Shorting Fees, Private Information, and Equity Mispricing

Abstract

We document that stock lenders are informed about market conditions and pursue revenue maximization by setting premiums or offering discounts on stock lending fees. Using a model of supply and demand in the equity lending market, we illustrate the effect of stock borrowers' private information on the elasticity of shorting demand. Smart lenders respond to demand elasticity and increase their revenues through premiums or discounts on lending fees. Empirically, decomposing stock loan fees into intrinsic fee and premium or discount, we confirm lenders' market awareness, showing that premiums and discounts among difficult-to-borrow stocks both lead to increased lending revenues. This smart lending behavior has new implications about informed shorting, short interest, and transaction costs in the equity lending market.