Short-sale constraints and stock price crash risk: Causal evidence from a natural experiment

Abstract

We examine the relation between short-sale constraints and stock price crash risk. To establish causality, we take advantage of a regulatory change from the Securities and Exchange Commission (SEC)’s Regulation SHO pilot program, which temporarily lifted short-sale constraints for randomly designated stocks. Using Regulation SHO as a natural experiment setting in which to apply a difference-in-differences research design, we find that the lifting of short-sale constraints leads to a significant decrease in stock price crash risk. We further investigate the possible underlying mechanisms through which short-sale constraints affect stock price crash risk. We provide evidence suggesting that lifting of short-sale constraints reduces crash risk by constraining managerial bad news hoarding and improving corporate investment efficiency. The results of our study shed new light on the cause of stock price crash risk as well as the roles that short sellers play in monitoring managerial disclosure strategies and real investment decisions.