Short Sales Constraints and Price Adjustment to Earnings Announcements

Abstract

This study looks at how short sales constraints affect the stock price adjustment to the release of public information in the Hong Kong Stock Exchange for a sample of 4,757 firm-event observations over the period 1994-2011. Using a unique feature of this market that allows us to directly investigate the impact of the imposition of short sales restriction, we find following results. First, nonshortable stocks react more strongly to negative information than shortable stocks. Second, nonshortable stocks are overpriced before the negative earnings announcement. Hence, part of the strong market reaction of nonshortable stocks on announcement day could be due to the correction of such overpricing. Third, prices of nonshortable stocks reverse following the announcement of negative information, suggesting that investors overreact to the negative information on the announcement day. Fourth, it takes longer time for the prices of nonshortable stocks to fully adjust to the negative earnings information. On the whole, our results are supportive of the stream of research that finds the imposition of short sales restrictions reduce the efficiency of stock markets.