Short-selling Pressure and Technological Exploration of Firms: A Randomized Policy Experiment

Abstract

This study examines how the short-selling pressure affects firms' technological exploration. Short-sellers who make a profit from downward stock price movements reduce innovating firms' incentives and ability to explore new technological areas by spreading negative information and limiting their ability to acquire skilled human capital. We exploit a randomized policy experiment on short selling. In 2005, the US SEC randomly selected one-third of Russell 3000 firms and made it significantly easier to short-sell their stocks by removing the uptick rule. The results from the difference-in-differences estimation show that the increased short-selling pressure significantly deterred the tread firms' technological exploration. We further test two important mechanisms that could change the incentives and the ability to explore new technologies. First, the negative effect of short-selling pressure on exploration is weakened when the executives hold the stock options (incentive channel). Second, the negative effect is mediated by the firm's decreased hiring of skilled human capital from other firms that limits learning-by-hiring (ability channel). This study contributes to the literature by demonstrating that the financial market frictions have a far-reaching impact on the technological exploration of firms and the roles of managerial incentives and human capital acquisitions.