Measuring the Effect of the Benchmark Inclusion Subsidy on M&A Activity

I study the impact of benchmark (S&P 500) inclusion on firm’s M&A activity and risk tolerance in mergers. To get unbiased results I contrast companies that are close in industry and size but have different benchmark status. The results provide evidence that benchmark firms engage in statistically greater number of acquisitions. The analysis also reveals that target’s cash flow riskiness is an essential driver of M&A activity. Higher target risk negatively affects acquisitiveness, but benchmark firms result in being less sensitive to it. Thus, benchmark firms prefer relatively riskier targets. Both empirical findings can be explained by the theoretical driver of mergers for benchmark companies – “benchmark inclusion subsidy”, proposed by Kashyap et al. (2021, 23). This subsidy results in higher post-merger prices of benchmark stocks due to passive investors' steady demand, even after risky mergers. Such valuation benefit from being in a benchmark motivates companies to engage more in mergers and acquisitions. The study provides practical insights for managers, individual investors, and regulators. The results contribute to the existing knowledge in the fields of M&A drivers and the effects of benchmark inclusion, connecting these two dimensions.