Demand Curves for Stocks Do Slope Down: New Evidence From An Index Weights Adjustment

Weights in the Toronto Stock Exchange 300 index are determined by the market values of the included stocks’ public floats. In November 1996, the exchange implemented a previously announced revision of its definition of the public float. This revision, which increased the floats and the index weights of 31 stocks, conveyed no information and had no effect on the legal duties of shareholders. Affected stocks experienced statistically significant excess returns of 2.3 percent during the event week, and no price reversal occurred as trading volume returned to normal levels. These findings support downward sloping demand curves for stocks. An obvious event with which to examine the slope of demand curves for stocks is one that changes supply. In the absence of new information, a shift in supply should not affect stock prices if demand curves for stocks are flat. Scholes (1972), using a sample of secondary equity distributions, asks whether stocks are “...unique works of art...” or merely abstract claims to residual cash flows with many close substitutes, as is assumed in much of finance theory. However, Scholes finds that the negative price impact of secondary offerings depends on the seller’s identity -implying the revelation of unfavorable information -and rules out a pure supply effect. Mikkelson and Partch (1985), also using a sample of registered and unregistered secondary offerings, find weak evidence of downward sloping demand curves, but are unable to cleanly distinguish this explanation from the alternative explanation based on unfavorable information. A different class of events -additions to widely-followed stock market indexes -ostensibly provides a setting where information effects should not be present. Shleifer (1986) documents a permanent price increase for stocks added to the S&P 500 index and argues that if S&P index membership is associated with increased demand for the stock, the price increase is, prima facie, consistent with downward-sloping demand curves. However, several studies have identified alternative sources of the price increase accompanying index inclusion, chiefly, favorable information, enhanced liquidity, and price pressure. 1 Put simply, the existing literature has not provided unequivocal evidence on the slope of demand curves for stocks because an event that is unambiguously free of information has not been identified. In this paper, we examine the slopes of demand curves for common stocks using a unique event at the Toronto Stock Exchange. In November 1996, the Toronto Stock Exchange (TSE) redefined the public float (the number of shares outstanding less blockholdings) for listed firms to include all ownership stakes less than 20 percent, up from 15 percent previously. This decision, which brought the TSE’s definition of the public float into line with that used by its regulator, the Ontario Securities Commission (OSC), increased the float for 31 stocks in the TSE 300 index. Since weights in the TSE 300 index are determined by the market values of the included stocks’ public floats, these float changes translated into economically