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.