Does External Governance Hinder or Improve Firm Innovation? Evidence from the Short Selling Pressure

Abstract

This study adds to the debate about the influence of external governance on publicly traded firms by focusing on how a specific source of external governance, i.e., the short selling pressure, affects firm innovation, a crucial dimension associated with firms’ long-term success. Drawing on external governance and innovation literatures, we consider the dual facets of innovation, i.e., innovation efforts and output, and argue that the presence of short selling pressure may lead firms to decrease innovation input but simultaneously increase innovation output. We use a difference-in-differences design based on a policy experiment that relaxes short selling constraints, and find supporting evidence of our theory. By showing the seemingly conflicting outcome of the short selling pressure, we contribute to the innovation literature and deepen our understanding of external governance.