Implications of Short Selling for Corporate Finance

Abstract

Corporate managers often view short sellers as market manipulators whose actions drive their company's stock price below intrinsic value. But recent academic research suggests that some short sellers are effective in processing publicly available information and that their short selling may provide useful information to market participants. This article summarizes the authors’ own published research, which provides evidence of informed short selling by linking it to changes in corporate fundamentals.More specifically, the authors’ findings indicate that increases in short interest are reliable indicators of an economically (as well as statistically) significant decline in a company's operating performance over the following three years. And when examining changes in short interest around announcements of seasoned equity offerings, the authors also find a negative relation between an increase in short interest and future operating performance. In addition, they find that the greater the increase in short interest in the period leading up to the SEO announcement, the more negative is the stock‐price response to the announcement itself.The authors’ findings suggest that corporate managers can benefit from monitoring the short‐selling activity in their company's stock. Short‐selling data can be used to reassess corporate strategy or rethink major corporate decisions that have been announced but not carried out, and take preemptive actions to forestall impending future declines in performance and so preserve value.