Negative Externalities of Regulation: Identity‐relevant Information in Mandatory Short‐selling Disclosures

Abstract

Since November 2012, short sellers have been required to disclose all their significant short positions against European firms. While this regulation was primarily implemented to have implications for financial markets, I explore its negative externalities on shorted firms. Using mandatory disclosures of short positions between 2013 and 2019, I find that short‐selling notifications and the number of short sellers with an open short position are positively associated with shorted firms’ dividend policies. Notably, the association is more pronounced for upward and initial notifications compared to downward and follow‐up notifications. These results are robust to several matching methods and a battery of robustness tests. Additional results reveal that shorted firms might increase their dividends because short‐selling disclosures reveal the identity of active and large short sellers, highlighting the importance of short sellers’ heterogeneity. I also show that shorted firms increase their dividends temporarily and do not react homogenously, as they engage in a cost–benefit analysis to decide whether to use their dividend policy. Overall, I document the real effects on shorted firms of an alternative form of short selling, bridging the gap between passive and activist short selling. I conclude that mandatory short‐selling disclosure regimes carry negative externalities for firms due to the provision of short sellers’ identity‐relevant information.