ABSTRACT. A number of explanations have been offered to explain the market’s reaction to reconstitution of the S&P indexes. Most of these explanations have derived from theories of finance or economics. We offer an alternative explanation, one based on institutional theory. Briefly, when firms are added to an S&P index, it sends a signal that the firm has become “legitimate,” and investors are willing to pay more for its securities. Being dropped from an index does not mean that the firm has lost its “legitimacy,” however, so the market would not react. The results support this explanation. Inclusion of a firm in these indexes is associated with increases in both shareholder wealth and trading volume, while deletion of a firm shows no significant decrease in either. pp. 23–42
JEL Classification: C43, E44, L11, L25

Keywords: market reaction, S&P index, shareholder wealth, trading volume