The SEC's Busted Randomized Experiment: What Can and Cannot Be Learned

Abstract

During 2005-2007, the US Securities and Exchange Commission ran a randomized experiment, in which it removed short sale restrictions for some “treated” firms, chosen at random, and left these restrictions in place for others. The SEC experiment has been exploited by many finance and accounting scholars, who report evidence that removing short sale restrictions affected a wide range of financial outcomes, including share prices, firm investment strategy, accounting accruals, auditor behavior, innovation, and much more. We show that the SEC busted its own randomization experiment, in a way which undermines most prior studies. The SEC in fact conducted three distinct randomized experiments; these can be examined separately but cannot be combined without further, likely unjustified assumptions. We discuss what one can and cannot learn from these three experiments. We also develop reasons and supporting evidence for why relaxing short-sale restrictions was unlikely to affect most of the outcomes studied in recent work. We explain the need, when studying the indirect effects of the SEC experiment, to account for nonrandom choices by short sellers on which firms to “target”, and the nonrandom responses of firm managers and other market participants to removal of short sale restrictions. We then revisit selected results from prior studies (effect of the experiment on open short interest and share prices), and find no evidence that the relaxing short-sale restrictions affected either measure.