Strategic adjustment of capital structure: Evidence from firms newly added to the S&P 500 index

We examine the capital structure of firms that are newly added to the S&P 500 index. The leverage ratio gradually decreases during the two‐year pre‐addition period and then increases during the two‐year post‐addition period, resulting in a U‐shaped trend. This trend is more pronounced in financially weak firms, those facing significant competition for index inclusion, and firms with weak governance. Moreover, the trend is primarily driven by debt policies. This U‐shaped pattern in the leverage ratio cannot be explained by changes in the cost of capital or mechanical mean reversion. The overall results are consistent with firms′ strategically reducing their leverage ratios to temporarily improve financial health prior to index revisions.