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Review of Quantitative Finance and Accounting

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17.01.2017 | Original Research

What’s in the news? The ambiguity of the information content of index reconstitutions in Germany

verfasst von: Houdou Basse Mama, Stefan Mueller, Ulrich Pape

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 4/2017

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Abstract

We analyze stock price behavior around reconstitutions of the German DAX index family from 1990 to 2013. The strong price run-up of added stocks in the 2 months preceding the announcement date remains robust until 2 months after the effective date (ED), and is fully reversed 5 months later. Conversely, stock prices of deleted firms are under pressure until 10 months after the ED. Unlike most previous studies, we find that outright entries and exits have temporary price effects, as do additions to and deletions from better-known indices; however, promotions and demotions related to lesser-known indices command permanent stock price responses. Rather surprisingly, deleted stocks consistently earn higher abnormal returns than added stocks in the 5-year post-event period. Specifically, the return differential levels out at 77.3%. We establish that this differential in permanent stock prices is attributable to differences in operating performance and media coverage. In practice, index reconstitutions do not appear to give unambiguous signals about the long-run investment appeal of affected firms. However, index fund managers not constrained by tracking error minimization would be better off holding deleted stocks for 5 years after the ED.

Vorheriger Artikel Value creation and the probability of success in merger and acquisition transactions

Nächster Artikel A geometric treatment of time-varying volatilities

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This view is reflected in the statement by Bernd Scheifele, CEO of HeidelbergCement upon the decision of the German stock exchange operator, Deutsche Börse AG, in June 2010 to add HeidelbergCement to the best-known German equity index, the DAX. For him, this addition “marks the achievement of an important company target in 2010” (HeidelbergCement.com 4 June 2010). Similarly, Peugeot comments on its comeback in the French CAC 40 index as “reassuring for investors,” and the return to the spotlight should allow the firm to enhance its reputation internationally benefiting from better monitoring by the financial community (News Economy Market 5 March 2015).

We also provide evidence that the return differential is not an artefact of changes in systematic risk (as measured by market beta) nor of size effects. While both variables are significantly (but differently) related to permanent stock prices, they have no explanatory power for the difference in returns on index deletions and additions. They even become insignificant if used, e.g. in conjunction with proxies for operating performance. The superior performance of deletions does not reflect the reward to efforts of re-entering firms; neither is it driven by firms that have to exit an index (although they might not have poor performance), because the newly added have better performance.

This attests to the disclaimer of the provider of the DAX index family: “Deutsche Börse is not providing investment advice through the publication of indices or in connection therewith. In particular, the inclusion of a company in an index, its weighting, or the exclusion of a company from an index, do not in any way reflect an opinion of Deutsche Börse on the merits of that company” (Deutsche Börse AG 2012, p 18).

Following the unusual index jump due to the short squeeze of Volkswagen shares in 2008, Deutsche Börse AG decided to cap the relative weight of individual stocks to 10% (Schmidhammer et al. 2016).

In addition, there have been substantial alterations of the then prevailing index landscape, including the phase-out of the NEMAX 50 index and the creation of the TecDAX, the reduction of the number of MDAX constituents from 70 to 50. Finally and for the first time, foreign firms have become eligible to all selection DAX indices, except for the DAX.

We thank Houdou Basse Mama for making part of his data available to our study. For brevity, detailed analyses of the differences in internal managerial information in the US, UK, and Germany are relegated to Online Appendix #1.

The CDAX contains all German public companies listed on the PS and GS segments and is considered the German all-share market index.

Please, refer to Binder (1998) for an excellent review of the event study methodology since 1969.

Using the CAPM or the Carhart (1997) four-factor model does not qualitatively alter the inferences drawn from the market model. These results are available from the authors on request.

We complement the short-term perspective by an investigation of intermediate effects where the event-window begins 12 months before the AD and ends 24 months after the ED ([AD − M12, ED + M24]). This analysis is available as Online Appendix #3.

The CAARs referred to relate to various studies, including Lynch and Mendenhall (1997), Biktimirov and Li (2014), Chen et al. (2004), Chen (2006), Mase (2007) and Zhou (2011). A comparison of the results for less prestigious indices is provided as Online Appendix #2b. It confirms that ARs on the AD are larger for discretionary indices. The results relative to the reversal are largely mixed, while it still holds true that the DAX index family is more closely related to the FTSE indices.

For additions, the reversal already observed in the 3 months after the event continues throughout the following 24 months following the event. It adds up to −21.6% (significant at the 5% level) for the 2 post-event years. Interestingly, the anticipatory effects are not limited to the two months before the event, but can be observed throughout the whole year preceding the event. Additions show 11 months (of which 7 are significant) with positive CAARs. Deletions show 10 months (of which 5 are significant) with negative CAARs, which again supports the view that investors rely on the rules-based nature of the index system to forecast future reconstitutions.

The performance difference is present before and after the reorganization of the German index family in 2003. A split of the long-term results before and after 2003 can be found in Online Appendix #4.

The process included manual matching of company names with corresponding Dow Jones Intelligent Indexing™ Company Codes. For instance, for the addition of HeidelbergCement to the DAX index on 21 June 2010, the request for press articles after the event is defined as: “fds = HBDMAG and (rst = (SDDZ or SFREUT) and la = (de or en) and date from 20/09/2010 to 19/09/2011)”.

Using profit margins as alternative measure for performance, we find differences between added and deleted firms only in years t − 1, t = 0, and t + 1. In these 3 years additions show significantly higher ratios while deletions have negative profit margins, ranging from −4.62% to −4.06%. These results are available on request.

Adjusting the t-values by Rogers standard errors clustered by firm plus year dummies (as in Chan et al. 2013), in unreported analyses, allows similar inferences and the R² of the various models increases significantly. These results are available on request from the authors. Other variables used in the multivariate analyses but not plotted in Eq. (4), are change in profit margin (∆PM), changes in leverage (∆LEV), and change in research and development (∆RND).

Because our sample spans 1990–2013, there might have been specific structural changes in the market that warrant specific attention (we thank the reviewer for this comment). Indeed, the March 2003 reorganization of the trading segments in Germany and changes in market conditions (crisis) appear as structural change candidates. As shown in Online Appendices #8 and #9, these changes in the market settings have no explanatory power for the differential returns between additions and deletion; neither does their interaction.

We thank an anonymous reviewer for raising this issue.

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Titel: What’s in the news? The ambiguity of the information content of index reconstitutions in Germany
verfasst von: Houdou Basse Mama
Stefan Mueller
Ulrich Pape
Publikationsdatum: 17.01.2017
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 4/2017
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-017-0617-1

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