Abstract
This paper examines the link between index membership and corporate investment and financing policies. Using a plausibly exogenous reshuffling of the constituents of a widely-benchmarked bond index, I find that index membership carries both a yield and a liquidity premium in secondary bond markets. This premium then feeds-back into primary markets, where index member bonds experience lower costs of debt than their identical non-index counterparts. Moreover, I find that a loss of index membership results in firms dynamically adjusting their financing away from debt and towards equity, and reducing total investment as a result. Consistent with bond index membership affecting firms through their costs of capital, I find that these effects are heterogeneously stronger in financially constrained firms and firms that are more reliant on corporate debt financing.
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