Things often get worse before they get better: using contest theory to explain the effect of informational risk around inclusion in S&P 500 on cost of capital

Malika Chaudhuri, Ranadeb Chaudhuri, Jay Janney and Mohinder Parkash

The European Journal of Finance, 2022, vol. 28, issue 8, 848-869

Abstract: The link between cost of capital and information risk is one of the most fundamental and controversial issues in financial accounting. We need an exogenous shock to unequivocally tease out the link between information risk and cost of capital (CoC). In this study, we consider a firm’s listing with the S&P 500 index as the exogenous shock. Listing with the index is expected to bring the firm into the limelight, leading to increased scrutiny of the firm and its management performance by market participants and stock analysts. This may expose the firm to increased information risk, which may adversely affect its cost of capital in the short run. Empirical evidence in this study suggests firms that are added to the S&P 500 index exhibit higher cost of capital over the first year after inclusion compared to a carefully constructed matched sample of non-S&P 500 stocks. Results also indicate that the volume of information released and precision of information once a firm is listed with the index significantly impact its cost of capital.

Date: 2022
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DOI: 10.1080/1351847X.2021.1933119

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