Long-term price effect of S&P 500 addition and earnings quality

When a company is added to the S&P 500 Index, it receives a positive price response. Several explanations for this effect have been suggested, but empirical findings do not provide a conclusive cause. The inclusion of a company in the index may strengthen managerial incentives to provide high-quality disclosures of financial data. This study is an examination of the earnings quality of S&P 500 companies before and after their addition to the index. It finds that discretionary accruals significantly decrease after companies are added to the index, which greatly improves earnings quality. This change in earnings quality provides a possible explanation for the price response to the S&P 500 addition.