Political Connections and Short Sellers

Abstract

Prior studies document politically-connected firms (PCFs) tend to have a higher probability of government bailout. This study finds that the government bailout guarantee, embedded in PCFs, deters the short sale activity. Informed short sellers view the guarantee as a higher expected cost of short sale against PCFs. The deterrence effect of this government guarantee decreases the return predictive power of the short sale activity. The effect also leads heavily-shorted PCFs to have a higher factor-adjusted return than heavily-shorted non-PCFs. Further evidence shows the implicit government guarantee impediments the incorporation of bad news into the stock prices of PCFs, mitigating the severity of the crash risk.