Raghu Rau, Kishore Tandon, Linda Allen, Colin

Mayer, John McConnell, Erik Lie, Darius Palia, David Reeb, Robert Schwartz and seminar participants at

Baruch College, Cambridge University, Concordia University, Oxford University, University of Iowa,

and the European Finance Association Meetings. We thank the Bolsa de Madrid for allowing access to

data used in the study. Dahya acknowledges financial support from the Baruch College Fund and the

Eugene M Lang Junior Faculty Fellowship.

Correspondence: Jay Dahya, Associate Professor of Finance, Baruch College, The City University of

New York, Box B10-225, One Bernard Baruch Way, New York, NY 10010-5585, Ph. 646-312-3511,

email: [email protected]


The extant evidence on S&P 500 Index additions reports a permanent positive stock price effect to news

of index membership. This result is touted in favor of a long-run downward sloping demand curve for

stocks. It is well-known that S&P 500 Index additions are selected on criteria covertly set by S&P.

Consequently, studies on S&P 500 Index additions cannot rule out S&P certification, if any, and its

impact on stock prices. In this study, we circumvent this restriction by scrutinizing the IBEX 35 Index

which comprises the 35 most liquid publicly-traded Spanish stocks. IBEX 35 Index additions (and

deletions) are automatic and based solely on stock liquidity. In this certification-free setting, our results

reveal transitory price pressure effects to IBEX 35 Index changes, after controlling for contemporaneous

changes in information content and information production. These findings are most consistent with a

short-run downward sloping demand curve for Spanish stocks.

JEL Classification: G14

Keywords: Demand curves; Index changes; IBEX 35 Index; Spain


Academics and industry practitioners have devoted considerable effort to establish whether stocks have

perfect substitutes that give rise to horizontal demand curves. If demand curves for stocks are indeed

horizontal, then a surge in demand or supply for a stock, absent new information, should have little effect

on prevailing stock prices. Equity index reconstitution offers an ideal setting to test whether changes in

stock prices occur in the absence of new information. The extant evidence on equity index changes has

focused on the S&P 500 Index. From an inspection of these studies, Harris and Gurel (1986) and Lynch

and Mendenhall (1997) report results consistent with price pressure effects and a short-term downward

sloping demand curve for stocks. If stocks have a short-term downward sloping demand curve then

prices should only momentarily be affected by a change in demand induced by S&P 500 indexing. Any

temporary price-pressure should dissipate once excess demand for the stock is satisfied. If the stock price

is permanently affected by S&P 500 indexing then evidence is consistent with a long-run downward

sloping demand curve for stocks. Studies by Shleifer (1986), Goetzmann and Garry (1986), Jain (1987),

Dhillon and Johnson (1991), Beneish and Whaley (1996), Blouin, Raedy, and Shackelford (2000), Blume

and Edelen (2001), Chordia (2001), Wurgler and Zhuravskaya (2002), Elliott and Warr (2003), Hegde

and McDermott (2003), and Denis, McConnell, Ovtchinnikov, and Yu (2003), hereafter DMOY (2003)

report a permanent stock price effect to index additions which is consistent with a long-run downward

sloping demand curve for stocks.

Permanent price effects to index changes do not always support a downward sloping demand

curve. If the long-run change in stock price is contemporaneous with stock inclusion certification by

index compilers, or a change in the required rate of return and/or expected earnings, then the belief that

demand curves are downward sloping may be misplaced. For example, Jain (1987), Dhillon and Johnson

(1991), DMOY (2003), Hegde and McDermott (2003) and Chen, Noronha, and Singhal (2004), hereafter

CNS (2004), among others, show that a permanent positive price effect to S&P 500 Index additions is

also consistent with information content and information production that (a) causes index inclusion and/or

(b) leads to an improvement in corporate performance. In establishing whether stock price effects occur

in the absence of new information, academic studies have been unable to rule out if S&P certify stocks for

inclusion in the S&P 500 Index. Although the S&P boasts that S&P 500 Index membership is based on

public information, the S&P does admit to employ a secretive selection procedure when determining

stocks for inclusion and exclusion.

It is this possibility that gives rise to our analysis of IBEX 35 Index changes. Unlike the S&P

500 Index, the IBEX 35 comprises stocks ranked solely on liquidity as measured by turnover and trading

volume. To construct the IBEX 35, all companies listed on the Spanish Stock Exchanges are ranked

according to liquidity and the thirty-five most liquid stocks in terms of turnover and trading volume form

the IBEX 35 Index. Changes in the composition of the IBEX 35 Index are therefore automatic and

preclude index compiler certification. To explore whether changes in stock prices occur in the absence of

certification, we perform a battery of tests on stock prices, realized earnings (and expectations), financing,

proxies on information production, and equity ownership on a sample of IBEX 35 Index changes from

1992 through 2007.

We begin with an event study on stock prices and trading volume surrounding announcements of

additions and deletions to the IBEX 35 Index. We find that neither index additions nor deletions are

associated with any significant move in stock prices on the announcement day. (This is unsurprising

given that the IBEX 35 Index comprises the most liquid Spanish stocks and information on stock liquidity

is readily available to investors. Hence, index reconstitution should be fairly predictable.) The bulk of the

change in stock prices occurs from the announcement day through the effective day of index inclusion or

exclusion. For example, IBEX 35 Index additions are associated with a positive stock price increase of

2.12% from the announcement through the effect day of index membership, which is fully reversed over a

20-day period following physical inclusion of the stocks to the index. Deletions to the index are

associated with a negative stock price response of 2.94% from announcement through effective date,

which is also reversed over a 20-day period after removal of stocks from the index. The event study

results support the price pressure hypothesis, and are therefore most consistent with a short-term

downward sloping demand curve for Spanish stocks.

Examination of long-run price effects to index changes uncovers a sustained increase in stock

prices for up to two years after announcements of index deletions, but no sustained price change to index

additions. The long-run price effects to IBEX 35 Index changes present a fly-in-the-ointment, for two

reasons. First, the stock price effect to index deletions should be negative (and not positive) to credibly

support the view of long-run downward sloping demand curves for stocks (see DMOY (2003)). And

second, the arguments advanced in support of short- and long-run downward sloping demand curves

requires a symmetric price effect to index additions and deletions (see CNS (2004)).

Nonetheless, this asymmetric result might be explained by contemporaneous information content

and information production, which elicits a change in the required return and/or expected earnings, to

news of index exclusion. To explore this further, we examine changes in earnings forecasts (and realized

earnings) of newly added and deleted firms. This analysis documents a slight increase in actual earnings

that is beyond expectations in companies added to the index, which is not statistically significant at the

0.10 level or less. However, we do see a significant up-tick in both expected and realized earnings in

companies recently removed from the index. It would seem that the permanent price effect to index

deletions can, at least in part, be explained by an increase in contemporaneous earnings for companies

forced to leave the IBEX 35 Index.

We then examine factors that might engender a change in the required rate of return in newly

added and deleted companies. To that end, we monitor the ability of firms to attract new capital by

probing financing patterns and other proxies for information production (including media coverage,

analyst following, changes in equity ownership and Merton‟s Shadow cost) for both IBEX 35 Index

inclusions and exclusions. Our analyses reveal that neither index additions nor deletions are associated

with any significant changes in financing, analyst following, equity ownership or Merton‟s Shadow cost.

There is however, a modest increase in equity financing to index additions, and a strong uptick in press

coverage to index deletions, but neither is statistically significant at the 0.05 level or less.

In a setting where index reconstitution is automatic, and lacks index compiler certification, our

findings reveal that stock liquidity primarily drives stock price behavior around IBEX 35 Index additions.

The evidence on IBEX 35 Index deletions is less clear. Companies removed from the index are

associated with an initial drop in stock price which is fully reversed thirty days after index exclusion.

However, over the longer term, there is a sustained increase in the average stock price for this set of firms

which is correlated with an increase in earnings expectations and realized earnings.

In a multivariate setting, after we control for the simultaneous increase in earnings in firms

removed from the IBEX 35 Index, our findings appear most consistent with temporary price pressure

effects to index changes. These findings buttress belief that the demand curve for stocks is downward

sloping in the short-term. As an additional check on the strength of these findings, we run formal tests

centered on stock liquidity changes for sample index changes from 60 days before to 60 after news of the

event (e.g., Amihud (2002)). The results from this analysis reveal transitory deviations in stock prices to

both IBEX 35 Index additions and deletions, which reaffirm the view that the demand curve for Spanish

stocks is short-term downward sloping.

Nevertheless, we still have one unresolved issue. So far, no rational explanation had been

advanced for the improvement in earnings (and expectations) in the set of firms removed from the IBEX

35 Index. To address this hiatus, we examine whether greater scrutiny and pressure exerted by the capital

market on managers of companies recently removed from the index might explain the lasting

improvement in earnings. Since no direct measure of scrutiny or pressure on managers exists, we use

proxies including the rate of „forced‟ top management turnover, and asset and employee restructuring,

from two years before to two years after the index reconstitution date. This analysis reveals that the rate

of CEO turnover increases by 89% following the removal of a firm from the IBEX 35 Index, which is

accompanied by substantial reductions in the asset and employee bases of these companies. In

comparison, we observed a decrease in top management turnover of 9% and fewer announcements of

asset and/or employee restructuring activities in the set of companies that was added to the IBEX 35

Index. Thus, increased capital market scrutiny directed at managers that have been stripped of index

membership appears to elucidate the marked increase in earnings. To confirm this belief, we run

additional multivariate analyses to show that the sustained increase in stock prices following loss of index

membership is largely due to corporate restructuring, which coincides with higher operating performance.

In sum, the evidence on IBEX 35 Index changes is most consistent with the dearth of studies on

S&P 500 Index changes that favor short-run downward sloping demand curves for stocks (and at odds

with the extant evidence in support of long-run downward sloping demand curves). The findings from

this study also hint that index compiler certification may feature in explicating the permanent price effect

observed to S&P 500 Index additions, however an exact measurement on its impact, if any, is beyond the

scope of this study.

The next section of this study provides information on the construction of the IBEX 35 Index and

briefly reviews prior studies on index changes. Section II describes the sample and data. Section III

reports the results of the short- and long-run stock price and volume effects. Section IV presents analyses

on realized and forecast earnings. Section V documents changes in financing, equity ownership, media

coverage, analyst following, and shadow costs from before to after IBEX 35 Index changes. Section VI

presents the multivariate analysis, Section VII presents various robustness checks, and Section VIII

concludes the paper.

I. Background

A. IBEX 35 Index

In comparison to the S&P 500, Dow 30, and FTSE 100, the IBEX 35 has a recent history that dates backs

to 1988. Its origins can be traced to the Society Iberian OM (OMib) who in response to a growth in

futures trading constructed an index, the FIEX 35, comprising thirty-five leading stocks listed on the

Madrid Stock Exchange. In 1990, MEFF Renta Fija established a second Spanish futures market in

Barcelona which resulted in the construction of a second equity index, the MEFF, comprising the largest

stocks on the Barcelona Stock Exchange. The IBEX 35 Index was a result of consolidation of competing

indexes on the Madrid and Barcelona Stock Exchanges. The IBEX 35 Index is a value-weighted index

that was created as an investment instrument which would reflect the general behavior of Spanish equities

and serve as an underlying asset for options and futures trading in Spain. The first trades on the IBEX 35

were made on January 14, 1992, though the index had been in virtual effect since January 2, 1991.

The IBEX 35 is the official index for the market segment of continuously traded stocks which is

composed of the thirty-five most liquid equities quoted in cash pesetas among those listed on the joint

stock exchange system of the four Spanish stock exchanges in Madrid, Barcelona, Bilbao, and Valencia.

The IBEX 35 Index is revised on a semi-annual basis and inclusion in the index is guaranteed for the

thirty-five Spanish stocks that rank highest in terms of liquidity as measured by trading volume and

turnover over a supervision period. The interval of six months prior to the start of January and July serves

as the supervision period for the inclusion (and exclusion) of stocks to the IBEX 35 Index.

The composition of the IBEX 35 Index is amended for routine and special operations. The index

turnovers that are of primary interest to us are routine additions and deletions which occur when a new

stock is one of the thirty-five stocks that ranks highest in terms of liquidity and replaces a stock that is

removed from the index. Those resulting from special operations are removed from our analysis because

they elicit a change in the stable share ownership of the firm, which might itself convey new information

to market participants. A shift in stable ownership can arise from mergers, acquisitions and restructuring

activity. Stocks can also be deleted for special operations when (1) a large fraction of total share turnover

is contracted by a single party, (2) a stock is thinly traded, (3) a stock undergoes a serious drop in

liquidity, or (4) a stock is suspended from trading on the relevant exchange for a lengthy period.

A Technical Advisory Committee (TAC) led by a chairperson and comprising between five to

nine members is responsible for the IBEX 35 Index and their main functions include: (1) supervising the

calculation of the index in accordance with existing technical guidelines set forth by the Sociedad de

Bolsas, SA; (2) examining the proper operation of the index as an underlying index for futures trading; (3)

approving changes in the composition of the index every six months or whenever the Committee sees fit

for operational reasons; and (4) reporting on technical aspects pertaining to the composition of the IBEX

35 Index. 1

The TAC meets every six months to redefine the index for the following semi-annual period.

1 The procedures for IBEX 35 Index reconstitution were overhauled on December 3, 2007. The new rules changed the

organization of the entire market for Spanish stocks, and set new rules on the disclosure of large holdings. The new rules

impacted the IBEX 35 Index, more directly, by altering existing rules on the control period, market capital ranking, and

computation of the index, which would change to use free float weights.

TAC decisions on IBEX 35 Index composition made at ordinary meetings are published within 48 hours

after the TAC meeting and are effective on the first day of the following month.2

As noted above, the IBEX 35 comprises the thirty-five most liquid stocks quoted on the four

Spanish stock exchanges over a six-month supervision period. The TAC determines the inclusion or

exclusion of a stock to the IBEX 35 Index on trading volume (the number of orders in the order-driven

market) and the quality of trading volume as measured by the characteristics and quantity of transactions

made in the market including statistics on buy-sell spreads and turnover. Another key determinant for

IBEX 35 inclusion is that a stock‟s average capitalization must be greater than 0.30% of the average index

capitalization over the six-month supervision period. The TAC does not always require six months of data

on a company for inclusion in the index and on rare occasion will include a stock if it meets the necessary

liquidity requirements within 60 days of the supervision period. The TAC‟s only benchmark is therefore

a stock‟s liquidity and that single observable measure forms the basis of the Committee‟s decisions

regarding IBEX 35 Index addition or removal.

In sum, the role of the TAC is mechanistic and determined solely by a stock‟s relative liquidity

ranking, such that composition of the IBEX 35 Index is in essence an automated process. In contrast, the

S&P Committee utilizes a variety of criteria in their decisions to add and remove stocks from the S&P

500 Index including; stock liquidity, stock ownership concentration, profitability, and U.S. industry

representativeness. Thus, the role of the S&P Committee in implementing S&P 500 Index changes is

unclear and one akin to a private club with fraternal membership criteria.3

B. Prior literature on equity index changes

CNS (2004) provide a comprehensive survey of prior studies on S&P 500 Index changes, thus our review

of this literature will be brief. Prior studies on S&P 500 Index changes can be broadly classified into

three groups. The first group documents a surge (drop) in stock price to news of S&P 500 Index additions

(deletions), which is reversed in subsequent weeks. Harris and Gruel (1986) and Lynch and Mendenhall

2 Any other actions taken at meetings in special session are generally released to the public immediately and become effective as

prescribed by the TAC. 3 Beneish and Whaley (1996) equated S&P 500 Index additions and deletions to a game. A game which entailed a degree of

speculation, since newly added stocks were chosen by the S&P on criteria including industry representation, liquidity, ownership

concentration, profitability, and others that the S&P saw fit.

(1997) both document price reversals following the addition and deletion of a stock to the S&P 500

Index, which they argue supports the price pressure hypothesis. For example, for a sample of 194 newly

added and 13 deleted companies, Harris and Gurel (1986) report a positive stock price response of 3.13%

and -1.40%, respectively. These announcement period excess returns are reversed for both additions and

deletions after the effective day. Dash (2002) lends further credence to the price pressure hypothesis by

examining the stock price performance of companies that were removed from the S&P 500 Index when

they did not satisfy share price, market capitalization, liquidity, company fundamentals, or other S&P

Special Index Committee criteria. For Dash‟s sample of 53 index deletions, initial price losses from

announcement through effective day were recouped by the 60th day after the effective exclusion of the

stock. A mean reversion in stock prices due to price pressure effects is consistent with short-term

downward sloping demand curves for stocks.

The second group of studies comprises those that report evidence consistence with long-run

downward sloping demand curves for stocks. Shleifer (1986), Goetzmann and Garry (1986), Jain (1987),

Dhillon and Johnson (1991), Beneish and Whaley (1996), Blouin, Raedy, and Shackelford (2000), Blume

and Edelen (2001), Chordia (2001), Wurgler and Zhuravskaya (2002), Elliott and Warr (2003), Hegde

and McDermott (2003), and DMOY (2003) all report permanent price effects to S&P 500 Index additions

(or deletions). Over various intervals from 1986 through 2002, these studies report a permanent stock

price increase ranging between 2.8% to 8.20% to index additions and an average stock price drop of 4.5%

to index deletions. Since the vast majority of the studies on S&P 500 Index changes fall into this second

group, it would appear that evidence on S&P 500 Index changes does favor a long-run downward sloping

demand curve for stocks.

The third set of studies examines whether announcements of index changes are associated with

information effects that might better explain the permanent stock price effects to S&P 500 Index

additions. The leading candidates for information effects embedded in announcements of index changes

are a change in expected future earnings (DMOY, 2003), certification by the S&P Special Committee on

the prospects and longevity of stocks selected for addition or deletion (Dhillon and Johnson, 1991; and

Jain, 1987), and an adjustment to the required rate of return through a change in long-term liquidity either

by an expected change in investor base or shadow cost (Hegde and McDermott, 2003; CNS, 2004; and

Elliott, Van Ness, Walker, and Warr, 2006). CNS (2004) conduct a comprehensive examination of 279

S&P 500 Index additions and 145 deletions from 1979 through 2000 and report an asymmetric stock price

effect to index additions and deletions. A positive and permanent stock price effect of 6% is observed to

index additions but no lasting effect to index deletions. They posit that a change in the required return, as

measured by investor awareness and shadow cost, contributes to the asymmetry in long-run stock prices.

Of the fourteen studies since 1986 that examine S&P 500 Index additions, twelve record a

permanent positive stock price effect, whilst only one of the six studies on index deletions reports a

negative and symmetric stock price effect. The absence of a symmetric effect to S&P 500 Index changes

conflicts with evidence that supports both short- and long-run downward sloping demand curves for

stocks. The lack of a symmetric price response can best be explained by information effects, such as

certification, though, the S&P strongly disavows such claims, or that index membership itself conveys

information on the prospects of the firm which manifests itself in an adjustment to the required rate of

return or a change in future earnings.

To alleviate concerns of index compiler certification, a novel methodology employed by Kaul,

Mehrotra and Morck (2000) examines the stock price impact on 31 Canadian stocks that increased their

weighting in the TSE 350 due to an index weighting reconfiguration. The authors document a permanent

stock price effect of 2.3% following the weighting change on the same date, which they state is consistent

with long-run downward sloping demand curves. We believe our study on IBEX 35 Index changes

conducted in a certification-free setting complements Kaul, Mehrotra and Morck (2000), albeit, we

scrutinize index additions and deletions over a long time period.

To that end, we conduct event studies on IBEX 35 Index changes to establish whether investors

react to news of index additions and deletions. We then examine the trend, if any, in long-run excess

stock returns following index reconstitution to identify if there is any discerning permanent or transitory

pattern in stock return behavior. If our results are consistent with prior U.S. studies on price pressure

effects then we should only find a transitory price effect to index changes once we have controlled for

contemporaneous changes in earnings and capital costs. Whereas, a permanent stock price effect to IBEX

35 Index changes, even after controlling for changes in earnings and the required rate of return, would be

consistent with the bulk of evidence on S&P 500 Index changes that curry favor with a long-run

downward sloping demand curve for stocks.

In the next section, we outline our data and sample selection procedure.

II. Sample and Data

We collate date on IBEX 35 Index reconstitution from January 1992 through December 2007. (We

consciously stop our data collation in December 2007 because Spanish equity markets were overhauled at

this time, and the requirements for IBEX 35 Index membership were also modified.)4 Over this 16-year

period, the Madrid Stock Exchange identifies 182 index changes. Of these, 26 were a result of a merger,

buyout, spinoff, bankruptcy, or company name change. The final sample of 156 index changes comprises

78 additions and 78 deletions. The announcement and effective dates of each index addition and deletion

are ascertained from the Madrid Stock Exchange. These dates are corroborated with those reported in La

Gaceta and Cinco Dias newspapers.5 On average, there are 18 days between the announcement of the

IBEX 35 Index change (i.e., the TAC meeting date) to the effective date (i.e., the day on which the index

change is implemented).

For the sample of 156 changes eligible for further analysis, daily stock returns, volume turnover,

the book value of assets, earnings per share (eps), and net income data are taken from the Datastream

database over a four-year period centered on the initial announcement of the change. Our measures of

stock price performance are daily abnormal returns (AR), cumulative abnormal returns (CAR), and

cumulative buy-and-hold abnormal returns (BHAR). AR, CAR, and BHAR are computed using the

market model over various dates and time intervals, where ANN is the announcement date, EFF is the

4 As a sensitivity check on our results, we redo our entire analysis using data from January 1992 through December 2011. The

key change that takes place is that our sample size increases from 156 to 190 index changes because 17 index additions and 17

deletions occur between January 2008 and December 2011. Nonetheless, the key findings of our study remain largely unaffected,

though it is worth noting that in our regressions, the variables for institutional equity ownership and Merton‟s Shadow cost show

greater relative importance, with p-values ranging between 0.09 and 0.19. However, we cannot be sure whether this is due to the

restructuring of the Spanish equity markets and the IBEX 35 Index, or a general increase in investor awareness after December

2007. 5 There were two instances where there was a difference in the reported announcement date between those provided by the

Madrid Stock Exchange and those reported in the broadsheet press. In these cases, we decided to use the earliest announcement

as our formal announcement date.

effective date, PRE20 is the 20-day period preceding the announcement date, and POST20 is the 20-day

period following the effective date.

Our measures of operating performance are return on assets (ROA) and industry-adjusted return

on assets (IAROA). ROA is computed as net income scaled by the beginning of the year book value of

total assets. To compute IAROA, we first identify the industry group for each of our index changes using

the Financial Times Industry Classifications and then calculate an average ROA for each industry group.

We then subtract the average industry-matched ROA from the sample firm ROA, in each year, from two

years before through two years after the index change. Our procedure is in spirit to that recommended by

Cai (2007).

For each sample firm, in the year of index change, we also search the I\B\E\S\ database to gather

current, one year and two year forward looking analysts‟ eps forecasts starting two years before the index

change and ending two years after. Of the initial sample of 156 firms announcing index changes, we are

unable to gather eps forecast data for 31 firms. We also scan the Bloomberg and Reuters databases to

assemble data on the number of shareholders, the number of institutional investors, and the number of

large institutional equity holdings over two years before through two years after the announcement of the

index change for each sample firm. Finally, we search the Securities Data Corporation (SDC) database

for all announcements of new debt and equity financing undertaken by our sample firms from two years

before to two years after the announcement of index addition or deletion.

Table 1 presents the average [median] values on various accounting and stock market measures

for all IBEX 35 Index constituents in column 2. In total, 191 firms were, at any one time, members of the

IBEX 35 Index between January 1992 and December 2007. Of these, 78 were removed from the index

and 78 were added, leaving 35 founding members. Two interesting observations emerge from an

inspection of the data in Table 1. First, a comparison of the data across the columns shows that the

average index constituent is significantly larger (in terms of market capitalization and the number of

employees) and their stock is more heavily traded (in terms of daily and weekly trading volume) than in

firms added or removed. Second, a comparison of firms added to the index to those removed from the

index reveals higher operating performance (in terms of ROA and EPS) and a lower beta in the latter set

of firms. All the other variables in Table 1 are indistinguishable between the two groups.

In the next section, we document stock prices and volume turnover to IBEX 35 Index changes.6

We report results based on AR, CAR, and BHAR measured relative to the IBEX 35 Index. Changes in

trading volume are computed in the spirit of Elliott and Warr (2003). Our measure of volume turnover is

trading volume scaled by shares outstanding. We compute turnover in trading volume by scaling event-

period by reference-period volume turnover. In this equation, the numerator is the volume for additions

or deletions scaled by the IBEX 35 Index constituents‟ volume over the event period, and the

denominator is volume over a 30-day pre- or post-reference period standardized by the IBEX 35 Index

constituents‟ volume over the same 30-day pre- or post-reference period. The pre-reference period

volume turnover is measured from 31 days before through the day prior to the announcement of an index

addition or deletion and the post- reference period volume turnover is the 30-day average trading turnover

beginning 31 days after the effective date. Thus, trading after the effective date must last for a minimum

of 60 days.

III. Event Study, Trading Volume and Long-run Performance

We begin with an event study on the announcements of IBEX 35 Index additions and deletions from

January 1992 through December 2007. To compute ARs we estimate market model parameters for each

firm in our sample over the 150-day period beginning 21 days after the announcement date. The ARs are

estimated over an event window that spans 20 days before through 20 days after the initial announcement

date of the index change. We then present data on changes in trading volume and volume turnover over

the same 40-day event window centered on the announcement day.

Table 2 presents the analysis on stock returns, volume and volume turnover.7 Panel A focuses on

index additions and Panel B on index deletions. Several observations on index additions can be drawn

6 Because data are not available for each company, the size of the sample varies across tests. For each test, we report the size of

the sample employed. 7 We employ announcement periods of various lengths to determine whether the results of our event study are robust. We also

estimate market model parameters over various pre-event intervals. The event study results are robust to the length of

from an inspection of ARs, CARs and BHARs in Panel A. First, the mean announcement day AR of

0.59% (p-value = 0.52) is not significantly different from zero. The announcement of a new entrant to the

IBEX 35 does not convey new information. Second, the mean AR of 1.96% (p-value < 0.01) for newly

added stocks is statistically significant only on the day on which the stock officially becomes part of the

index (i.e., the effective date). This would suggest that investors increase demand in a stock only when it

is actually an IBEX 35 constituent and not before. Third, the CAR from announcement through effective

day of 2.12% (p-value = 0.01) to index additions is reversed over a 20-day period after the effective day.

The increase in ARs from the announcement through the effective date for this set of firms is

most consistent with price pressure effects. The price pressure effects are relieved in the aftermath of

index inclusion (Harris and Gurel, 1986; Jain, 1986; Lynch and Mendenhall, 1997). An alternative

interpretation that we cannot rule out, for the run-up in price to index inclusion, is that quasi-arbitrageurs

enter the market by adding stocks to their portfolios in the hope of turning them around at the effective

date at more favorable prices (Benish and Whaley, 1996; and Madhavan and Ming, 2002).

Finally, the volume and volume turnover data to index additions also display a mean reverting

pattern that is in line with the AR and CAR results for this set of firms. For example, trading volume on

the announcement and effective day to index additions are 14.9% (p-value = 0.19) and 28.8% (p-value <

0.01), respectively, and the run up in trading volume for this group of companies is 30.2% (p-value =

0.01) from the announcement through the effective date.

Panel B of Table 2 mimics Panel A for index deletions. An inspection of these data reveals three

noteworthy observations. First, index deletions are associated with a negative announcement day ARs of

–0.31% (p-value = 0.79) which is not statistically significant at conventional levels. Second, a significant

average AR of –2.66% (p-value = 0.01) to index exclusion is recorded on the effective day. These

observations imply that firms removed from the IBEX 35, on average, lose around 3% of their value from

the announcement through the effective day, which is fully recouped 20 days after the effective day. (As

before, we do recognize that these patterns are also compatible with index tracking and/or the activities of

announcement period and the interval applied to estimate market model parameters. Further discussion on this topic is reserved

for section VII.

quasi-arbitrageurs.) Third, the data on turnover and trading volume to index deletions are consistent with

the drop in stock price from announcement through effective day for these firms. For example, the

trading volume on the effective day to index deletions is two times higher than the average volume over a

20-day period before the announcement day. The difference between the pre-announcement period and

effective day volume is statistically significant at the 0.01 level. Interestingly, the sharp rise in volume

from the announcement through the effective day stabilizes within 20 days following the exclusion of the

stock from the index.

Up to this point, stock price and volume effects to index changes appear to be short-lived and

consistent with short-run downward sloping demand curves for stocks.

Nonetheless, we still have not fully ruled out arguments favoring long-run downward sloping

demand curves for stocks. To explore the likelihood of a permanent stock price effect, if any, we

examine long-run stock returns and operating performance following announcements of IBEX 35 Index

changes and report the results in Table 3. Our analysis on long-run stock returns focuses on the 60, 120,

and 180 day-period following the official inclusion (exclusion) of stocks to the index. In these analyses,

we use market-adjusted and buy-and-hold returns. To supplement the evidence on long-run stock price

behavior, we also present data on the operating performance of newly added and deleted companies. Our

measures of operating performance are return on assets (ROA) and industry-adjusted return on assets

(IAROA).

Panels A and B of Table 3 present the results on the long-run performance analyses to index

additions and deletions, respectively. An inspection of Panel A reveals the absence of a permanent

„positive‟ stock price effect to IBEX 35 Index additions. In fact, the excess returns (and buy-and-hold

returns) for these companies is negative over 60, 120, and 180 days after inclusion to the index, which is

most consistent with mean reversion. With the exception of the ER and BHAR over 60 days after the

effective inclusion date, the excess returns over the longer horizon are not significant at the 0.10 level or

less. These results contrast with the 12 studies on S&P 500 Index additions that report CARs that are

positive and permanent. Our results show that in a setting free of certification, there is no permanent

positive stock price effect to index additions. In fact, the positive announcement through effective day

excess returns display mean reversion up to 180 trading days after the addition of a stock to the IBEX 35

Index. Nonetheless, this could finding be due to a sharp run-up in stock prices prior to their official

inclusion. Remember, that stock liquidity is observable so this possible explanation cannot be ruled out

without further scrutinizing the excess returns prior to the announcement date. To that end, we present ER

and BHAR over 60 days, 120 days, and 180 days before the initial announcement of index membership.

There does appear to be a run-up that is smaller in magnitude to the returns observed on the effective date,

and not statistically significant at the 0.05 level or less. This leads us to believe that the demand curve for

Spanish stocks is short-run downward sloping, which is consistent with evidence presented by Harris and

Gurel (1986) and Lynch and Mendenhall (1997) on S&P 500 Index additions.

As a check on our long-run stock price analyses, we also examine long-run operating

performance, as measured by ROA and IAROA of companies added to the IBEX 35. The change in ROA

from the year before to the year after index inclusion is 0.655, which is statistically significant at the 0.05

level.8 It seems that the inclusion of a stock to the IBEX 35 is correlated with an increase in operating

performance in the year following index membership.

Even so, the documented increase in ROA for newly added firms may be misleading since all

firms might have undergone an increase in ROA, thus, what we are observing is a general market

phenomenon. To address the impact of economy wide changes, we compute industry-adjusted ROA

(IAROA) for each sample firm two years before through two years after the index change. Once we

adjust the ROA for each sample firm by its Financial Times industry-matched benchmark firm‟s ROA,

the average change in IAROA, for our set of index additions is no longer statistically significant at the

0.05 level or less. In our analysis of stock price effects and long-run performance, we report evidence in

favor of short-term price pressure effects to IBEX 35 Index additions. In the absence of a permanent

stock price effect, we would not expect to find any improvement in the operating performance of newly

added companies - - that is the result we observe in Panel A of Table 3 for our sample firms relative to

their industry peers.

8 The changes in ROA presented in Table 2 are comparable to those documented by Crespi-Cladera and Garcia-Gastona (2000)

in their analysis of operating performance in large publicly traded Spanish companies.

In Panel B of Table 3, we mimic the analyses in Panel A on our sample of IBEX 35 Index

deletions. The long-run returns to index deletions over 60, 120 and 180 days after the effective day are all

positive and statistically significant with p-values less than 0.05. This result is consistent with Harris and

Gurel (1986), Lynch and Mendenhall (1997) and Dash (2003) who report a mean reversion in stock prices

following the exclusion of a stock from the S&P 500 Index. Interestingly, the negative announcement

through effective day excess returns rebound permanently after removal from the IBEX 35 Index. The

rebound causes a permanent positive price effect of 2.08% over a 180-day period following the exclusion

of these companies from the Index, which cannot be explained by the run-down in stock prices prior to

the index exclusion announcement, or for that matter at the announcement also. In summary, we

document no lasting stock price effect to IBEX 35 Index additions but there is evidence of a permanent

price effect to deletions up to 180 days after the removal of the stock from the index, albeit positive.

To complement the long-run price analysis, we also examine the operating performance of newly

deleted companies. We record a significant improvement in ROA for up to two years after index

exclusion. The increase in ROA for this set of companies is statistically significant at the 0.05 level or

less. However, as before, we also examine IAROA. The results on the changes in IAROA from one year

before to up to two years after index deletion are also positive and statistically significant at the 0.05 level

or less.

The key result from the event study is that IBEX 35 Index changes are associated with a

symmetric short-run price effect that is consistent with existing liquidity hypotheses on index changes

(Harris and Gurel, 1986; Lynch and Mendenhall, 1997). There does however appear to be an anomalous

reversion in long-run stock prices to exclusions from the index. The increase in stock prices appears to be

permanent, and in excess of 2% over a 180-day period after the removal of the stock from the index.

Additional analysis on industry-adjusted operating performance for this set of firms reveals an up-tick in

IAROA which might explain the sustained price increase to IBEX 35 Index deletions. It might be argued

that the increase in stock prices and operating performance to index deletions is due to greater capital

market scrutiny directed at managers, which elicits a revision in investors‟ expectations on earnings. To

explore this possibility further, in the next section, we examine whether realized earnings and earnings

forecasts can justify the permanent price effect to IBEX 35 Index deletions.

IV. Realized and Forecast Earnings

The permanent improvement in stock prices to IBEX 35 Index deletions is contemporaneous with an

increase in industry-adjusted operating performance. This might manifest in greater inspection by

investors and analysts of newly deleted firms. To test this conjuncture, we analyze changes in realized

earnings and investors‟ expectations of future earnings when stocks are added to and deleted from the

index. We take data on annual analysts‟ earnings forecasts for our sample firms from I\B\E\S as a proxy

for investors‟ expectations of future earnings. In conducting our analysis, we examine changes in average

realized earnings and earnings forecasts from before to after the date of index reconstitution for each

sample firm. One caveat with our analysis is that I\B\E\S does not cover all firms in our sample. We are

able to gather meaningful forecast data on only 64 additions and 61 deletions. Thus, while we do not

place too great an emphasis on these results, they do appear to be consistent with those reported in Table

3 on IAROA.9

To test whether analysts revise earnings expectations for firms added to and deleted from the

IBEX 35 index, we begin by comparing the change in realized and forecast eps for sample firms from

before to after the year of index change. From an inspection of realized earnings and eps forecasts

surrounding index additions and deletions in Table 4, three noteworthy points emerge. First, index

additions and deletions are both associated with an increase in eps in the two years after the index change.

The average increase in eps from a year before through two years after the removal of stocks from the

index is larger in magnitude than the increase in stocks added to the index. For example, the change in

eps is 0.44 (p-value < 0.01) to deletions and only 0.15 (p-value = 0.20) to additions. These results

reaffirm those on IAROA presented in Table 3.

9 One explanation for the reduction in sample size is that we choose to exclude forecasts made by new analysts which might

distort our analysis and track forecasts for each continuing analyst for 48 months surrounding the index change announcement.

The inclusion of the 7 firms that were originally removed because they were covered by new analysts does not change our key

results.

Second, eps forecasts are modestly higher in companies leaving the index (in Panel B) than in

companies added to the index (in Panel A), but not significantly different from one another. For example,

the average eps forecast for companies removed from the index is 1.60, while it is 1.52 for companies

added to the index, in the year following reconstitution. Third, the scaled change in eps forecasts is

always larger when firms are removed from the index. In Panel A of Table 4, the change in forecast eps is

0.12 from the year of index entry through two years after, and the comparable change in firms removed

from the index, in Panel B of Table 4, is 0.19. It appears that analysts revised their eps forecasts upward

to both newly added and deleted firms, but more so in the latter set. (As an additional check on these

results we also compute standardized revisions in eps forecasts for our two sets of companies. These

results are not formally presented in a table but available from the authors on request. We standardize the

change in eps forecast by the average stock price. Changes in standardized forecasts are higher across the

board in firms removed from the index than in firms added. Again, these findings are consistent with an

increase in both forecast and realized earnings to index deletions.)

As a final check on our earnings analyses, we also compute earnings forecast errors as the

difference between the analysts‟ median eps forecast and the realized eps in the same financial year from

two years before to two years after joining or leaving the index. The results on changes in eps forecast

errors in Table 4 are the most telling. For example, the change in eps forecast errors from one year before

to one and two years after index deletions are 0.17 and 0.27, respectively. In comparison, the change in

eps forecast errors over the same intervals to index additions are 0.05 and 0.03, respectively. There is a

statistically significant difference in actual earnings and eps forecast errors between index additions and

deletions.

Apparently, companies removed from the IBEX 35 Index witness higher earnings relative to

expectations and better operating performance (as measured by IAROA or realized eps) in comparison to

their peers that are added to the index. Our earnings analyses reveal that a change in earnings beyond

expectations may be responsible for the permanent positive stock price rebound to index deletions, which

is consistent with increased market scrutiny placed on managers of newly deleted companies (DMOY,

2003).

V. Investor Awareness

As noted at the outset, a firm‟s stock price and operating performance might also increase as a result of

increased investors‟ knowledge and awareness of stocks following index reconstitution. We do

acknowledge that it is unlikely that investor knowledge and awareness will increase following the

removal of a stock from an index. Nevertheless, we examine proxies on investor awareness that might

elicit changes in the costs of financing. The proxies capture the ability of firms to attract new capital, the

production of information demanded by investors and analysts, and changes in the equity ownership of

newly added and deleted companies.

To determine whether index membership influences the ability of firms to attract new capital, we

examine debt and equity financing announcements for each firm in our sample over two years before and

after the announcement of index change. The data on debt and equity announcements for each firm over

this period are extracted from the SDC database. Panel A of Table 5 reports a two unit increase (from 18

to 20) in debt financing announcements from before to after index addition. For the same set of firms,

equity financing announcements increase by 36% (from 14 to 19). There is also a doubling in the dollar

value of equity issued in this set of firms. The data on the average dollar of debt and equity capital raised

is presented in square parentheses. All in all, neither the increase in the average dollar level nor the

number of announcements of debt or equity is statistically significant at the 0.05 level or less to index

additions.

Changes in the levels of debt and equity financing to index deletions are presented in Panel B of

Table 5. In this set of firms, there is a unit drop in debt and equity financing announcements following

index removal. Examination on the change in the average dollar level of debt and equity in Panel B

shows there is a drop of $1.23 million in debt raised and a $2.39 million increase in equity issued. A

more interesting comparison might be to compare the financing between firms added to the index against

those removed. The differences in the financing patterns for these two sets of firms all have p-values

greater than 0.05. On the whole, the results fail to report any significant revisions in debt or equity

financing to IBEX 35 Index changes.

To supplement our analysis on the ability of sample firms to attract new capital, we examine

whether these companies witness any change in information production to a change in index membership.

As might be expected, the absence of a direct measure to assess the production of information poses a

significant problem. To remedy this situation, we scrutinize two proxies. Our first proxy compares the

number of analysts that were covering sample firms from two years before to two years after the

announcement of index change. The results of this analysis in Panels A and B in Table 5 show an average

increase in one analyst following index membership, but no change in analyst coverage when a firm is

forced to leave the index.

The second proxy assumes that investors‟ and analysts‟ needs are reflected in greater information

produced by the media. With this assumption in place, we record the number of articles reported in La

Gaceta and Cinco Dias (Spain‟s two leading business newspapers) over a 48-month period centered on

the announcement of index reconstitution. We report the change in press coverage to index additions in

Panel A, and to index deletions in Panel B of Table 4. In Panel A, the change in press coverage for newly

added firms is 5% for articles in La Gaceta (from 264 to 278 announcements) and 8% (from 193 to 209

announcements) for articles in Cinco Dias. This analysis demonstrates that index additions experience a

slight increase in information production as measured by press coverage but the change is not statistically

significant at the 0.05 level or less. Panel B of Table 4 reports the change in press coverage for companies

removed from the index. For articles reported in La Gaceta there is a 16% increase (from 208 to 241

news items) and for those in Cinco Dias there is a 15% increase (from 186 to 214 news items). Again,

neither of the increases in press coverage to index deletions is statistically significant at conventional

levels.

As noted above, assessing investor awareness is difficult in that there is no direct measure.

Hence, in the next section, we supplement our analysis on analyst and press coverage with additional

proxies indicative of investor awareness. This includes examining changes in the number of shareholders,

large institutional blockholders, and Merton‟s Shadow Cost from before to after the announcements of

index additions and deletions (CNS, 2004).

The changes in equity ownership from before to after index reconstitution are also presented in

Table 5. If, indeed, newly added companies attract greater investor awareness, then we might expect an

increase in the number of shareholders drawn to these companies, as they become more aware of the

stock (now in the index). Data on changes in equity ownership is gathered following the announcement

of index change and taken as late as possible prior to the announcement from Bloomberg and Reuters.

Panel A of Table 5 reports changes in the number of registered shareholders and institutional

investors who own >5% of the firm‟s equity for index additions. Panel B mimics Panel A for sample

deletions. From an inspection of Panel A, the number of shareholders increased by 13% (p-value = 0.32)

from two years before to two years after the announcement, while no change is observed in institutional

blockholders who own >5% of the firm‟s equity over the same time period. The increase in both the

number of registered shareholders to index membership is not significant at conventional levels. In

comparison, Panel B of Table 4 reports a slight drop in the number of registered shareholders and

institutional equity holders to index deletions. The number of registered investors declines by 3% from

69 to 67, and the number of large blockholders drops by 1. These results on IBEX 35 Index additions and

deletions are much smaller in magnitude but identical in sign to those reported by Pruitt and Wei (1989)

and CNS (2004) on S&P 500 Index deletions.

In line with CNS (2004), we extend our analysis on investor awareness to examine Merton‟s

investor recognition hypothesis (1987).10

If index membership entices investors to hold the stock for its

diversification potential then the segmentation cost, or commonly called shadow cost, for a company will

fall and stock price will rise. However, this may not be true when a stock is forced to exit an index as

investors are unlikely to become unaware of stocks previously in the index. Using the method described

by McConnell and Kadlec (1994), we estimate shadow costs for sample firms by scaling the residual

standard deviation on the daily excess return of each newly added (deleted) stock by the market

capitalization of the IBEX 35 Index, and then multiply this term by the market value of the newly added

10 In Merton‟s model of segmented markets for stocks, investors hold only those stocks in their portfolio of which they are aware.

Investors will, therefore, hold equity in less than fully diversified portfolios. The difference in the returns expected by less than

fully diversified investors will be higher then that demanded by fully diversified investors (estimated by the CAPM). The

difference between the returns of the completely and incompletely diversified portfolios is Merton‟s Shadow Cost.

(deleted) firm, scaled by the number of shareholders. This technique computes monthly shadow costs

over two years before and two years after the announcement of the index change for sample companies.

Estimates of pre- and post-announcement shadow costs are presented in Panel A of Table 4 for

index additions and in Panel B for index deletions. An inspection of Panel A reveals a decrease in the

mean shadow cost of –0.016 (from 0.525 to 0.509) for newly added companies. This slight decrease

represents a reduction in shadow costs, though the p-value for the change is not significant at

conventional levels (p-value = 0.34). Panel B of the same table reports the change in shadow cost for

newly deleted companies. This set of firms experience an increase of 0.019 (from 0.441 to 0.460)

following index removal. The p-value for the change is 0.52. The results on shadow cost tell us that

neither index additions nor deletions are associated with any meaningful change in segmentation costs.

Taken collectively, the results, or lack thereof, on changes in investor awareness to IBEX 35

Index changes appear to buttress belief in favor of a short-term downward sloping demand curve for

stocks. However, we are still required to address the seemingly anomalous long-run increase in stock

prices and earnings to index deletions.

VI. Multivariate Analysis

The univariate analyses on IBEX 35 Index changes are most consistent with price-pressure effects and

short-term downward sloping demand curves for stocks. However, a significant long-run price reversal to

index deletions presents a conundrum. To explore the determinants of this jarring price effect further, we

estimate OLS regressions using long-run stock returns following the deletion of a stock from the IBEX 35

Index as the dependent variable. Specifically, we use long-run returns over 180 days after the effective

exclusion of the stock from the index as our dependent variable. For the independent variables in the

OLS regressions, we take changes from two years before to two years after removal of the stock from the

index in the following variables, which were described in sections III, IV and V in greater depth: analysts‟

earnings forecasts; eps forecast error; $ debt issuance; $ equity financing; number of media citations from

La Gaceta and Cinco Dias; number of analysts issuing recommendations on the stock; number of

registered investors; number of blockholders owning 5% or more of the equity; and shadow cost. Though

not shown in the table, we also include the debt-to-assets ratio to capture leverage, the average book value

of assets to proxy firm size, and the geometric growth in sales to reflect growth opportunities. The data

on these additional control variables is sourced from Datastream. We present the results on four

regression specifications in Table 6. The regression specifications in columns 2 and 4 of the table use the

change in realized eps to reflect the change in earnings, while the specifications in columns 3 and 5 of the

same table use the change in eps forecast error to capture the change in earnings. The only other twist in

the regression set-up is that we run separate regressions for our two press sources: columns 2 and 3 use

the number of citations from La Gaceta and columns 4 and 5 use the number of mentions in Cinco Dias.

The variables of primary interest to us are the change in eps in columns 2 and 4, and the change

in eps forecast error in columns 3 and 5. (We do not include both variables in the same regression since

they are highly correlated with one another.) In three of the four regression specifications, these variables

are statistically significant at the 0.05 level or less. In the fourth, the p-value on the coefficient is 0.07.

The positive coefficient on the change in eps and change in eps forecast error support the view that firms

removed from the IBEX 35 Index perform beyond expectations. As noted earlier, it appears that greater

attention is directed at the managers of these companies from investors and analysts alike (DMOY, 2003).

None of the other independent variables in Panel B of this table are statistically significant at the 0.05

level or less. The only variable that is worthy of further mention is the change in press coverage which

has p-values that range between 0.12 and 0.14. The multivariate analysis on IBEX 35 Index deletions

confirms our earlier suspicion that the permanent stock price effect observed for this set of companies is

due to higher earnings that is beyond expectations. One obvious question that these findings raise is

whether the managers running firms that left the index are those responsible for the subsequent increase in

earnings. That is an issue that we explore a little further in the next section.

Before we move to tackle this issue, for completeness, we also run the same OLS regression

specifications on the sample of index additions and report the results in Panel A of Table 6. In line with

the univariate results on index additions, the multivariates analysis show that none of the independent

variables that proxy a change in either future earnings or the required rate of return is statistically

significant at the 0.05 level or less. The variable that is closest to the 0.05 level of statistical significance

is the change in the dollar level of equity financing. The sign on this coefficient is positive with p-values

ranging between 0.08 and 0.10. It appears that index membership causes firms to ramp up their equity

issuance. One possible explanation for this finding could be that managers are timing the issue of stock

when they suspect that demand is higher than usual. However, in this case, it seems that there is only a

temporary surge in demand and a long-run decline in stock price after a firm joins the index. Hence,

managers seeking to time equity issuance would be better placed to refrain from equity issuance

following inclusion of their firm in the IBEX 35 Index.

In sum, the regressions confirm our hunch that the lasting price reversal to index deletions is due

to an up-tick in earnings. But, the key question is by how much? To get a crude idea on the implied

impact of higher earnings on the long-run stock price effect to IBEX 35 Index deletions, we multiply the

mean change in eps for this set of firms by the value on the coefficient on the change in realized eps in

column 4 in Panel B of Table 6. Once this implied estimate is stripped away from the long-run excess

return of 2.08%, we are left with an insignificant 1.83%. It would seem that a simple, yet logical,

explanation can be advanced for the asymmetric long-run price behavior to IBEX 35 Index changes. That

is, after we take stock of the marked improvement in earnings to IBEX 35 Index deletions, our results in a

setting that is free of index-compiler certification, provides evidence in support of the price pressure

hypothesis, which causes temporary illiquidity, and favors belief that the demand curve for stocks is

short-term downward sloping.

VII. Robustness Tests

In this section we discuss some of the sensitivity analyses and robustness tests.

A. Medians and differences in medians

We conducted our univariate and multivariate statistical tests on stock returns, accounting data and non-

financial information using the mean of the distribution. To determine the sensitivity of these results, we

also conducted the tests with median changes in stock returns, accounting data and non-financial metrics.

In the main, our results are unchanged when we use median values and median changes in the variables.

In instances, where there is a significant difference between mean and the median values in a variable, the

results are generally more robust when the median value is used.

B. Percentage changes in EPS

We conducted our analysis on changes in forecast eps and realized eps using dollar level changes. As a

check on these results, we also report percentage changes in forecast and realized eps in square

parentheses in Table 4. The changes in both forecast eps and realized eps were mildly more significant

with percentage changes than with absolute dollar level changes.

C. Event study of stock prices

To determine whether the results of our stock price event study are robust, we employed announcement

periods of various lengths. We also estimated the market model parameters over various pre-event

intervals. Finally, we used simple market-adjusted returns in which the AR was calculated as the

difference between the return of the subject stock and the return of a simple equal-weighted market index.

The event study results are robust to the length of the announcement period considered, the interval used

to estimate market model parameters, and whether we use the market model or a simple market

adjustment to calculate ARs.

D. Short-term liquidity tests

In our analyses, we observe that price pressure effects are the most probable explanation for temporary

stock price and volume movements around index additions and deletions. Indeed a visual inspection of

relative volume over a 60-day window centered on the announcement index change reveals a sustained

volume increase in firms entering and exiting the IBEX 35 Index that starts around a week before the

TAC announcement date and ends a few days after the effective date. The relative volume for both sets of

firms declines to more normal levels within three weeks of the effective date of inclusion or exclusion.

Nonetheless, we have not yet formally confirmed the presence of price pressure effects and short-

term illiquidity in these stocks. To remedy this shortcoming, we apply the Amihud (2002) measure of

illiquidity, which takes the average ratio of absolute returns over trading volume measured using daily

data for non-zero volume days over a 60-day period centered on the effective date of an index change.

We believe this is an appropriate measure of illiquidity because it can best be described as the lambda

from the Kyle (1985) model which captures the price pressure effects of trades.

The results from this analysis (though not presented in a table) show that liquidity is constrained

over 17 days following the inclusion of a stock to the index and over 19 days after the removal of a stock

from the index. Our proxy of price pressure, the ratio of returns to trading volume, resumes stability

within three weeks of the effective inclusion and exclusion of stocks to the IBEX 35 Index. These

findings reaffirm our initial thoughts in support of the price pressure hypothesis. As an additional check

on these results, we apply a variant on the Amihud measure that displaces stock turnover for volume in

the illiquidity measure equation. The results from these tests are quantitatively similar to those that apply

the formal Amihud illiquidity measure.11

E. Similarity to Russell 2000 Index changes

A criticism that can be directed at our study is that there are other indexes that undergo automatic

reconstitution (Becker-Blease and Paul, 2010). The Russell 2000 small-cap index is one such example.

The Russell 2000 Index is formulated by ranking all companies based on their market value on May 31

each year. Given that additions and deletions to the Russell 2000 occur on a single scheduled date each

year, and the market value of each firm is public knowledge, then there is little guesswork involved in

predicting the companies to be added or eliminated (Madhavan, 2001). In many ways, this criticism is

hard to reject. However, we present several arguments that warrant study on the IBEX 35 Index.

To begin, the IBEX 35 Index is the domestic and international benchmark for the Spanish Stock

Market and is one of the ten most traded indices in Europe. Since 1992, the IBEX 35 Index has been the

underlying index for futures and options contracts traded on MEFF. The IBEX 35 is also the benchmark

for bond funds issued by JP Morgan, Wells Fargo, UBS, and ETFs issued by leading investment houses

such as BBVA, and Deutsche Bank, among others, thus there is significant trading and index tracking

activity of the IBEX35 across the globe. Unlike the Russell 2000 Index, the IBEX 35 comprises stocks

11 We recognize that there are at least four possibly better measures of liquidity that employ microstructure data on trades and

quotes: (i) the bid-ask spread (Amihud and Mendelsohn, 1986); (ii) the effective bid-ask spread (Chalmers and Kadlec, 1998);

(iii) the transaction price impact (Brennan and Subrahmanyam, 1996); and (iv) the probability of information-based trading

(Easley, Hvidkjaer and O‟Hara, 2002). The unavailability of high frequency data on trades and quotes for our sample firms

limits our analysis to the Amihud (2002) measure of daily illiquidity.

that are among the largest in Continental Europe and around the world. For example, the largest

companies on the IBEX 35 Index include Telefonica, Santander, BBVA and Repsol, which also trade as

ADRs in the United States. The IBEX 35 is a tradable index which carries muster with retirement funds

and insurance companies across Europe and beyond who are heavy investors in the index, as are

individual investors, primarily in Europe. Last but not least, in 2011, according to the IMF, Spain ranked

thirteenth in terms of GDP with a notional value of $1.5bn, which was a hundred million dollars greater

than the GDP of Canada, who were fourteenth on the list.

In addition, several design features of the Russell 2000 Index, in general, reduce its appeal in

attesting to whether the demand curve for stocks is downward sloping. First, firms are not added to

replace deleted firms, such that the number of firms in the index fluctuates from one reconstitution to the

other. Second, firms are not removed from the Russell 2000 if they fail to meet the criteria required for

membership after the reconstitution date. Third, foreign stocks are excluded from the index, even though

a large number of firms, especially from Canada, choose the U.S. equity markets as their primary listing

venue. And, fourth, spin-offs and IPOs are added on a quarterly basis between reconstitution dates which

means that the number of firms comprising the Russell 2000 will further vary. These design features do

not apply to the IBEX 35 Index.

F. Measures of increased managerial scrutiny

An improvement in earnings following the removal of a firm from the IBEX 35 Index is consistent with

increased capital market scrutiny directed at the managers of these firms. However, we have not yet

established any formal link between superior operating performance and greater scrutiny placed on

managers in firms removed from the index. To address this concern, we examine two well-known

outcomes of increased scrutiny - - the rate of CEO turnover and the rate of top management team

turnover.

To determine the rate of turnover in the CEO and in the top team, we collate board roster

information from two years before through two years after announcements of index deletions, for our

sample of 76 firms from annual filings held with the Madrid Stock Exchange. We then track all changes

in the positions of CEO, president, chairman of the board, finance director. These data are presented in

Panel B of Table 7. We identify 9 changes in the title of CEO in the period preceding index deletion and

17 changes in the aftermath. This translates into an 89% increase in CEO turnover. The data on top

management team turnover reveals a staggering 115% increase in the rate of top team turnover from

before to after index reconstitution.

Since the premise of this analysis is to gauge whether greater scrutiny was directed at top

management, we shift our focus to „forced‟ changes in the top team positions in the aftermath of index

removal. To make this determination, we cross-check each change in top management with news articles

and reports in both La Gaceta and Cinco Dias to discern the circumstances surrounding each management

turnover event. All changes in the top team, other than retirement, were designated as „non-routine‟. Of

the 28 „non-routine‟ changes in the top team, we assign 17 as „forced‟. „Forced‟ turnover was determined

by scrutinizing news items for one of the following reasons - a firing, poor performance or a disagreement

with large stockholders and/or other management that resulted in a senior management change.12

Of the

17 „forced‟ changes in the top team, 5 occurred before and 12 happened after the stocks were deleted

from the index, which translates into a 140% increase in the rate of „forced‟ top management turnover.13

To get a handle on the relative significance of the management turnover statistics in the firms

removed from the index, we also gather data on top team turnover in firms added to the index. The data

on these are presented in Panel A of the same table. The most striking feature in Panel A is the rate of

CEO turnover and top team turnover declined marginally following the inclusion of a firm to the IBEX 35

Index.

As a corollary, we also scrutinized news items gathered from La Gaceta and Cinco Dias on asset

and employee restructuring announcements for sample firms in the two years before and after index

reconstitution. The result of this rather crude analysis is also presented in Table 7. A quick look over this

data show that the incidence of asset divestitures, sell-offs, and employee downsizing increased in firms

12 The definition of „forced‟ has been borrowed from Warner, Watts and Wruck (1988), Denis and Denis (1995), Dahya,

McConnell and Travlos (2002), and Huson, Malatesta and Parrino (2004), among others, who devote the entirety of their study

on top management turnover. 13 As a check on these results, we also compute the change in the rate of „forced‟ turnover in the top management team from

before to after the announcement of IBEX 35 Index additions. The rate of „forced‟ turnover is almost identical in the year before

to after index inclusion. Interestingly, the rate in „forced‟ turnover prior to index additions and deletions is indistinguishable,

while there is a significant increase in unexpected senior management departures in the aftermath of index deletions.

that were deleted from the index, and decreased a tad in those firms added to the index. In sum, this

cursory examination reveals an increase in market scrutiny directed at managers whose firms were

removed from the index, as measured by a higher rate in top management turnover, which further

coincide with greater restructuring activity. Collectively, these findings provide a logical explanation for

the rise in earnings (and forecast earnings) in the years after firms are removed from the IBEX 35 Index.

G. Pre-event run-up and other controls

One issue that we have conveniently side-stepped throughout our analysis concerns the modest run-up in

stock price prior to index inclusions, and the mild run-down in price prior to index exclusions. Up until

this point, we have relied heavily on the pre-announcement excess returns in Table 3 to deflect this

shortcoming. The long-run excess returns in Panel A of this table report a pre-event run-up to index

additions of 0.92% over PRE120, 0.84% over PRE60, and 0.74% over PRE20. A symmetric run-down is

observed in Panel B to index deletions. For both index additions and deletions, the run-up and run-down

in price, respectively, are modest in comparison to the magnitude of excess returns observed from the

announcement through effective date of index reconstitution.

In an effort to better rule out the impact of pre-announcement activity biasing our results, we use

the regression specification in column 5 of Table 6 as our base specification. To this base model, we add

a variable to control for pre-announcement stock price drift. The variable we include is PRE20, which is

the cumulative abnormal return from the day before the announcement through twenty days prior. We

also expand this revised specification to include four additional independent variables (CEO turnover, top

team turnover, asset restructuring, and employee downsizing) that proxy increased management scrutiny.

As before, we use POST180 as the dependent variable in the first and second regressions in Panels A and

B of Table 8. The key difference between these regressions is that we use CEO turnover (which is an

indicator variable that equals one when CEO turnover occurred within two years of the index change) in

the first model in Column 2, and top team turnover over the same period, in the second model in column

3. The regressions in columns 4 and 5 mimic the model specifications in column 3 but switch the

dependent variable to POST120 and BHAR180, respectively. The rationale behind this move is to stress

test our measure on long-run returns.

There are two key results that emerge from an inspection of the regression output in Table 8.

First, our proxy on run-down in Panel B fails to explain the permanent positive stock price effect to index

deletions. And second, the variables that monitor CEO turnover and top team turnover in Panel B are both

statistically significant at the 0.06 level or less. Interestingly, the impact that the change in eps has on

long-run returns drops dramatically, with p-values ranging between 0.04 and 0.16, after we add the

indicator variables on CEO turnover and top team turnover. The key theme to emerge from the various

robustness checks is that IBEX 35 Index changes appear to elicit short-lived gyrations in stock prices and

volume. The somewhat anomalous behavior in long-run excess returns in this set of firms can be

explained by superior earnings performance that seems to coincide with top management turnover in

firms dismissed from the IBEX 35 Index.

VIII. Conclusion

If stocks do have perfect substitutes that give rise to horizontal demand curves then any changes in their

demand (or supply), absent new information, will have little, if any, impact on prevailing stock prices. It

has been argued that the effects of changes in the membership of equity index constituent‟s offers a

unique test on whether stocks have a downward sloping demand curve. The extant evidence on S&P 500

Index additions reports a permanent positive price effect to such changes, which is consistent with belief

that demand curves for stocks are, in the long-run, downward sloping.

The validity of this belief has recently been called into question for a number of reasons. First, if

we believe that stocks have long-run downward sloping demand curves, then a symmetric long-run

permanent price effect should be observed to both index additions and deletions. Second, this belief is

only valid if index compilers do not, maybe unwittingly, certify stocks for inclusion in the index. While

the S&P renounces claims of certification on the quality of the stocks added to (or removed from) the

S&P 500 Index, it is uncertain whether the S&P conveys information unknowingly on firm longevity in its

decisions to alter the composition of the S&P 500.

The lack of certification in IBEX 35 Index changes provides the primary impetus for our study.

Specifically, it is the automatic selection of stocks based on liquidity that presents a special environment

to test whether stocks have a downward sloping demand curve. In this study, we document a symmetric

stock price response to IBEX 35 Index changes that took place from 1992 through 2007. There is a short-

term increase in stock prices to announcements of index additions and a decrease in prices to deletions.

The event study results support price pressure effects, which is consistent with a downward sloping

demand curve for Spanish stocks.

To completely rule out evidence in favor of a long-run downward sloping demand curve for

stocks, we also examine long-run stock returns to IBEX 35 Index changes. This analysis uncovers a

permanent increase in stock prices to index deletions, and only transitory changes in stock prices to index

additions. The long-run price effects to IBEX 35 changes present a quandary for two reasons. First, the

stock price effect to index deletions should be negative to support the view of a long-run downward

sloping demand curve for stocks and second, the argument advanced in support of a short- and long-run

downward sloping demand curve for stocks requires a symmetric long-run price effect to index additions

and deletions (see CNS (2004)). The asymmetric price effect might be explained by contemporaneous

changes in information content and information production, which causes a change in the required return

and/or future earnings to index reconstitution.

To that end, we scrutinize changes in both actual and forecast earnings, and a host of factors that

might engender a change in the required rate of return in firms entering and leaving the IBEX 35 Index.

We observe that the somewhat bizarre stock price effect to index deletions is correlated with a significant

up-tick in both forecast and realized earnings. Once the impact of the simultaneous earnings effect is

stripped away from the long-run price effect to index deletions, the remaining residual on long run returns

is no longer statistically significant. Upon further investigation, we discover that the increase in realized

and forecast earnings coincides with turnover in the senior managerial ranks. In sum, the evidence on

IBEX 35 Index additions and deletions is most consistent with a price pressure effect and a short-run

downward sloping demand curve for Spanish stocks.

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Table 1

Descriptive Statistics for IBEX 35 Index additions and deletions The IBEX 35 Index comprises all firms in the index from January 1992 through December 2007. Mean and median values in parentheses are presented for each variable listed in

column 1. Data on all firms in the IBEX 35 Index over the entire sample period are presented in column 2. The sample of 156 IBEX Index changes are dichotomized into 78 index

additions and 78 index deletions. Data on the sample of 156 firms that were added to the index from January 1992 through December 2007 are reported in columns 3 and those that

were removed from the index over the same period are presented in column 4. Accounting information and share prices including volume data are taken from Datastream and

cross-checked with information provided to us by the Bolsa de Madrid. Data on earnings per share are taken from I/B/E/S. Market capitalization is year-end closing stock price

multiplied by the number of diluted shares outstanding at that time. ROA is computed as earnings before interest, taxes, and depreciation divided by beginning-of-year total book

value of assets. Annual information on the number of employees, number of registered shareholders, and number of subsidiaries is ascertained from Bloomberg and Reuters for

each year over 1992 through 2007.

IBEX 35 Index IBEX 35 Index IBEX35 Index

Additions Deletions

Number of firms (# observations) 191 (1172) 78 (312) 78 (312)

Market capitalization ($m) 14,050 [6,896] 934 [696] 1,004 [877]

Book value of total assets ($m) 17,993 [8,552] 1,069 [916] 1,084 [936]

Net income ($m) 378 [297] 33 [37] 79 [70]

Return on assets – ROA 2.41% [3.84%] 2.91% [4.30%] 3.87% [7.21%]

Stock beta 0.92 [0.89] 1.23 [1.50] 0.93 [1.19]

Earnings per share - EPS 1.57 [1.48] 1.69 [2.08] 1.94 [3.10]

Price Volume 0.30 [0.24] 0.20 [0.16] 0.18 [0.16]

Weekly stock trading volume (m) 33.4 [10.1] 2.4 [1.8] 2.3 [1.7]

Daily stock trading volume (m) 8.4 [2.3] 0.7 [0.3] 0.6 [0.3]

Number of employees 15,456 [8,614] 9,629 [4,916] 9,447 [5,014]

Number of registered shareholders 90 [78] 58 [69] 79 [66]

Number of subsidiaries 267 [95] 114 [67] 99 [48]

Table 2

Stock price response and volume turnover to IBEX 35 Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of

changes into 76 index additions and 76 index deletions. Data on share prices and volume are taken from Datastream. ANN is the

announcement day, EFF is the first day on which the index change is effective, and PRE20 is the 20-day period prior to the

announcement day. ANN to EFF represents the period from announcement to the effective day. POST20 is the 20-day period

from the effective day through 20 days after the effective day Abnormal returns (AR) and cumulative abnormal returns (CAR)

are computed according to the market model. BHAR represents buy-and-hold returns. Volume turnover in trading volume is

computed by scaling event period by reference period volume all scaled by shares outstanding. * and ** indicate statistical

significance at the 0.05 and 0.01 level.

Panel A: IBEX 35 Index additions

Final sample 78 78 78

Stock returns

AR CAR BHAR

Announcement date (ANN) 0.0059

Effective date (EFF) 0.0196**

ANN through EFF 0.0212**

0.0209**

ANN –20 through ANN –1 (PRE20) 0.0074 0.0063

EFF through EFF + 20 (POST20) -0.0250**

-0.0231**

Stock volume and volume turnover

Volume Volume turnover




ANN –20 through ANN –1 (PRE20) 0.104

EFF through EFF + 20 (POST20) 0.197*

ANN / PRE20 1.34 1.03

EFF / PRE20 2.72**

2.21*

POST20 / PRE20 1.76* 1.23

Panel B: IBEX 35 Index deletions


Stock returns

AR CAR BHAR

Announcement date (ANN) -0.0031

Effective date (EFF) -0.0266**

ANN through EFF -0.0294**

-0.0217**

ANN –20 through ANN –1 (PRE20) -0.0098 -0.0083

EFF through EFF + 20 (POST20) 0.0325**

0.0284**

Stock volume and volume turnover

Volume Volume turnover




ANN –20 through ANN –1 (PRE20) 0.157

EFF through EFF + 20 (POST20) 0.203*

ANN / PRE20 0.89 1.24

EFF / PRE20 2.71**

2.48**

POST20 / PRE20 1.38 1.02

Table 3

Long run performance to IBEX 35 Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of

changes into 78 index additions and 78 index deletions. Data on accounting information, share prices and volume are taken from

Datastream. EFF to EFF+60, +120 and +180 represents the period from the effective day through 60, 120, and 180 days after the

effective day (POST60, POST120 and POST180). PRE60, PRE120, and PRE180 cover the period from the day before the

announcement day through 60, 120, and 180 days prior, respectively. Excess returns (ER) are computed using the zero one

model, where the intercept is 0 and a unitary beta is assumed. BHAR represents buy-and-hold returns. Return on assets (ROA) is

earnings before interest, taxes, and depreciation scaled by the book value of assets. Industry-adjusted return on assets (IAROA) is

computed by subtracting the mean industry-matched ROA from the ROA of each sample firm in each year. * and ** indicate

statistical significance at the 0.05 and 0.01 level.



Long-run stock returns ER BHAR

ANN –180 through ANN –1 (PRE180) -0.0075 -0.0013



ANN through EFF 0.0200* 0.0190

*

EFF through EFF + 60 (60POST) -0.0212* -0.0255

**

EFF through EFF + 120 (120POST) -0.0156 -0.0169

EFF through EFF + 180 (180POST) -0.0086 -0.0108

Long-run operating performance ROA ΔROA y-1 ΔROA y

ROA in two years before change (ROAy-2) 1.644

ROA in year before change (ROAy-1) 1.693

ROA in year of change (ROAy) 1.966 0.273

ROA in year after change (ROAy+1) 2.348 0.655 **

0.382*

ROA in two years after change (ROAy+2) 1.951 0.258 -0.015

Industry-adjusted long-run operating performance IROA ΔIROA y-1 ΔIROA y

IROA in two years before change (IROAy-2) 0.072

IROA in year before change (IROAy-1) 0.090

IROA in year of change (IROAy) 0.145 0.055

IROA in year after change (IROAy+1) 0.197 0.107

0.072

IROA in two years after change (IROAy+2) 0.100 0.060 -0.045



Long-run stock returns ER BHAR

ANN –180 through ANN –1 (180PRE) -0.0008 0.0012

ANN –120 through ANN –1 (120PRE) -0.0094 -0.0062

ANN –60 through ANN –1 (60PRE) -0.0080 -0.0073

ANN through EFF -0.0208* -0.0191

*

EFF through EFF + 60 (60POST) 0.0209* 0.0202

*

EFF through EFF + 120 (120POST) 0.0222**

0.0209*

EFF through EFF + 180 (180POST) 0.0208* 0.0220

**

Long-run operating performance ROA ΔROA y-1 ΔROA y

ROA two years before change (ROAy-2) 1.493

ROA in year before change (ROAy-1) 1.806

ROA in year of change (ROAy) 1.715 -0.091

ROA in year after change (ROAy+1) 3.244 1.438 **

1.529**

ROA two years after change (ROAy+2) 3.160 1.354**

1.445**

Industry-adjusted long-run operating performance IROA ΔIROA y-1 ΔIROA y

IROA two years before change (IROAy-2) 0.003

IROA in year before change (IROAy-1) 0.068

IROA in year of change (IROAy) 0.083 0.015

IROA in year after change (IROAy+1) 0.237 0.169**

0.154**

IROA two years after change (IROAy+2) 0.220 0.152**

0.137**

Table 4

Realized and Forecast EPS to IBEX 35 Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of

changes into 78 index additions and 78 index deletions. Analysts‟ earnings per share forecasts (eps) are extracted from I\B\E\S.

Mean forecasts of eps before the announcement a stock will be added and deleted to the index are compared with eps forecasts

following the announcement to compute a change in forecasts. The change in eps forecast is computed for current-year and one

year-ahead. FB represents forecast before and FA represents forecasts after the index change. EB denote realized eps before and

EA refers to realized eps after the index change announcement. The year in which the index change was announced is y, and y-2,

y-1, y+1, y+2 are two and one years before and after year y, respectively. Data on realized eps are taken from Datastream. * and

** indicate statistical significance at the 0.05 and 0.01 level.


Final sample 64 64

Forecast EPS ($) Forecast

Forecast two years before change (FBy-2) 1.60

Forecast in year before change (FBy-1) 1.52

Forecast in year of change (Fy) 1.48

Forecast in year after change (FAy+1) 1.52

Forecast two years after change (FAy+2) 1.60

Change in forecast EPS ($) ΔForecast

Change in forecast in year after change (FBy-1to Fy) -0.04 [-2.6%]

Change in forecast in year after change (FBy-1to FAy+1) 0.00 [0.00%]


Change in forecast in year of change (Fyto FAy+1) 0.04 [2.7%]


Realized EPS ($) Earnings

Earnings in year before change (EBy-2) 1.60


Earnings in year of change (Ey) 1.46

Earnings in year after change (EAy+1) 1.55

Earnings in two years after change (EAy+2) 1.61

Change in realized EPS ($) ΔEarnings

Change in earnings in year after change (EBy-1to Ey) -0.04 [-2.7%]

Change in earnings in year after change (EBy-1to EAy+1) 0.05 [3.3%]


Change in earnings in year of change (Eyto EAy+1) 0.09 [6.1%]

Change in earnings in year of change (Eyto EAy+2) 0.15 [10.3%]

Forecast error ($) Error

(FBy-2) - (EBy-2) 0.00

(FBy-1) - (EBy-1) 0.02

(Fy) - (Ey) 0.02

(FAy+1) - (EAy+1) -0.03

(FAy+2) - (EAy+2) -0.01

Change in forecast error ($) ΔError

Change from [(FBy-1) - (EBy-1)] to [(Fy) - (Ey)] 0.00

Change from [(FBy-1) - (EBy-1)] to [(FAy+1) - (EAy+1)] -0.05

Change from [(FBy-1) - (EBy-1)] to [(FAy+2) - (EAy+2)] -0.03

Change from [(Fy) - (Ey)] to [(FAy+1) - (EAy+1)] -0.05

Change from [(Fy) - (Ey)] to [(FAy+2) - (EAy+2)] -0.03


Final sample 61 61

Forecast EPS ($) Forecast

Forecast two years before change (FBy-2) 1.72

Forecast in year before change (FBy-1) 1.58

Forecast in year of change (Fy) 1.49

Forecast in year after change (FAy+1) 1.60

Forecast two years after change (FAy+2) 1.68

Change in forecast EPS ($) ΔForecast

Change in forecast in year after change (FBy-1to Fy) -0.09 [-5.7%]





Realized EPS ($) Earnings



Earnings in year of change (Ey) 1.44

Earnings in year after change (EAy+1) 1.70

Earnings in two years after change (EAy+2) 1.88

Change in realized EPS ($) ΔEarnings

Change in earnings in year after change (EBy-1to Ey) -0.07 [-4.6%]


Change in earnings in year after change (EBy-1to EAy+2) 0.37**

[24.5%]**

Change in earnings in year of change (Eyto EAy+1) 0.26* [18.1%]

*

Change in earnings in year of change (Eyto EAy+2) 0.44**

[30.1%]**

Forecast error ($) Error

(FBy-2) - (EBy-2) 0.08

(FBy-1) - (EBy-1) 0.07

(Fy) - (Ey) 0.05

(FAy+1) - (EAy+1) -0.10

(FAy+2) - (EAy+2) -0.20

Change in forecast error ($) ΔError

Change from [(FBy-1) - (EBy-1)] to [(Fy) - (Ey)] -0.02

Change from [(FBy-1) - (EBy-1)] to [(FAy+1) - (EAy+1)] -0.17*

Change from [(FBy-1) - (EBy-1)] to [(FAy+2) - (EAy+2)] -0.27**

Change from [(Fy) - (Ey)] to [(FAy+1) - (EAy+1)] -0.15*

Change from [(Fy) - (Ey)] to [(FAy+2) - (EAy+2)] -0.25**

Table 5

Change in financing, press and analyst coverage, equity ownership, and shadow cost

to IBEX 35 Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of

changes into 78 index additions and 78 index deletions. We collected data on the number of new debt and equity issues from

SDC over a 48-month period centered on the announcement of index change. Two popular broadsheets, La Gaceta and Cinco

Dias, were scanned to assess the production of information from 2 years before to 2 years after each index change. We collected

data on the number of shareholders, institutional investors, and blockholders for each firm in each year for four years centered on

the announcement of index change from Reuters and Bloomberg. Shadow cost is computed as the residual standard deviation of

the newly added or deleted stock return over the year scaled by the IBEX 35 Index market value multiplied by the market value

of the stock added to or deleted from the IBEX 35 Index at year-end, scaled by their number of shareholders. Data on the number

of shareholders for each sample firm is gathered in the year before and after the date of index change from Reuters and

Bloomberg. * and ** indicate statistical significance at the 0.05 and 0.01 level.



2 years before 2 years after Change

Financing

Debt [$ amount] 18 [$10.5m] 20 [$17.9m] 2 [$0.31m]

Equity [$ amount] 14 [$21.3m] 19 [$42.3m] 5 [$21.0m]

Analyst Coverage

Number of analysts 9 10 1 (11%)

Forecast revisions 26 28 2 (8%)

Press Coverage La Gaceta (news items) 264 278 14 (5%)

Cinco Dias (news items) 193 209 16 (8%)

Equity ownership

# Registered shareholders 55 62 7 (13%)

# Institutional shareholders 3 3 0 (0%)

(> 5% equity)

Merton’s Shadow Cost 0.525 0.509 -0.016 (3%)




Financing

Debt [$ amount] 17 [$11.38m] 16 [$10.15m] -1 [-$1.23m]

Equity [$ amount] 10 [$23.80m] 9 [$26.19m] -1 [$2.39m]

Analyst Coverage

Number of analysts 11 11 0 (0%)

Forecast revisions 28 41 13 (46%)

Press Coverage La Gaceta (news items) 208 241 33 (16%)

Cinco Dias (news items) 186 214 28 (15%)

Equity ownership

# Registered shareholders 69 67 -2 (-3%)

# Institutional shareholders 4 3 -1 (-25%)

(> 5% equity)

Merton’s Shadow Cost 0.441 0.460 0.019 (4%)

Table 6

OLS regressions to IBEX 35 Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of changes into 78 index additions and 78 index

deletions. The dependent variable in the OLS regressions is excess returns computed using the zero one model over a 180 days after the effective date (POST180). Analysts‟ earnings

per share forecasts (eps) and analyst coverage data are extracted from I\B\E\S. Mean forecasts of eps before the announcement that a stock is added to or deleted from the index are

compared with eps forecasts following the announcement to compute a change in forecasts. The change in eps forecast is computed using the one year-ahead forecast. Data on

realized eps are taken from Datastream. We collected data on the number of new debt and equity issues from SDC over a 48-month period centered on the announcement of index

change. Two popular broadsheets, La Gaceta and Cinco Dias, were scanned to assess the production of information from 2 years before to 2 years after each index change. We

collected data on the number of shareholders, institutional investors, and blockholders for each firm in each year for four years centered on the announcement of index change from

Reuters and Bloomberg. Shadow cost is computed as the residual standard deviation of the newly added or deleted stock return over the year scaled by the IBEX 35 Index market

value multiplied by the market value of the stock added to or deleted from the IBEX 35 Index at year-end, scaled by their number of shareholders. Data on the number of

shareholders for each sample firm is gathered in the year before and after the date of index change from Reuters and Bloomberg. P-values are reported in parentheses.

Panel A: IBEX 35 Index Additions

Final Sample 64 64 64 64

Change in realized eps 2.88 (0.29) 2.74 (0.31)

Change eps forecast error 3.23 (0.24) 2.99 (0.29)

Change in $ debt issuance 0.10 (0.39) 0.10 (0.40) 0.10 (0.40) 0.10 (0.36)

Change in $ equity issuance 0.32 (0.10) 0.35 (0.09) 0.38 (0.08) 0.37 (0.09)

Change in press coverage

- La Gaceta 0.29 (0.48) 0.28 (0.49)

- Cinco Dias 0.39 (0.41) 0.33 (0.50)

Change in analyst coverage 0.89 (0.22) 0.96 (0.20) 0.99 (0.19) 0.97 (0.21)

Change in registered shareholders 2.34 (0.27) 2.96 (0.24) 3.44 (0.20) 3.59 (0.19)

Change in blockholders >5% 1.08 (0.53) 1.11 (0.53) 1.10 (0.53) 1.15 (0.42)

Change in shadow cost -2.44 (0.30) -2.61 (0.28) -2.78 (0.27) -2.90 (0.23)

Adjusted r2 0.1488 0.1584 0.1446 0.1585

Panel A: IBEX 35 Index Deletions


Change in realized eps 4.15 (0.00) 4.31 (0.00)

Change in eps forecast error 3.85 (0.07) 4.02 (0.05)

Change in $ debt issuance -0.31 (0.72) -0.34 (0.66) -0.30 (0.67) -0.39 (0.57)


Change in press coverage

- La Gaceta 0.74 (0.14) 0.78 (0.14)

- Cinco Dias 0.89 (0.12) 0.84 (0.12)


Change in registered shareholders -1.25 (0.66) -1.03 (0.67) -1.18 (0.67) -1.09 (0.67)

Change in blockholders >5% -1.86 (0.24) -2.01 (0.17) -1.92 (0.20) -2.00 (0.17)

Change in shadow cost 1.88 (0.39) 1.96 (0.36) 1.93 (0.35) 2.02 (0.33)

Adjusted r2 0.2844 0.2584 0.2983 0.2602

Table 7

Change in top management turnover, asset restructuring, and employee downsizing to IBEX 35

Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample

of changes into 78 index additions and 78 index deletions. We collate information on board composition for each firm in the

sample from annual filings held at the Bolsa de Madrid and cross-checked with Bloomberg. We then track annual turnover in

the positions of CEO (chief executive officer), COB (chairman of the board), President, and FD (finance director or chief

financial officer) in each year over 1992 through 2007. Data on announcements of asset and/or employee restructuring are

gathered from La Gaceta and Cinco Dias over a four year period centered on the announcement date of the index change.

The news items were cross-referenced with Reuters News Service. * and ** indicate statistical significance at the 0.05 and

0.01 level.




Top management turnover

CEO 12 11 -1 (-8%)

CEO, COB, President 16 16 0 (0%)

CEO, COB, President, FD 23 21 -2 (-9%)

Forced (CEO, COB, President, FD) 7 5 -2 (-40%)

Restructuring announcements

Assets - Divestitures and sell-offs 16 10 -6 (-38%)

Employees – downsizing 9 6 -3 (-33%)




Top management turnover

CEO 9 17 8 (89%)

CEO, COB, President 14 32 18 (129%)

CEO, COB, President, FD 20 43 23 (115%)

Forced (CEO, COB, President, FD) 5 12 7 (140%)

Restructuring

Assets - Divestitures and sell-offs 12 18 6 (50%)

Employees – downsizing 6 13 7 (117%)

Table 8

Robustness checks on OLS regressions to IBEX 35 Index additions and deletions The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of changes into 78 index additions and 78 index

deletions. The dependent variable in the OLS regressions in columns 2 and 3 is excess returns computed using the zero one model over a 180 days after the effective date

(POST180). The dependent variable in the OLS regression in column 4 is excess returns computed using the zero one model over a 120 days after the effective date (POST120). In

column 5, the dependent variable is buy-and-hold excess returns over 180 days after the effective date. Data on realized eps are taken from Datastream. We collected data on the

number of new debt and equity issues from SDC over a 48-month period centered on the announcement of index change. Two popular broadsheets, La Gaceta and Cinco Dias, were

scanned to assess the production of information from 2 years before to 2 years after each index change. We collected data on the number of shareholders, institutional investors, and

blockholders for each firm in each year for four years centered on the announcement of index change from Reuters and Bloomberg. Shadow cost is computed as the residual standard

deviation of the newly added or deleted stock return over the year scaled by the IBEX 35 Index market value multiplied by the market value of the stock added to or deleted from the

IBEX 35 Index at year-end, scaled by their number of shareholders. Data on the number of shareholders for each sample firm is gathered in the year before and after the date of

index change from Reuters and Bloomberg. Run-up is the abnormal stock return over the 20-day period prior to the effective date of index change (PRE20). CEO turnover is an

indicator variable that equals one when CEO turnover occurred within two years of the index change date. Top team turnover is an indicator variable that equals one when CEO,

COB (chairman of the board), President or FD (finance director) turnover occurred within two years of the index change date. Announcements of asset and employee restructuring

are identified in La Gaceta and Cinco Dias for each sample firm that was added to or deleted from the IBEX 35 Index. We use the number of announcements for each firm two years

before and after the date of index reconstitution. P-values are reported in parentheses.

Panel A: IBEX 35 Index Additions

Dependent variable POST180 POST180 POST120 BHAR180


Change in realized eps 2.12 (0.42) 2.28 (0.38) 1.40 (0.83) 2.68 (0.30)

Change in $ debt issuance 0.10 (0.40) 0.11 (0.36) 0.08 (0.59) 0.15 (0.24)


Change in press coverage – Cinco Dias 0.30 (0.58) 0.23 (0.66) 0.19 (0.85) 0.14 (0.92)


Change in registered shareholders 2.19 (0.38) 2.48 (0.33) 3.68 (0.18) 4.22 (0.13)

Change in blockholders >5% 1.00 (0.58) 0.87 (0.72) 0.62 (0.90) 1.61 (0.27)

Change in shadow cost -2.27 (0.35) -2.99 (0.22) -1.63 (0.41) -3.74 (0.10)

Run-up - PRE20 -1.86 (0.26) -1.73 (0.29) -2.04 (0.22) -2.23 (0.18)

CEO turnover (indicator =1) -0.82 (0.59)

Top team turnover (indicator =1) -1.16 (0.83) -1.74 (0.50) -1.27 (0.78)

Asset restructuring -0.71 (0.35) -0.66 (0.42) -0.39 (0.63) -0.83 (0.30)

Employee downsizing -0.39 (0.91) -0.46 (0.80) -0.49 (0.79) -0.66 (0.61)

Adjusted r2 0.1836 0.1891 0.1528 0.1634

Panel A: IBEX 35 Index Deletions

Dependent variable POST180 POST180 POST120 BHAR180


Change in realized eps 2.63 (0.24) 2.73 (0.23) 3.19 (0.16) 2.96 (0.19)

Change in $ debt issuance -0.35 (0.63) -0.38 (0.55) -0.55 (0.43) -0.76 (0.28)


Change in press coverage – Cinco Dias 0.63 (0.14) 0.71 (0.11) 0.68 (0.14) 1.07 (0.07)


Change in registered shareholders -1.08 (0.71) -0.92 (0.84) -0.66 (0.92) -0.83 (0.92)

Change in blockholders >5% -1.24 (0.68) -1.69 (0.28) -1.41 (0.36) -1.19 (0.79)

Change in shadow cost 2.01 (0.18) 2.04 (0.18) 2.11 (0.26) 2.35 (0.11)

Run-up - PRE20 0.99 (0.43) 1.23 (0.38) 1.48 (0.35) 1.69 (0.20)

CEO turnover (indicator =1) 3.04 (0.00)

Top team turnover (indicator =1) 2.89 (0.03) 3.04 (0.05) 3.47 (0.00)

Asset restructuring (indicator =1) 1.38 (0.24) 1.55 (0.19) 1.71 (0.17) 1.60 (0.20)

Employee downsizing (indicator =1) 1.09 (0.26) 1.00 (0.25) 1.30 (0.30) 1.12 (0.29)

Adjusted r2 0.3140 0.3096 0.2168 0.2347

Figure 1

Relative Volume on IBEX 35 Index additions and deletions

The sample consists of 156 changes to the IBEX 35 Index from January 1992 through December 2007. We split the sample of changes into 78 index additions and 78 index

deletions. Relative trading volume data is extracted from Datastream over 20 days before the announcement date and through 20 days after the effective date of the index change.

Average trading volume values for IBEX 35 Index additions and deletions are plotted in blue and red, respectively. For exposition, a 5-day moving average trend line for the sample

of index additions and deletions is also plotted.

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IBEX 35 Inclusiones and Exclusiones

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