This review surveys the existing empirical literature on the real effects of short selling on firms, addressing them through three main perspectives: corporate governance, financial decisions, and performance. The results of the (too) few empirical studies under scrutiny converge to a common rationale: a positive impact as a disciplinary mechanism on corporate governance and corporate investment policy and a positive impact on operating and corporate social responsibility (CSR) performance, even if some results are still puzzling. It appears that further investigations are necessary and should test the consequences of short selling on firms from a broader and more systematic perspective, with different theoretical and methodological approaches.
Short sellers are currently attracting considerable media attention as they target numerous well-known listed companies in various countries (e.g., Tesla in the USA, Casino in France).
Short sellers have been extensively identified as well-informed and sophisticated investors who contribute to market informational efficiency (e.g.,
Based on the results of previous investigations, this literature review intends to assess whether and how short sellers can have a positive or negative effect on firm-level outcomes. A huge flow of empirical research has tried to identify the determinants of short selling in terms of size, growth, uncertainty of firm environment, firm complexity, ease of stock borrowing, market liquidity, overvaluation, earnings management, accruals management, CSR attributes, entrenchment—the list is not exhaustive. However, surprisingly few empirical papers
The studies that have investigated the impact of short selling on corporate governance also focus on two main aspects: firm misconduct and internal corporate governance.
This first stream of research relies theoretically on the traditional agency problem between managers and shareholders and specifically on firm managers’ misconduct when they pursue their own interests and divert value at the expense of shareholders by manipulating corporate disclosure and earnings. The main question addressed by these studies is whether or not short sales constrain such malicious behavior.
Only one study supports the price pressure hypothesis.
All the other studies offer evidence supporting the disciplining hypothesis and suggest that short selling functions as an external governance mechanism to discipline managers and has a beneficial, rather than detrimental, effect on the corporate market.
One study (
Finally, based on the results of the papers surveyed, it appears that short sales are an effective external corporate governance mechanism to discipline managers and controlling shareholders.
On the specific governance topic of the design of managers’ incentive contracts,
On the other hand, the “bear raids threat hypothesis” stresses that “firms can increase the convexity of the compensation pay to mitigate the adverse effect of bear raids and decrease incentives that are linked to stock performance” (
If internal and external corporate governance mechanisms are not monitoring firms’ top management successfully, corporate boards can fire CEOs.
Finally, it appears that short selling could be a complementary discipline mechanism to improve internal corporate governance and the monitoring of top managers but that conclusions about the impact on the design of incentivizing contracts are mixed.
Financial decisions have been investigated by previous studies to assess whether or not short selling has real effects on the firm, specifically on corporate investment and more broadly on other financial decisions.
However, these results can also been interpreted as a positive impact, as they put pressure on companies to reduce overinvestment (managerial myopia).
Conversely,
All these studies mainly converge toward short selling having a disciplinary effect on managers who see investment decisions in terms of reducing overinvestment and/or underinvestment and supporting long-term value creation.
Three dimensions of firm performance have been investigated so far: growth, operating performance, and corporate social responsibility (CSR).
Broadly speaking, most of the studies surveyed in this paper are in the finance area, and their assumptions and hypotheses are based on the same theoretical premises with a positive a priori toward short selling. Conversely, the research of
Building on threat rigidity theory assumptions,
Conversely,
Even if the purpose of these investigations was not to assess the impact of short sales on operating performance (concentrating instead on other firm attributes such as earnings management or corporate governance), they nevertheless addressed this impact as a side effect.
Two alternative assumptions could be made about a firm’s CSR behavior in the presence of increasing short-selling pressure. On the one hand, “managers [may] have incentives to create a positive firm image by enhancing CSR performance… If a firm’s engagement in CSR indicates less unethical behavior that may cause a future drop in share price, and/or it suggests lower future impact of bad news on its stock price, short sellers may be deterred from taking positions against the firm, since there will be less profit when the short selling position is closed” (
From a narrower perspective in the CSR field,
The results of the (too) few empirical studies examined here converge to a common rationale—the positive impact of short selling as a disciplinary mechanism on corporate governance and corporate investment policy and a positive impact on operating and CSR performance—even if some results are still puzzling. As short-selling activity is increasing, further research on its impact is of tremendous importance to assess its economic relevance; it cannot simply be justified by its positive impact on market informational efficiency. Investigation of its real effects has largely been too narrow.
Most empirical data are from the U.S., a few from China, and very few from other countries. Moreover, most U.S. studies are based on the Security and Exchange Commission’s (SEC) 2004 approval of regulation SHO between 2005 and 2007 and measure short selling indirectly through the threat of short selling. Most of the studies are also based on the traditional assumptions of financial theory. Further investigation should test the consequences of short selling on firms from a broader and more systematic perspective, with different theoretical and methodological approaches. Specifically, the impact of short selling on firm growth, operating performance, investment, and employment should be prioritized.
As far as we have been able to identify them.
Most of the studies mentioned in this paper have measured short selling indirectly through the threat of short selling. Numerous countries used to ban or constrain short selling to eliminate stock price manipulation but have subsequently removed restrictions on short sales on randomly selected pilot firms for which short sales were authorized without any constraints (e.g., the SEC’s 2004 approval of regulation SHO in the U.S.). This allows researchers to assess the effect of short selling by comparing the pilot firms that were more likely to be threatened by short sellers to the others.