Abstract
We characterize the effect of short selling costs on interactions between informed and uninformed speculators, showing how this dynamic impacts corporate decisions. Manipulation coexists with informed trading at low shorting costs, reducing price informativeness and firm investment. Manipulation becomes less profitable as shorting costs increase, making prices more informative and boosting investment if speculators are less likely to be informed. At high shorting costs, informed shorting is unprofitable even without manipulation threats, resulting in low price informativeness and constraining firm investment. Our model shows how contracts that pre-commit funds induce managers to stop manipulation through stock repurchases, implementing efficient investment.
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