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Short Selling: A Review of the Literature and Implications for Future Research

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Abstract

This systematic literature review critically analyzes studies on the determinants of short selling and the implications for information distribution, real economic decisions, financial reporting, and external auditing. We select and review studies within a research framework, identifying two of the most important areas in the literature: short sellers as important information intermediaries and short sellers’ influence on accounting, auditing, and other corporate decisions as the ‘spillover effect’ of the information distribution. Of the two, the former has a strong emphasis on financial markets, whereas the latter extends this traditional topic in finance to financial economics, corporate governance, and accounting. Our review highlights that, although short sellers use both private information and public information in selecting stocks for shorting, we know little about how they use private and non-financial information to influence managerial economic decisions and firms’ financial reporting decisions. In discussing potential future research, we emphasize that penetrating the information ‘black box’ and positioning research regarding the information that short sellers use and how they use it are necessary to advance the short-selling literature.
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Short Selling: A Review of the Literature and Implications for Future Research
Haiyan Jiang*
Department of Accounting and Corporate Governance
Macquarie University
New South Wales
Australia
Email: haiyan.jiang@mq.edu.au
ORCiD: 0000 0002 1806 5510
Ahsan Habib
School of Accountancy
Massey University
Private Bag 102904
Auckland, New Zealand
Email: a.habib@massey.ac.nz
ORCiD: 0000-0003-2433-3961
Mostafa Monzur Hasan
Department of Accounting and Corporate Governance
Macquarie University
New South Wales
Australia
Email: mostafa.hasan@mq.edu.au
ORCiD: 0000-0003-2891-2979
The paper is forthcoming at European Accounting Review
*Corresponding author
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ABSTRACT
This systematic literature review critically analyzes studies on the determinants of short selling
and the implications for information distribution, real economic decisions, financial reporting,
and external auditing. We select and review studies within a research framework, identifying
two of the most important areas in the literature: short sellers as important information
intermediaries and short sellers’ influence on accounting, auditing, and other corporate
decisions as the ‘spillover effect’ of the information distribution. Of the two, the former has a
strong emphasis on financial markets, whereas the latter extends this traditional topic in finance
to financial economics, corporate governance, and accounting. Our review highlights that,
although short sellers use both private information and public information in selecting stocks
for shorting, we know little about how they use private and non-financial information to
influence managerial economic decisions and firms’ financial reporting decisions. In
discussing potential future research, we emphasize that penetrating the information ‘black box’
and positioning research regarding the information that short sellers use and how they use it
are necessary to advance the short-selling literature.
Keywords: Short selling; Information intermediaries; Financial reporting; Corporate decisions
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1. Introduction
We provide a systematic review of the voluminous literature on short-selling activity, focusing
on short sellers’ information gathering and dissemination roles and the way in which such
activities affect real economic decisions, financial reporting, and auditing issues.1 Short sellers
sell securities that they do not own but rather borrow from a broker. Short sellers profit from
the trading strategy of selling high and buying low.When share prices drop later, short sellers
buy back the securities and return them to the broker from whom they originally borrowed
them. Therefore, the profit from this strategy depends on whether the short sellers can buy back
the shares at a lower price. Early theoretical studies (e.g. Diamond & Verrecchia, 1987; Miller,
1977) indicate that, because of the cost and risks involved in short sales, short sellers will
choose to short stock only if they believe that the stock price will decline in the future to
compensate at least for the additional costs and risks.2 Despite this, studies suggest that short
selling constitutes a notable proportion (around 20–31 percent) of stock trades in the US equity
markets (Chen, Zhu, & Chang, 2019; Diether, Lee, & Werner, 2009b). Short sales occur
for a myriad of reasons that roughly fall into either informed or uninformed short-selling
categories. Short sellers’ belief that the stock is overvalued based on fundamental analysis
motivates informed short selling (e.g. Dechow, Hutton, Meulbroek, & Sloan, 2001). To
conduct informed trading, short sellers rely on the underlying economics or fundamentals of
different stocks in stock selection (e.g. Dechow et al., 2001; Desai, Ramesh, Thiagarajan, &
Balachandran, 2002; Engelberg, Reed, & Ringgenberg, 2012) and/or simply follow a
momentum-based strategy (Curtis & Fargher, 2014; Lamont & Stein, 2004). We review this
1. The advantage of systematic reviews lies in a ‘replicable, scientific, and transparent process that enables the
researcher to provide an audit trail, justifying his/her conclusions(Tranfield, Denyer, & Smart, 2003, p. 218).
2. Some examples of the costs and risks of short selling include the uptick rule, restrictions on access to proceeds
from short sales, unlimited loss with increases in the stock price, legal constraints on short selling by certain
institutions, and negative rebate rates (Diamond & Verrecchia, 1987). Engelberg, Reed, and Ringgenberg (2018)
use variance of lending fees as a proxy for short-selling risk and find that higher short-selling risk is associated
with lower future returns, decreased price efficiency, and less short-selling activity by arbitrageurs.
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strand of the literature because it pertains to information acquisition and distribution,
highlighting short selling’s profound implications for economic decisions and financial
reporting. Meanwhile, financial markets have witnessed the development of a new type of short
sellers, commonly known as activist short sellers (Paugam, Stolowy, & Gendron, 2020; Zhao,
2020). Well-known examples include Citron Research, Copperfield Research, Glaucus
Research, Gotham City Research, Iceberg Research, and Muddy Waters Research. The
emerging literature suggests that activist short sellers play a key role in policing financial
markets, revealing financial manipulation and accounting fraud.3
A smaller subset of papers investigates the role of uninformed short sellers executing
market-neutral arbitrage strategies—for example investors or portfolio managers undertaking
short selling to hedge against the downside risk of a long position (Ederington, 1979) and
shorting shares in the acquiring firm’s stock in a merger situation while going long in the target
firm’s stock (Baker & Savaşoglu, 2002). Investors may also undertake short sales to arbitrage
a price differential between the stock and the debt convertible into the stock (Duca, Dutordoir,
Veld, & Verwijmeren, 2012). However, we exclude this stream of the literature from our
review, as Reed (2013) provides excellent coverage of such research.
Research on short selling reveals short sellers’ price discovery roles and highlights their
ability to exploit public information to facilitate their financial statement analysis and stock
valuation (e.g. Ackert & Athanassakos, 2005; Aitken, Frino, McCorry, & Swan, 1998; Asquith,
Pathak, & Ritter, 2005; Au, Doukas, & Onayev, 2009; Boehmer, Jones, & Zhang, 2008; Desai
et al., 2002; Diether, Lee, & Werner, 2009a; Duffie, Garleanu, & Pedersen, 2002; Lynch,
Nikolic, Yan, & Yu, 2014; Sobaci, Sensoy, & Erturk, 2014; Takahashi, 2010). Extending this
3. Zhao (2020) finds that activist short sellers tend to target opaque firms that experience about three times as
negative abnormal returns in both the short and the long term as non-opaque targets. Although this evidence is
suggestive of informative shorts, Zhao (2020) also finds that opaque targets experience more dramatic price
reversals, particularly when there is a substantial initial drop in targets’ prices immediately after the attacks:
evidence of manipulative short selling.
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traditional literature, the research further advances our knowledge, showing substantial private
information acquisition by short sellers prior to negative information events (e.g. the public
revelation of financial misconduct, the announcement of accounting restatements, stock
downgrades, bond rating downgrades, and so on) and the profitability of such trading strategies
(see sections 3.1 and 3.2 for a detailed review of this literature). With an improved research
design and the availability of high-frequency daily short-trading data around specific corporate
news events, this stream of literature provides direct evidence on (i) the types of negative news
on which short sellers trade; (ii) the precise timing of the trading; and (iii) the profitability of
the specific event-based trading strategy.
Meanwhile, a new stream of literature explores whether short-selling interests affect
corporate decision making. For example, managers react to short-selling pressure by modifying
their financing and investing decisions (Grullon, Michenaud, & Weston, 2015) and improving
managerial compensation pay-for-performance sensitivity (DeAngelis, Grullon, & Michenaud,
2017). In a similar vein, studies demonstrate that managers attempt to improve their financial
reporting quality in the presence of high short interest. Collectively, this stream of literature
recognizes the dynamic interactions between short sellers as market participants and corporate
financing, investing, contracting, and financial reporting decisions.
Our review also identifies some gaps in the short-selling literature and highlights some
inherent challenges that researchers face in their research designs. First, it is possible to enrich
further the literature on the motivations behind short sellersstock coverage decisions. It is
unclear whether short sellers have profound knowledge of firms’ corporate governance
mechanisms, problematic corporate strategies, and other indicators of corporate long-term
operational ‘red flags’ when selecting stocks for shorting. Although corporate governance is of
paramount importance in corporate operations and firm performance, it is an under-researched
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area in the short-selling literature, and we identify a lack of direct investigation of short sellers
knowledge of and trading on (suboptimal) corporate governance practices.
Meanwhile, although a plethora of research confirms short sellers’ superior ability to
collect and process both public and private information, we know little about the source of such
information and the means by which sellers obtain such private information. A few papers
(Berkman, McKenzie, & Verwijmeren, 2016; Christophe, Ferri, & Hsieh, 2010) reveal that
short sellers receive tips from insiders and financial analysts, thereby enabling them to front
run those parties and take a short position before the revelation of the negative information to
the public. We believe that this offers a promising avenue for further research.
In addition, researchers studying short selling face a few inherent technical challenges,
such as self-selection bias and potential reverse causality. Recent studies advance the research
methods by utilizing the US short-selling Regulation SHO (Reg SHO hereafter) and the
regulatory short-selling regimes in China’s and Hong Kong’s equity markets as exogenous
shocks for conducting difference-in-difference (DiD) tests to draw causal inferences. These
tests, despite being fruitful in overcoming reverse causality, are essentially restricted to a few
markets that enforce the regulations. We make recommendations for a more innovative
research design for future research.
The available literature (both theoretical and empirical) on short selling, published in
accounting- and finance-related journals, is voluminous. To ensure the quality of the reviewed
papers, we select studies published between 1967 and 2020 in journals that are ranked B and
above in the Australian Business Dean Council’s (ABDC) 2019 journal rankings.4 Seneca
4. We find a high degree of overlap in the journal rankings in the accounting and finance field in the ABDC and
the Association of Business Schools (ABS) journal rankings. The ABDC tends to be a more inclusive list, and
we decide to follow the ABDC ranking (ABDC, 2019; ABS, 2018). For a complete list of journals of the ABDC
and ABS ranking systems, please see ABDC 2019 Journal Rankings, retrieved from
https://abdc.edu.au/research/abdc-journal-list/2019-review/; Last accessed: June, 18, 2020, and ABS 2018
Journal Rankings, retrieved from https://charteredabs.org/academic-journal-guide-2018/; Last accessed: June,
18, 2020.
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(1967) appears to be the first study on short selling that views short sales as a predictor rather
than a causal variable of the stock price. In searching for articles, we use a series of keywords,
including ‘short sale(s),’ ‘short selling,’ short interest(s),’ ‘short sellers,’ ‘short selling
threat(s),’ shorting,’ and ‘Regulation SHO’ in databases like EBSCOhost, Emerald Insight,
Scopus, Web of Science, Google Scholar, and the Social Science Research Network (SSRN).
Collectively, we identify a total of 149 papers, of which 95 investigate the information
intermediary effects of short-selling activities (section 3) while 21 explore the effect of short
selling on managerial real economic decisions and financial reporting issues (section 4). We
find that 94 of the papers appear in A*-ranked, a further 38 papers in A-ranked, and 5 in B-
ranked journals. We include a total of 12 working papers in our review. Working papers pose
a challenge because of their sheer number and because they have not undergone peer review.
We choose a subset of papers that have been presented at top conferences or are influential in
the field.
We organize the remainder of the review as follows. Section 2 describes the
controversies surrounding short-selling activities, the measurement proxies used, and the
regulations concerning short selling. Section 3 reviews papers examining the information that
short sellers use, the characteristics of the stocks that short sellers target, and the information
effect of short selling on the stock markets. Section 4 reviews the empirical literature on the
real effects of short selling on managerial decisions (section 4.1) and the disciplinary effect of
short selling on financial reporting decisions and external auditing (sections 4.2 and 4.3).
Section 5 discusses the technical problems in the current short-selling studies and makes
suggestions for future research. Section 6 concludes this review. It is to be noted that we prepare
four tables using online appendices to present more detailed information about the research
issues, sample, and findings of the papers reviewed in the main sections. The specific table is
mentioned in the pertinent section.
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2. Short- Selling Activities: Controversies, Measurements and Regulations
2.1. Short Sellers: Are they the Good, the Bad or the Evil?
Evidence on whether short sellers are informed is important, because it is relevant when
assessing the potential cost, through loss of value-relevant information, of restricting short sales
(Diamond & Verrecchia 1987) and at the same time when evaluating the potential benefit of
higher-frequency disclosures of short sales (Aitken et al., 1998; Christophe, Ferri, & Angel,
2004). A large strand of literature intensively debates the role of short sellers in the financial
market. One school of thought argues that short sellers are sophisticated investors, playing an
important role in price discovery and stock market efficiency and disciplining corporate
managers, because they collect information from a variety of public and private information
sources (Boehmer et al., 2008; Christophe et al., 2004, 2010; Diether et al., 2009b).5 Opponents
of such a favorable view argue that short sellers are uninformed and predatory traders who play
a detrimental role in the society by manipulating stock prices, inducing market volatility,
generating unwanted selling pressure, and limiting market efficiency (Allen & Gale, 1992;
Brunnermeier & Oehmke, 2014; Goldstein & Guembel, 2008; Ljungqvist & Qian, 2016).6
However, as we will detail in section 3, the extant evidence supports the notion that short sellers
are collectively informed and possess superior information to other market players.
5. For example, former short-selling expert Kathryn Staley (1996) notes in her book The art of short selling that
Short sellers accumulate volumes of disparate facts and observations then they make an intuitive leap based on
the information at hand. Frequently, the signs point to large problems that will not be revealed in total until after
the collapse.In a similar manner, James Chanos, President of Kynikos Associates, in his testimony before the
Securities and Exchange Commission (SEC) Roundtable on Hedge Funds, mentions that, before choosing stocks
for short sale, his firm (Kynikos Associates) pursues a rigorous financial analysis and focuses on securities issued
by companies that seem to have (i) materially overstated earnings; (ii) an unsustainable or operationally flawed
business plan; and/or (iii) engaged in outright fraud. https://www.sec.gov/spotlight/hedgefunds/hedge-
chanos.htm; Last accessed: June, 18, 2020.
6. Brunnermeier and Oehmke (2014) provide a model that shows that temporarily depressed stock prices from
short selling force a financial institution to fire sell long-term assets to repay debt and satisfy the leverage
constraint. Such losses allow predatory short sellers to make a profit on their short positions.
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2.2. Regulations or non-Regulations: A Dilemma
Given the controversies surrounding short-selling activities, the regulations aiming to restrict
such activities are sporadic and often prompted by financial crises or a credit crunch to help
stabilize the market. Hence, the removal of shorting bansis often experimental in nature. For
instance, the regulator in the US has adopted different forms of short-selling restrictions over
the years, including the uptick rule (allowing shorting only when the price is at least a tick
higher than the previous trade), which it introduced in 1934 but revoked in 2007; the short-
selling ban of 797 financial stocks during the financial crisis of 2008; Rule 201 of Reg SHO
(allowing only limited orders to sell short after a 10 percent intraday decline in a stock’s price);
and SEC Rule 105 of Regulation M (prohibiting the purchase of securities in follow-on and
secondary offerings when the purchaser has effected short sales in the securities within a
specified amount of time prior to the pricing of an offering) (Brunnermeier & Oehmke, 2014;
Jones, 2012; Shkilko, Ness, & Ness, 2012). Likewise, a number of international financial
regulators have taken measures against short selling. For example, in August 2011, in the midst
of the European sovereign debt crisis, regulators in France, Spain, Italy, and Belgium imposed
temporary bans on short selling for some financial stocks (Brunnermeier & Oehmke, 2014). In
the equity markets in mainland China and Hong Kong, only designated securities are eligible
for short selling (Bai & Qin, 2014; Chang, Cheng, & Yu, 2007; Zhao, Li, & Xiong, 2014).7
Despite the intention behind regulatory restriction of short selling as a means of
alleviating the severity of market panic, studies report mixed findings in relation to the benefits
7. Short sales were restricted in mainland China until March 31, 2010, when a pilot scheme permitted 90
designated stocks to engage in short selling in China’s A-share markets to improve information efficiency. Short-
selling activities have been on the rise since the Chinese Government relaxed the short-sale restriction on stocks
in 2010 (Jin et al., 2018). Hong Kong lifted restrictions on short sales after January 1994 and has been identifying
eligible stocks for shorting every year through a selection mechanism ever since (Chang et al., 2007).
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of short-selling restrictions. Proponents of short-selling restrictions find that temporary and
targeted short-sale restrictions on the stocks of vulnerable institutions can save these
institutions (Brunnermeier & Oehmke, 2014). Examining the regulations and feasibility of
short selling in 46 equity markets around the world, Bris, Goetzmann, and Zhu (2007) show
that market returns display significantly less negative skewness when short selling is either
prohibited or not practiced. Anecdotal evidence also suggests that stock exchanges and their
listed firms seek protection against short sales and therefore oppose the removal of short-selling
constraints (He & Tian, 2015). For instance, Lamont (2012) finds that firms deliberately switch
stock exchanges to seek protection against short sellers.
However, overwhelming evidence suggests that short-selling restrictions/constraints
distort the market efficiency by slowing down the incorporation of negative private information
(e.g. Choy & Zhang, 2019; Danielsen & Sorescu, 2001; Ho, 1996; Hasan, Massoud, Saunders,
& Song, 2015; Shyu, Chan, & Liang, 2018), which in turn causes overvaluation8 and bubbles.
Short-selling restrictions also reduce hedging’s effectiveness (Brunnermeier & Oehmke, 2014;
Chang et al., 2007; Zhao et al., 2014), adversely affect the option markets, as evidenced by a
significant increase in option bid–ask spreads for banned stocks relative to unbanned stocks
(Grundy, Lim, & Verwijmeren, 2012), and tend to be associated with IPO underpricing
(Boulton, Smart, & Zutter, 2020). Bris et al. (2007) also demonstrate that stocks incorporate
negative information faster in equity markets in which short sales are allowed and practiced,
highlighting the benefits of removing short-sale restrictions. Using a regulatory change in
China as a quasi-natural experiment, Ni and Zhu (2016) document that, when short-selling
8. Although Miller (1977) hypothesizes that dispersion of investor opinion in the presence of short-sale constraints
leads to stock price overvaluation, empirical tests of Miller’s hypothesis examine the valuation effects of only one
of these two necessary conditions. For example, Figlewski (1981) finds some weak evidence that more heavily
shorted firms underperform less heavily shorted firms using a limited sample from 1973 to 1979. Although his
least shorted firms produce positive abnormal returns with statistical significance, his most shorted deciles do not
produce significant negative abnormal returns. However, Boehme, Danielsen, and Sorescu (2006) find strong
evidence of significant overvaluation for stocks that are subject to both conditions simultaneously. However,
Mashruwala and Mashruwala (2018) provide evidence supporting the beneficial effect of accounting conservatism
in reducing overvaluation for firms with the highest short-selling constraints and investor disagreement.
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constraints are removed, more unrevealed negative information is incorporated into the stock
price, which leads to a stock price crash.
To conclude, quantifying the welfare effect of prohibiting short sales is remarkably
complex, owing to (1) the substitutive nature of the benefits and the costs of short-selling bans,
in that the bans on short selling reduce trading activity but do not increase transaction costs,
(2) the short-term effects being different from the long-term equilibrium, that is, lower trading
activity as a result of a ban is a permanent effect while higher transaction costs are a temporary
phenomenon (Lensberg, Schenk-Hoppé, & Ladley, 2015), and (3) bans on short selling often
occurring in times of extreme market circumstances and, therefore, not being completely
exogenous, which complicates the keeping all else equal’ requirement in the design of an
empirical study.9 Given that short sales contain valuable firm-specific information and convey
an information signal to uninformed investors who buy on the margin (Shyu et al., 2018),
regulators should rather encourage and/or mandate stock exchanges to disclose short-selling
activities more frequently (Liu, Ma, & Zhang, 2012).
2.3. Measurements
The extant studies use various measures to assess short-selling activities. These measures,
however, differ little in terms of the underlying construct. One of the most widely used
measures of short-selling intensity is the ratio of the short-selling volume to the total trading
volume. This measure captures the regular trading volume and is less skewed than other
measures (see Christensen, Drake, & Thornock, 2014; Diether et al., 2009a). Another
commonly used short-selling measure is the ratio of the number of shares sold short to the
number of shares outstanding. This measure of short selling performs well in capturing
deviations in the unconditional short volume (Senchack & Starks, 1993; Shkilko et al., 2012).10
9. We acknowledge one of the reviewers for this insightful comment.
10. Using short interest as a proxy for shorting demand, however, is problematic, because the quantity of
shorting represents the intersection of supply and demand. The quantity of shorting should respond to both the
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A few studies use alternative measures of short selling that differ to some extent from
the above two measures. For example, Lamont and Stein (2004) use the value-weighted short-
interest ratio (i.e. the market value of shares sold short scaled by the value of shares
outstanding). In addition, given that, on the New York Stock Exchange (NYSE), specialists
who are involved in high-frequency trading for hedging execute a large proportion of short-
selling transactions, the authors calculate short selling for the NYSE as the number of shares
that public investors (as opposed to NYSE member firms) sell short divided by the total share
volume. Ni and Zhu (2016) use an indicator variable that takes the value of one if the stock of
a particular firm is on the short-sales list and zero otherwise.
To capture properly the undisclosed private information embedded in short selling,
some recent studies (e.g. Bao, Kim, Mian, & Su, 2019; Cheng, Shyu, & Wang, 2019) measure
short-selling interest using the residual short interest, which they estimate as the residuals from
the following regression:
 =+ + + + (1)
where SIR is the shares on loan to short sellers relative to the market capitalization of the stock;
 is the institutional ownership; CONVERT is a dummy variable that takes the value of one
when a firm has convertible bonds or convertible preferred stock and zero otherwise; and
TREND is the time trend variable. The studies incorporate these variables to isolate the effects
of the supply of loanable shares, hedging-based shorting, and variation over time in the average
shorting costs that are not related to the existence of firm-specific negative private information
(Bao et al., 2019).
cost and the benefit of shorting the stock, so stocks that are very costly to short will have low short interest.
Impossible-to-short stocks have an infinite shorting cost, yet the level of short interest is zero. Thus, short
interest can be negatively correlated with the shorting demand, overpricing, and shorting costs (Lamont, 2012).
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In the spirit of the above measure, Purnanandam and Seyhun (2018) use a standardized
measure of shorting to account for the demand for information-based short selling. They
calculate this standardized measure as follows:
  = 



 (2)
where SI/SO is the scaled short-interest ratio. The authors claim that, by construction, this
measure reflects the deviation from the average level of shorting of a stock after accounting for
its variance.
The above-discussed measure may not capture short-selling activities around firm-
specific events. Therefore, some studies estimate abnormal short interest (short spikes) around
corporate-specific events (e.g. earnings announcements, analyst downgrades, seasoned equity
offerings, and corporate misconduct) as the difference between the short-interest ratio (e.g. the
ratio of the short volume to the total trading volume) and the average short-interest ratio over
a benchmark period11 (Chen, Kadapakkam, & Yang, 2016; Christensen et al., 2014; Christophe
et al., 2004, 2010). For example, Chen et al. (2016) estimate the abnormal short turnover as:
  ,= ,
 ,    (,)
    (,) (3)
A few recent studies (e.g. Beneish, Lee, & Nichols, 2015; Chang, Lin, & Ma, 2019)
exploit a new dataset from Markit Data Explorer (DXL) that provides equity lending data from
more than 100 institutional lenders, which collectively represent the largest pool of loanable
equity inventory in the world. Using this comprehensive dataset, Beneish et al. (2015) measure
short-selling intensity as the total shares that DXL lenders borrowed divided by the total shares
11. The benchmark period consists of all the trading days in the short volume dataset that do not fall within an 11-
day earnings announcement period window (Christophe et al., 2004).
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outstanding (also see Chang et al., 2019; Massa, Zhang, & Zhang, 2015; Saffi & Sigurdsson,
2011).12
Studies also differ on the use of the frequency (e.g. daily and monthly) of short-selling
data. It is important to emphasize that the daily short-sale volume is different from the monthly
short interest with respect to its ability to capture underlying phenomena. For example, the
monthly short interest reflects information about longer-term firm fundamentals and therefore
is more suitable for examining the information efficiency of short-selling activities (Comerton-
Forde, Do, Gray, & Manton, 2016; Diether et al., 2009b). On the other hand, daily short-sale
volume data capture intra-month shorting and can quantify the magnitude and timing of short-
selling activity more precisely. Therefore, daily short-sale volume data permit more powerful
and accurate tests than the monthly frequency of short-interest data to study short-term trading
strategies such as index arbitrage, convertible bond arbitrage, and merger arbitrage (Comerton-
Forde et al., 2016; Diether et al., 2009b; Liu & Wu, 2014). Thus, given the availability of
different short-selling measures and the unique information content of these alternatives, a
deeper understanding of the strength of alternative measures and the purpose of the inquiry is
a prerequisite for a well-designed short-selling study.13
3. Short Sellers as Important Information Intermediaries
A large body of research examines short sellers’ information role in equity markets. Supporting
the notion that short sellers are informed traders, studies report that short sales or short interest
predict and precede future stock price underperformance and increase the market efficiency
12. Beneish et al. (2015) consider ‘limits to the supply of lendable shares’ as a key impediment to pricing
efficiency. However, Reed (2015) argues that this may not be the case, as the supply of available shares is closely
related to other variables, like the demand and price for borrowing, quantity borrowed, and short interest.
Therefore, Reed (2015) suggests that ‘supply should not be considered as a completely independent view of the
equilibrium relationship among quantity, price, and demand(p. 97).
13 Table A4 (see online appendices) summarizes the papers reviewed in Section 2 that are mainly in the areas of
short selling regulations and are not included in Table A1-A3.
15
and price discovery of overvalued stocks. For example, Rapach, Ringgenberg, and Zhou (2016)
find that short sellers are informed traders who can anticipate future aggregate cash flows and
associated market returns. We now review the strand of the literature that examines the price
discovery function stemming from short-selling activities. For ease of exposition, we
categorize such research into three broad themes, namely (i) the information sources that short
sellers use; (ii) the characteristics of the securities that short sellers target; and (iii) the
information superiority and the effect of short sellers’ information dissemination on the capital
markets. Table A1 (see online appendices) shows the papers reviewed in this section.
3.1. The Information Sources of Short Sellers
The extant literature offers two major explanations for the superiority of short sellers’ stock
valuation abilities: the public and private information hypotheses. The public information
hypothesis conjectures that short sellers are sophisticated investors with superior capability in
processing publicly available information accurately and efficiently. The private information
perspective suggests that short sellers’ information advantage may derive from their acquisition
of private information that is not accessible to all the market participants (e.g., Anderson, Reeb,
& Zhao, 2012; Christophe et al., 2010).
3.1.1. Public Information Perspective
It is well accepted that short sellers target firms with overpriced stocks and lower expected
future returns and that they base the stock valuation on fundamental analysis (Dechow et al.,
2001; Desai et al., 2002; Engelberg et al., 2012). Like other information users, short sellers, in
predicting future stock returns, calculate and compare the ‘intrinsic’ values based on
accounting data in relation to the market value. As expected, it is documented that short sellers
16
target securities with low fundamental-to-price ratios and then unwind their positions as these
ratios revert to their normal levels (Cheng, Yan, Zhao, & Chang, 2012; Dechow et al., 2001).
Furthermore, short sellers can differentiate between low ratios as a result of temporarily low
fundamentals due to non-recurring items and low ratios that are attributable to temporarily high
prices, and they only target firms with the latter characteristic (Dechow et al., 2001).
Similarly, Engelberg et al. (2012) find that short sellers’ ability to analyze publicly
available information contributes substantially to their information advantage, but they obtain
only weak evidence that short sellers anticipate firms’ forthcoming news events. Deshmukh,
Gamble, and Howe (2015) conclude that short sellers predict future negative operating
performance but do not address the question of whether the superior information is due to short
sellers’ utilization of public information or the acquisition of private information.
Drake, Rees, and Swanson (2011) divide information into four categories captured by
11 variables based on publicly available information about firms and investigate whether short
sellers have better comprehension of these variables than financial analysts.14 They reveal that
short sellers interpret all 11 variables properly in accordance with how those information
variables affect future stock returns, whereas analysts fail to do so. Drake et al. (2011) point to
the difference in information-processing abilities between financial analysts and short sellers,
serving as an exemplar of advancement in short-selling research. Hobbs, Keasler, and McNeil
(2012) document that short sellers are able to exploit the behavioral biases associated with
overpricing events, such as the airing of the television show ‘Mad Money,’ which provides a
large number of buy recommendations in a typical month.
3.1.2. Private Information Perspective
14. The four information categories include accounting (earnings surprise, accruals, and capital expenditures),
valuation (market value of equity, earnings-to-price ratio, book-to-market ratio, and average daily stock turnover),
growth (sales growth and forecasted long-term growth), and momentum (earnings forecast revision and price
momentum).
17
Since short sellers are sophisticated information users, we would expect them to seek and
utilize information that is non-financial or not publicly available. For instance, studies report
short sellers’ informational advantage in identifying and shorting stocks of firms that
experience subsequent public revelation of financial misconduct (Karpoff & Lou, 2010),
accounting restatement announcements (Desai, Krishnamurthy, & Venkataraman, 2006), bond
rating downgrades (Henry, Kisgen, & Wu, 2015), credit rating downgrades (Shi, Wang, &
Zhang, 2017), financial analysts’ stock downgrades (Christophe et al., 2010; Meng, Li, Jiang,
& Chan, 2017), large insider sales (Chakrabarty & Shkilko, 2013), private placements
(Berkman et al., 2016), and asset write-downs (Liu et al., 2012).
First and foremost, short sellers are able to detect accounting irregularities. Dechow,
Sloan, and Sweeney (1996) report an increase in short interest in the two months before SEC-
initiated Accounting and Auditing Enforcement Releases (AAERs) for a sample of firms.
Studying firms that the SEC disciplined for financial misrepresentation between 1988 and
2005, Karpoff and Lou (2010) demonstrate an abnormal short-interest rise in the 19-month
period immediately before the misrepresentation announcements, which is positively related to
the severity of misconduct and the levels of accrual manipulation. Desai et al. (2006) report
that the accumulation of short interest in restating firms prior to the restatement announcement
is large compared with that in non-restating firms, especially for restating firms with high levels
of accrual manipulation. Nevertheless, Drake, Myers, Scholz, and Sharp (2015) find that short
sellers seem not to anticipate restatement announcement dates, although abnormal short selling
is significantly higher than normal when firms announce restatements.15
A bond rating downgrade affects equity returns adversely (Goh & Ederington, 1993),
so Henry et al. (2015) propose that short sellers have an incentive to seek information pertinent
15. Drake et al. (2015) use daily short volume data over short windows around restatement announcements as
opposed to the monthly short interest data that Desai et al. (2006) use. The use of short window data increases
the likelihood that short-seller activities are directly related to the restatement characteristics rather than to other
information about earnings quality(pp. 220–221).
18
to rating downgrades. As expected, they find that short sellers use firms’ bond credit rating-
specific information to identify the bond rating downgrades and take the short position in
advance of such downgrades. The authors further demonstrate this effect to be stronger after
the passage of Regulation FD: evidence suggesting that short sellers have a greater private
information advantage when other private information communication with the firm is
restricted. Furthermore, as a result of the short sale, firms experiencing rating downgrades
shorten their post-downgrade negative equity return drift, suggesting faster price discovery
driven by short sales. Despite Henry et al.’s (2015) finding on short sellers’ use of bond rating-
related information in a way similar to a credit agent, they do not directly address the question
of whether short sellers collect public vs. private and/or financial vs. non-financial information
pertinent to bond rating or how short sellers obtain that information.
Shi et al. (2017) observe a stronger increase in short-selling interest prior to a credit
review announcement relative to a rating downgrade announcement, as the latter would be well
anticipated by the market participants following a prior negative credit review announcement.
The findings therefore support short sellersuse of the private information that the rated firms
provide.16
Christophe et al. (2010) find elevated short selling in the days immediately preceding a
stock downgrade announcement. They argue that this phenomenon is a result of short sellers
having private information—a tip from the brokerage house about the exact day of the
downgrade announcement—and establishing short positions accordingly. Although their
finding of short sellers’ use of tips does not rule out the possibility that short sellers, like
analysts, use the same valuation-relevant public information to assess the financial health of a
16. For example, Moody’s 2002 Special Comment (Fons, Cantor, & Mahoney, 2002, p. 5) states:Moody’s will
use confidential non-public information that issuers provide to Moody’s only for the purpose of assigning ratings.
Moody’s will not, without the permission of the issuer, disclose the information in the press release or other
research reports published in connection with the rating, or in discussions between Moody’s analysts and
investors, or other issuers ... Moody’s believes that the efficiency of capital markets is best served by permitting
issuers to disclose to rating agencies material non-public information for use solely in rating decisions.
19
firm, additional tests lend credence to the tipping hypothesis. Meng et al. (2017) obtain similar
findings for firms that star analysts follow but not for those that non-star analysts follow in the
Chinese stock market.
Similarly, Chakrabarty and Shkilko (2013) and Khan and Lu (2013) both document
positive abnormal short sales leading up to large insider sales. They conclude that the
information leakage from brokerages that execute insider sales explains short sellers’ ‘front
run’ of inside trading. Particularly, Chakrabarty and Shkilko (2013) find consistent evidence
that short sellers have knowledge not only of the insider’s rank but also of the unobservable
size of the insider’s trading position, although the results do not rule out the possibility that
some of short sellers’ information about insider sales is also due to their ability to analyze the
visible order flow, suggesting that short sellers use all the information, including the order flow
of other investors on the market, to make trading decisions.
Berkman et al. (2016) also observe the information leakage of insiders to short sellers,
revealing a significant increase in the average short interest surrounding the preannouncement
of stock private placements.17 Such an effect is more pronounced when more buyers are
involved in the private placements. Additionally, using insider trading activities as a measure
of private information in stocks, Purnanandam and Seyhun (2018) find that short-selling
activities are considerably informative about future stock returns when there is a higher
likelihood of insider trading. Short sellers also bring considerable additional information to the
market that contemporaneous insider trading does not fully capture.
Liu et al. (2012) document that short sellers accumulate short positions prior to asset
write-down announcements and that stocks experience significantly negative returns around
such announcements, suggesting short sellers’ informational advantage. Furthermore, short
17. Firms often engage in confidential conversations with potential investors (e.g. hedge funds) before the public
announcement of the private placement of their shares. The Securities Act in the US prohibits insiders who have
received private information during these conversations from trading.
20
sellers increase their positions significantly in the announcement month and keep increasing
their positions afterward, suggesting a feedback effect. Akbas, Boehmer, and Erturk (2017)
find that the ability of short sellers to predict future bad news, negative earnings surprises, and
downward revisions in analyst earnings forecasts provides an explanation for their discovery
of unfavorable information about firms. However, the study does not reveal the source of
information that short sellers use to facilitate their understanding and prediction.
Collectively, the aforementioned evidence suggests that short sellers use both public
and private information to facilitate stock valuation and that they are not mutually exclusive.
However, the evidence on private information acquisition and the sources through which they
obtain different private information requires additional investigation. This is complicated by
the fact that the private information acquisition phenomenon is often unobservable, researchers
having little or no access to such sources. An innovative study by Massoud, Nandy, Saunders,
and Song (2011) investigates short sellers’ use of private information when hedge funds short
shares of highly leveraged firms with lower credit quality to which they lend money. This type
of short selling takes place prior to public announcements of both loan originations and loan
amendments, strongly pointing to short sellers’ exploitation of their private information in this
scenario.
3.2. Characteristics of the Securities that Short Sellers Target
Dechow et al. (2001) find consistent evidence that short sellers tend to follow firms with a low
fundamental ratio, a large market value, and a high institutional shareholding. Christophe et al.
(2004) find similar evidence of informed shorting in pre-earnings announcements in stocks
with low book-to-market valuations. In addition, short sellers are typically more active in
small-cap stocks as opposed to medium- or large-cap stocks (Boehmer et al., 2008). Sloan
(1996) mentions the hypothetical long/short hedge portfolio based on accruals but does not
21
provide evidence that short sellers really target firms with high accruals. Richardson (2003)
tests this proposition empirically but fails to find evidence that short sellers target firms with
high accruals. Geczy, Musto, and Reed (2002) indicate that short sellers follow well-accepted
trading strategies based on factors such as size, book-to-market, and momentum effects.18
Previous research also reports dividend payments, company fundamentals, risk, option trading,
the interest rate spread, and past returns to be significant determinants of short selling in Hong
Kong (McKenzie & Henry, 2012).
Boehmer, Huszar, and Jordan (2010) demonstrate that heavily shorted portfolios
underperform over the subsequent month whereas lightly shorted stocks generate significant
positive abnormal returns in the US. Nevertheless, Andrikopoulos, Clunie, and Siganos (2012)
reveal that heavily shorted firms in the UK do not necessarily underperform their lightly
shorted counterparts. In fact, short sellers’ ability to predict future firm performance is limited
to firms that struggle for survival, such as firms that are about to fail or financial firms during
the financial crisis.19 One plausible explanation for the contradictory findings between the US
and the UK studies might be related to the rather lax regulatory constraints in the UK market,
which might increase less motivated (uninformed) tradersshort selling compared with that in
US markets, in which stringent regulatory requirements for short selling may result in the
participation of a large proportion of informed short sellers.
18. Geczy et al. (2002) also find that, while average borrowing costs are initially elevated for IPOs, they appear
to be insufficient to explain the long-run underperformance of IPOs. Edwards and Hanley (2010) find evidence
of active short selling in the first trading week of IPOs, a finding that is inconsistent with the notion that short-
sales constraints are binding in the immediate aftermarket. However, Patatoukas, Sloan, and Wang (2020) predict
and find that the IPOs that are the most susceptible to overpricing (using accounting measures of valuation
uncertainty as a proxy) have first-day sizable returns of +44 percent but lockup expiration returns of -10 percent.
They also find that these IPOs experience severe short-sales constraints that peak around the lockup expiration.
With respect to the informational efficiency of short sellers around seasoned equity offerings (SEOs)
announcements, Deshmukh, Gamble, and Howe (2017) find that firms with large increases in short interest prior
to the SEO announcement exhibit more negative announcement period returns and inferior long-term operating
and stock price performance following the equity issue. However, using daily short-selling data around seasoned
equity offerings (SEOs), Henry and Koski (2010) find no evidence of informed short selling, which is consistent
with manipulative trading.
19. Au et al. (2009) also reveal that heavily shorted firms underperform their lightly shorted counterparts, although
the magnitude of this underperformance using equal and value-weighted returns is only 0.59 percent and 0.19
percent per month, respectively, which is much lower than that reported in the US.
22
Anderson et al. (2012) state that family firms, both founder and descendent controlled,
could be a source of information leakage, providing outside investors with information to
engage in short sales. They demonstrate that family firms that were among the 2000 largest US
industrial firms at the beginning of 2004 experienced substantially higher abnormal short sales
before negative earnings shocks than non-family firms. In addition, the future abnormal stock
returns of family firms decreased in short-selling activity, suggesting that short-selling interest
provides useful information for forecasting abnormal returns for family firms.
Another strand of the literature finds that firms with poor financial reporting quality
tend to attract short sellers. Karpoff and Lou (2010) report that short sellers are aware of the
financial reporting quality and profit from shorting stocks with low financial reporting quality.
Focusing on real earnings management, Park (2017) reveals that firms with more real earnings
management activities increase the subsequent short-selling interest, as real earnings
management results in the overvaluation of stocks, a feature that attracts short sellers. Cheng
et al. (2019) document that short sellers are interested in firms with less comparative accounting
information (a proxy for poor reporting quality) but also find that ex-ante short-selling pressure
improves future accounting comparability. Singer, Wang, and Zhang (2018) find that short
sellers target firms that are about to disclose first-time internal control material weaknesses
(ICMWs) under Section 404 of the Sarbanes–Oxley Act, courtesy of their use of mainly private
rather than public information. Furthermore, the ability of short sellers to predict ICMWs is
more pronounced in firms operating in an environment with high information asymmetry.
Meanwhile, Christensen et al. (2014) reveal that firms disclosing pro forma earnings at the time
of earnings announcements tend to have a significantly larger short-selling volume than their
counterparts without adjusted earnings metrics in the earnings announced. The finding suggests
that pro forma disclosures give rise to information asymmetries that provide short sellers with
an informational advantage. Jain, Jain, and Robin (2019) document a negative and significant
23
relationship between short selling and accounting conservatism. Conditional conservatism, by
accelerating the recognition of bad news, reduces the possibility of a substantial stock price
decline in the future, the very notion from which short sellers make a profit. They rule out the
reverse causation concern that short-selling interest triggers conservatism by exploiting Reg
SHO, documenting that increased short selling during the regulatory period does not affect
conservatism.20
Short sellers are also able to detect and short stocks hoarding bad news to make a profit
accordingly. Consistent with this proposition, Callen and Fang (2015) document that short-
selling interest is positively related to a one-year-ahead stock price crash risk. Meanwhile, short
sellers profit from shorting firms with a high book–tax difference (BTD) that other investors
often misprice (Chi, Pincus, & Teoh, 2014). The authors demonstrate that short sellers can
profit from taking a short position in firms with a high BTD to exploit the overpricing because
of their ability to detect likely upward earnings management and overvaluation in firms with a
high BTD. Jain, Jain, and Rezaee (2016) document a negative association between short
interest and firms’ economic, social, and governance (ESG) performance, implying that short
sellers are interested in analyzing firms with unique ESG challenges that make their reported
financial statements less reliable and less transparent to the average uninformed investor.
Blau, Brough, Smith, and Stephens (2013) investigate whether short sellers can (a)
distinguish between good news’ and bad newssignals associated with the various types of
auditor change and (b) improve their trading revenue by shorting stocks of companies that
signal ‘bad newsauditor changes. They find that short-selling activity increases significantly
on and shortly after the announcement21 of auditor changes relating to auditor downgrades,
20. However, short selling also provides an external governance mechanism to monitor managers and to facilitate
information transparency, a view that Jin, Lin, Yang, and Zhang (2018) test and confirm using data from China.
21. The choice of selecting post-announcement period short-selling activity is premised on the empirical findings
that short sellers react strongly to pro forma earnings announcements (Christensen et al., 2014). Such evidence
implies that short sellers could be more reactive than proactive and hence might exhibit abnormal shorting activity
during the post-announcement period, particularly for unfavorable announcements.
24
auditor resignation, and auditor–client disagreement. They also document significantly higher
short-selling revenues during the post-announcement period related to auditor downgrades and
auditor resignation signals.
Pownall and Simko (2005) examine firms that experienced abnormal short interest
increases (short spikes) during the period 1989–1998, finding that the mean abnormal return
around short spike announcements is significantly more negative for firms with a low analyst
following. Since the stock prices of firms with a low financial analyst following tend to
incorporate information about future earnings slowly (Ayers & Freeman, 2003), the
information asymmetry is high in those firms. Following this line of inquiry, future research
might identify and examine the contexts in which information asymmetry is severe and short
sellers may complement the traditional sources of information intermediaries to facilitate
information dissemination. For instance, when firms experience a different operational
environment and economic and political uncertainty, they may have a high degree of
information asymmetry. It is worthwhile questioning whether short sellers seek information
about and trade shares of such firms more actively during the eventful period. A related
question is whether short interest is high in firms with a low level of transparency in general
due to a lack of media coverage and a low level of voluntary disclosure, including a lack of
managerial earnings guidance.
3.3. Short Sellers’ Information Superiority and the Effect of Information Distribution on Equity
Markets
3.3.1. Short sellers’ information superiority vis-à-vis other parties
While financial analysts are among the most extensively researched information
intermediaries, the relative advantage of short sellers in information processing and
dissemination compared with financial analysts also attracts research interest. Studying US-
25
listed Chinese firms’ financial reporting quality, Chen (2016) finds that short sellers tend to
target firms with ‘red flags’, although analysts fail to uncover such risks. The firms that short
sellers target experience significant negative abnormal returns, and this negative effect of stock
returns even spills over onto the untargeted firms that share the same non-Big 4 auditors with
the target firms and have poor earnings quality.
Cassell, Drake, and Rasmussen (2011) find a positive relationship between short
interest (an indication of audit risks) and audit fees. This is consistent with short sellers’ ability
to identify firms with suspect financial reporting, an ability that sends a reliable signal about
the increased risk of future misstatements. Importantly, the authors acknowledge that the two
parties could rely on one another: auditors on short sellers, because the latter can detect
misconduct, and short sellers on auditors, because auditors have access to clients’ private
information. The empirical evidence supports auditors’ reliance on short sellers but not vice
versa. Kecskes, Mansi, and Zhang (2013) find that debt holders respond to firmslevel of, as
well as changes in, short interest. In particular, firms with highly shorted stocks experience
significantly lower credit ratings and are more likely to have their ratings downgraded.
Although the evidence above suggests the information superiority of short sellers to
other information intermediaries, such information superiority does not guarantee short-selling
profit. Recent reports and empirical evidence highlight that many short sellers make losses.22
For example, Gargano, Sotes-Paladino, and Verwijmere (2019) document that, for the average
stock, 53 percent of the shares on loan experience losses. For the aggregate short-selling setting,
the authors reveal that the average share shorted of a stock incurs a loss of about 10.5 percent.
The authors also find that the tendency to reduce short interest increases monotonically with
the size of the losses and that short sellers who incur losses are less informed about future
22. In a Wall Street Journal article, Zweig (2018) reports that, over the nine years before 2018, short funds lost
more than 90 percent of their money.
26
returns than those who make gains. Jank and Smajlbegovic (2017) use data on daily disclosures
in Europe to identify large short positions of individual institutions and study their
performance. They provide evidence on short-selling skills among hedge funds, which earn
annualized risk-adjusted returns of about 5.5 percent. It is possible to explain this performance
with hedge funds trading on well-known factors (e.g. betting against beta) associated with
mispricing. Of course, because the portfolios of short sellers typically have negative exposure
to the market and other priced factors, an average loss in a bull market period can very well
correspond to outperformance.23
3.3.2. Information dissemination by short sellers and its effect on equity markets
While short sellers are well informed, it does not necessarily imply that their trading
incorporates the superior information into prices, because some informed traders tend to trade
in a way that restricts information dissemination (Boehmer & Wu, 2013). Therefore, many
studies set out to investigate whether stock prices are more accurate when short selling is active.
The general findings of these studies confirm that short selling speeds up the incorporation of
public information into share prices and helps markets to correct short-term deviations of stock
prices from the fundamental value and stock overvaluation (e.g. Chang, Luo, & Ren, 2014;
Jones & Lamont, 2002).24 Using high-frequency daily data on short selling, Boehmer and Wu
(2013) find that the shorting flow indeed makes prices more efficient and that this process
begins at intraday horizons.25 Studying short-selling data from 46 countries, Bris et al. (2007)
23. We are grateful to an anonymous reviewer for drawing our attention to this strand of the short-selling literature.
24. Although most empirical studies on short selling suggest that short sellers short overvalued stocks because
they are well informed, a few studies find that arbitrage needs motivate short selling rather than only exploiting
the gain by shorting overvalued stocks. For instance, Liu and Wu (2014) find no abnormal short selling in stock
acquirers ahead of a business merger announcement, indicating that short sellers are not informed about upcoming
mergers. Their evidence also shows that merger arbitrage needs mainly motivate the increased short selling
occurring on announcements of stock mergers and that the arbitrage price pressure that short selling generates
contributes to the observed negative returns to stock acquirers around merger announcements.
25. However, Bergsma and Tayal (2019) provide evidence on short interest-related mispricing—overpricing
(underpricing) in high (low) short-interest stocks. They find that the lottery stocks with a greater proportion of
27
find evidence that prices incorporate negative information more quickly in countries that permit
and practice short sales, whereas, in markets that prohibit short selling or in which it is not
feasible, market returns exhibit significantly less negative skewness. Lasser, Wang, and Zhang
(2010) find that market reactions to earnings announcements vary with the level of short
interest: that is, when extremely good news is released, firms with high levels of short interest
tend to have higher abnormal returns around earnings announcements than firms with low
levels of short interest. In contrast, in the case of extremely bad news in earnings
announcements, firms with high short interest experience smaller abnormal returns relative to
firms with low short interest.
Stock prices sometimes crash in response to bad earnings news exhibiting large
negative skewness. When earnings miss analyst forecasts, even by small amounts, the negative
earnings news can cause a disproportionately large stock price decline—the so-called torpedo
effect (Skinner & Sloan, 2002). Whether short selling is responsible for the torpedo effect is
contentious. On the one hand, research argues that short sales cause a torpedo effect, because
short selling is immediate bad news and results in a price plunge (Aitken et al., 1998); on the
other hand, Miller (1977) contends that stock will be overpriced if investors disagree about its
value and the market constrains pessimistic investors from shorting it. In line with this
theoretical argument, if short sellers, as rational arbitrageurs, are allowed to short overpriced
stocks before the earnings announcement, they can offset the overpricing that overoptimistic
investors cause. As a result, the price reaction to good and bad earnings news will be entirely
symmetrical, effectively curbing the torpedo effect (Mashruwala & Mashruwala, 2014).
Mashruwala and Mashruwala (2014) demonstrate consistent evidence that short-selling
constraints, combined with investor disagreement, contribute to the torpedo effect. This is
unsophisticated retail traders have a higher arbitrage risk. The high risk results in costly arbitrage, so overvalued
(undervalued) stocks exhibit more negative (positive) alphas.
28
consistent with short selling signaling immediate bad news, resulting in a price plunge (Aitken
et al., 1998).
A large short volume also ameliorates post-earnings announcement drift (PEAD) (e.g.
(Boehmer & Wu, 2013; Fang, Huang, & Karpoff, 2016), which is most pronounced during the
month immediately following the earnings announcement (Boehmer & Wu, 2013). This is
because short sellers accelerate the incorporation of earnings news into share prices (Berkman
& McKenzie, 2012; Boehmer, Jones, & Zhang, 2013). Studies on short selling’s role in PEAD
further support the positive role of short sellers in promoting efficient pricing. Despite short
saleseffect on mitigating PEAD, whether short sellers take short positions pre- or post-
earnings announcements is an unreconciled research issue: although Berkman and McKenzie
(2012) and Boehmer and Wu (2013) find reduced PEAD as a result of short sellers taking short
positions immediately after earnings announcements, Christophe et al. (2004) demonstrate an
increased short position pre-earnings announcements.
The informational benefits of short selling far exceed price discovery and stock
valuation. Huszár, Tan, and Zhang (2017) report that short sellers profit more in complex
industries with the highest profit potential. The results suggest that the aggregate shorted value
at the industry level is able to predict important industry shifts, such as declines in sales and
increased competition. Using cross-country data, Daouk, Lee, and Ng (2006) develop a
composite governance index, including the relaxation of short-selling restrictions. They find
that the index is associated with increased stock liquidity, a decreased cost of capital in the
global market, reduced price synchronicity, and IPO underpricing. Beber and Pagano (2013)
study the short-selling bans that 30 countries imposed (mostly European markets and
developed non-European markets) during the period of the global financial crisis from January
1, 2008 to June 23, 2009. They find that bans on short selling slowed down efficient price
29
discovery.26 Frino, Lecce, and Lepone (2011) provide similar findings of the negative impact
of short-selling bans on 14 equity markets, evidenced by wider bid–ask spreads, increased price
volatility, and reduced trading activity. Meanwhile, a few papers find that short-selling
constraints accentuate momentum (Hong, Lim, & Stein, 2000; Jegadeesh & Titman, 1993),
market crashes (Hong & Stein, 2003), accruals anomaly (Hirshleifer, Teoh, & Yu, 2011), and
idiosyncratic risk (Stambaugh, Yu, & Yuan, 2015). In contrast, lifting the short-selling ban in
China resulted in firms experiencing a lower cost of equity, conducting less earnings
management, and enjoying higher market liquidity and higher investment efficiency (Hu, Lu,
Ma, & Ye, 2019), while the removal of the short-selling ban for IPO stocks in Taiwan increased
price efficiency (Cheng et al., 2012).
Short salesinformation function is salient in a market with high investor sentiment.
High investor sentiment causes investors and even financial analysts to be overly optimistic,
thereby discouraging analysts from gathering and processing public information to produce
private information (Keshk & Wang, 2018). In this situation, high short interest in certain
stocks sends a negative signal that contradicts the overly optimistic belief, a red flag about
future performance. Receiving such a signal motivates financial analysts to exert more effort
on collecting information to produce more reliable forecasts. Keshk and Wang (2018) find
evidence supporting this prediction. The findings show how other information users benchmark
their beliefs according to short sellers’ activities, shedding light on the signaling effect of short
sales. An intriguing question for future research is whether financial analysts, institutional
investors, and other investors in general benchmark their trading strategies according to short
sellers’ trading activities.
26. However, Kolasinksi, Reed, and Thornock (2013) report that, during the 2008 short-selling ban period in the
US, short-selling activity became more informative. Beber and Pagano (2013, pp. 347–348) nevertheless
reconciled this contradictory evidence by noting the following, ‘in the presence of a partial short-selling ban,
banned stocks may feature slower price discovery yet their price may become more sensitive to the short sales
that investors are allowed to carry out on other stocks—especially if the ban is accompanied by increased
disclosure of short sales, as indeed was the case in the United States during the crisis.’
30
Section summary. Short sellers are collectively informed; they predict corporate
negative news and front run analysts’ recommendations and insider trading; they possess
superior information to financial analysts; and they trade on firm-specific information pre-
earnings announcements. As a result, short sellers’ trading provides capital markets with
discernible benefits.
4. Short Selling, Corporate Decisions and the Third-Party Effect
Do secondary stock markets have a real effect on corporate decision making or do they merely
reflect the market expectations of firm values (see Goldstein & Guembel, 2008)? In the
following sections, we review the stream of literature that examines the effects of short-selling
activities (a financial market mechanism) on corporate real decisions (section 4.1), on financial
reporting decisions (section 4.2), and on external auditing (section 4.3).
4.1. Short Selling and Real Economic Decisions
The extant studies, as demonstrated in Table A2 (see online appendices), provide evidence that
short-selling constraints, and the removal of these constraints, alter a firm’s investment
activities, financing decisions, payouts, and other corporate policies. Using Reg SHO as a
setting, Grullon et al. (2015) show that an increase in short-selling activity lowers share prices,
which in turn reduces investment and equity issues. Importantly, this finding is stronger for
small-growth and opaque firms that are susceptible to overvaluation. However, what is unclear
is whether the resulting changes in investment behavior have a bearing on future firm
performance. Chang, Lin, and Ma (2019) explore how the short-selling threat affects mergers
and acquisitions (M&A) returns. They argue that short sellers scrutinize managers’ future
actions and thus make them less likely to waste corporate resources on empire-building
activities. Furthermore, since short sellers’ own capital is at stake, they have a greater incentive
31
to undertake in-depth investigations into M&A deals. The results demonstrate that short-selling
threats result in higher M&A announcement returns. However, the governance role of short
selling in improving M&A efficiency is only observable for deals that are prone to agency
problems (e.g. when acquirers are financially less constrained).
With respect to the implications of short selling for payout decisions, Chen et al. (2019)
provide causal evidence that managers increase cash dividends (but not stock repurchases) as
a reaction to the removal of the short-selling constraint that Reg SHO implemented. This is
because paying a dividend is costly and thereby serves as a credible signal of stock
undervaluation that deters short sellers from shorting such stocks. Meanwhile, de Jong,
Dutordoir, and Verwijmeren (2011) find evidence that firms issuing convertible notes
simultaneously buy back their stocks to facilitate short selling by convertible debt arbitrageurs
in an effort to mitigate the negative stock price reaction at the convertible debt issuance. Meng,
Li, Chan, and Gao (2020) show that short sellers’ ability to uncover and disseminate a firm’s
negative information to the market makes access to external financing difficult and costly. This
might explain the positive relationship between short-selling threats and corporate cash
holdings (Wang, 2018). However, it is not clear whether investors value such high cash
holdings. Future studies may shed light on this unresolved question. Finally, Guo, Chi, and
Cook (2018) find that firms engage less in corporate tax avoidance strategies when the short-
interest levels are high. High tax avoidance is likely to signal bad news and might prompt short
sellers to take a short position in such firms. Consequently, short selling could discipline
aggressive tax-planning strategies. However, tax avoidance could also be beneficial for
shareholders, because it conserves cash (Edwards, Schwab, & Shevlin, 2016). The authors do
not include this relevant costbenefit trade-off proposition in their empirical specification.
Prior studies also provide evidence on the governance role of short sellers. For example,
DeAngelis et al. (2017) exploit the Reg SHO regime to investigate managerial incentive
32
contract design. They demonstrate that firms with increased short-selling pressure are likely to
grant relatively more stock options to top executives and adopt new anti-takeover provisions.
They argue that, in the presence of short-selling interest, the share price becomes more
informative about the agent’s effort and so can align better with pay-for-performance measures.
An increase in anti-takeover provisions in the compensation contract post-Reg SHO is due to
bear raiders depressing stock prices, a phenomenon that presents career concerns for managers.
Anti-takeover provisions often reduce such concerns by providing managers with greater job
security (Edmans, Goldstein, & Jiang, 2012). Bennett and Wang (2018) and Kunzmann and
Meier (2018) show that short selling increases the likelihood of forced CEO turnover, either
through the revelation of negative information or through the manipulation of stock prices.
However, the extent to which CEO power moderates this documented relationship is
unexplored. Finally, He and Tian (2015) posit that short sellers play a disciplining role and thus
help to improve the inherent quality and fundamental nature of corporate innovation, resulting
in improved innovation efficiency. As expected, they find that the short-selling pressure that
Russell 3000 index pilot firms experienced as a result of Reg SHO indeed improved corporate
innovation efficiency, a long-term outcome.
4.2. Short Selling and Firms’ Financial Reporting Decisions
4.2.1. Short selling and earnings quality
The financial reporting system is an important mechanism to improve capital allocation
efficiency. Financial reporting offers capital providers the primary source of independently
verified information about the performance of managers (Sloan, 2001), thereby facilitating
efficient resource allocation decisions by signaling investment opportunities to managers and
outside investors, disciplining self-interested managers to invest in value-maximizing projects,
and reducing firms’ cost of capital (Bushman & Smith, 2001). It is therefore not surprising to
33
see a surge in research, as shown in Table A3 (see online appendices), on the effect of short-
selling activities on various aspects of firms’ financial reporting quality.
Drake, Myers, Myers, and Stuart (2015) document that short sellers improve the
informativeness of stock prices with respect to future earnings. As short sellers are likely to
take a short position in firms for which stock prices have yet to incorporate information about
future fundamentals, the authors posit that short interest will facilitate the incorporation of
future earnings news into current stock prices. They find evidence in support of this hypothesis.
Furthermore, they find that this positive association is stronger in firms with a weaker
information environment, high valuation uncertainty, and high expected future earnings
growth.
In addition to using the market perception of earnings as a proxy for earnings quality,
research investigates the effect of short-selling activity on accruals and real earnings
management. Using firm-level short-selling data from 33 countries over a sample period from
2002 to 2009, Massa et al. (2015) document a significantly negative relationship between the
threat of short selling and accruals earnings management (AEM). The evidence is consistent
with the disciplining hypothesis, which predicts a decrease in earnings manipulation as short
sellers are sophisticated traders who are skilled at uncovering managerial misconduct. Massa
et al. (2015) establish causality running from short-selling threats to earnings management
using instrumental variable tests and exogenous regulatory shocks related to short-selling
threats. Jiang, Qin, and Bai (2020) extend Massa et al.’s (2015) research by revealing that a
short-selling threat constrains real earnings management (REM) internationally, a finding that
is primarily driven by firms operating in countries with weak shareholder protection.
Furthermore, firms with great short-selling potential substitute AEM with REM. Moreover,
they find that the monitoring effect of short sales is more pronounced in countries where short
sales are not only legal but also feasible.
34
In contrast to the study by Karpoff and Lou (2010), who investigate whether short
sellers can anticipate restatements stemming from previous financial manipulation, Fang et al.
(2016) document that Reg SHO pilot firms exhibited less earnings management during the pilot
period than non-pilot firms. They conclude by noting thatthe pilot program reduced the cost
of short selling sufficiently among the pilot firms to increase potential short sellers’ monitoring
activities, and that the increased monitoring induced a decrease in these firms’ earnings
management (Fang et al., 2016, p. 1253). The authors also find that earnings persistence
increased for pilot firms during the pilot period and PEAD disappeared for pilot firms only in
the bottom decile with the most negative earnings news during the period, while it remained
significant for non-pilot firms.
Jin, Lin, Yang, and Zhang (2018) find that the prospect of short selling significantly
increases conditional accounting conservatism among firms that are eligible for short selling,
using Chinas short-selling pilot program as an experimental setting. The positive association
is more pronounced for state-owned enterprises (SOEs), because short sellers are likely to exert
more disciplining effects on SOEs as they generally suffer from poor performance and lower
conservatism and are more prone to earnings manipulation. The authors further document a
significant reduction in conservatism for firms removed from the short-selling eligibility list,
thereby corroborating short sellersdisciplining role. Young (2016), on the other hand,
documents an adverse effect of reducing short-selling constraints in the US, revealing a
reduction in conditional conservatism among the pilot firms compared with the non-pilot firms
from the year before to the year after Reg SHO began.
4.2.2. Short selling and corporate disclosures
The empirical literature on the effect of short selling on disclosure behavior predominantly
focuses on managerial earnings forecasts, because managerial earnings forecasts are an
35
important source of corporate financial information for investors and yet managers have
considerable discretion about whether to issue forecasts, forecast formats, and precision (Hirst,
Koonce, & Venkataraman, 2008). We summarize this stream of literature and report them with
detailed information in Table A3 (see online appendices).
Li and Zhang (2015) use Reg SHO as a natural experiment to examine the causal effect
of short-selling constraints on managers’ voluntary disclosure choices. The authors predict that
managers of pilot firms will reduce the precision of short-run bad-news forecasts to maintain
the current level of stock prices, a prediction that they premise on the notion that the magnitude
of the price reaction to a disclosure is positively related to its precision. Measuring forecast
precision as the negative of forecast width, the authors reveal that the pilot firms indeed reduced
their bad-news forecast precision by about 17 percent relative to the control group on the
adoption of Reg SHO. They find no such evidence for changes in good-news forecast precision
between the treatment and the control group. Li and Zhang (2015) also do not find any
significant relationship between short-selling threats and bad-news forecast disclosures. They
further find that managers of pilot firms with bad earnings news reduced the readability of their
annual reports around the implementation of Reg SHO. Whether short sellers target firms with
poor readability of financial statements, however, remains unclear. Nevertheless, Clinch, Li,
and Zhang (2019) find that, relative to control firms, pilot firms increase the likelihood of
voluntary bad-news management forecasts, provide these forecasts in a timelier manner, and
accelerate the release of quarterly bad earnings news.27
Chen, Cheng, Luo, and Yue (2019) extend the work of Li and Zhang (2015) by
examining whether managers strategically enhance long-run forecasts to discourage short
sellers, because holding the position for a long time is costly and risky for short sellers. Chen
27. Clinch et al. (2019) find that the inconsistent results are attributable to the inclusion of prior forecasting
behavior as a control variable (p. 13), a variable that Li and Zhang (2015) do not include.
36
et al. (2019) predict that the pilot firms will increase good-news disclosures to mitigate the
downward pressure on stock prices because of the increased short-selling threat, and they find
evidence consistent with this hypothesis. The increase is more pronounced when managers’
forecasts are of higher quality; when there is greater uncertainty regarding firm value; and when
managers have higher equity incentives. Finally, the authors show that pilot firms issuing more
long-run good-news forecasts during the pilot program experienced a smaller increase in short
interest. While Li and Zhang’s (2015) findings suggest that short sellers may indirectly lead to
a worsening of the information environment, Chen et al. (2019) find that managers’ strategic
disclosure response to a short-selling threat can improve the information environment quality.
However, it is notable that Chen et al. (2019) use annual management forecasts, whereas
Clinch et al. (2019) and Li and Zhang (2015) use quarterly management forecasts; therefore, a
direct comparison among these studies may not be appropriate. Kubick, Omer, and Song (2019)
find that firms improve their tax disclosures when the threat of short selling increases to
minimize the possibility of a subsequent stock price drop. They find that this effect is stronger
among pilot firms led by senior executives whose stock and option portfolio is more sensitive
to changes in the stock price.
4.2.3. Short selling and external auditors
Short selling also affects firmscontracts with auditors. Hope, Hu, and Zhao (2017) examine
the effects of short-selling threats on audit fees and predict a positive relationship, arguing that
higher ex-ante threats of short-selling activities lead to the auditors facing higher litigation risk,
a precursor for an increase in audit fees. Using the Reg SHO setting, they find that the pilot
firms experienced a larger increase in audit fees than the non-pilot firms. Further empirical
analyses confirm that the positive effect is attributable to a shifting risk premium instead of
increased audit efforts, as they find no evidence that short-selling threats increase the audit
37
quality (a proxy for audit efforts). Given the existing evidence that short-selling threats improve
the financial reporting quality (Fang et al., 2016; Massa et al., 2015), the insignificant findings
that Hope et al. (2017) report stand as a contrast to the prior literature. Table A3 (see online
appendices) includes a few papers pertinent to this topic.
Section summary. This section summarizes the strand of literature that investigates the
effects of short-selling activities on firms’ real economic decisions and financial reporting
properties. The accumulated evidence so far suggests that short-selling threats have profound
implications for the efficiency and originality of corporate innovation, managerial empire-
building incentives, executive compensation designs, and financial reporting quality. However,
these two strands of literature have evolved rather independently, despite evidence suggesting
that good-quality financial reporting acts as a conduit for more informative firm-level
economic decisions (Roychowdhury, Shroff, & Verdi, 2019). Future research incorporating the
interactions among short-selling threats, financial reporting quality, and economic decisions
would provide useful insights into whether short sellers provide incremental benefits to capital
market development.
5. Discussion and Future Research Agenda
In this section, we discuss several issues related to short selling that warrant future research,
including potential research issues associated with the antecedents and consequences of short-
selling activities.
5.1. Research on Motivations for Short Selling is in its Infancy
Despite considerable progress in the literature on short selling, our review suggests that much
less attention is devoted to exploring the motives behind short selling. Therefore, we encourage
more studies to fill this void in the literature. In particular, future research could explore
38
whether and how the firm-level corporate governance landscape motivates short sellers to take
short positions. We make this proposition because Jensen (2005) asserts that the solution to
problems stemming from overvalued equities rests with the board of directors and with the
other elements of governance systems. Hence, it is worth inquiring whether sound governance
systems deter short selling given short sellers’ preference for shorting mispriced stocks.
Potential areas to investigate might include the strength of internal control, managerial
competence (e.g. managerial ability), the top management turnover, the existence of problem
director(s), the breach of law/contingent liability, problematic corporate strategies, and other
indicators of corporate long-term operational red flags. External parties may not perceive these
issues clearly, but they may have an important bearing on the decline of stock prices in the
future. Although a few studies use corporate governance as a possible moderator in their
investigation of the effect of short selling on various outcomes (e.g. Callen & Fang, 2015), a
direct investigation of how short sellers perceive and make use of their information advantage
in relation to the corporate governance strength of the target firm is absent. We call on
researchers to consider some salient governance mechanisms in future investigations.
Meanwhile, with the increasing awareness of sustainability and corporate social
responsibility, whether short sellers also evaluate firms’ CSR issues and perceive the hidden
operational risks in this area is an unexplored research issue. An interesting avenue for future
research would be to consider whether firms conduct impression management or provide a
more credible signal through their engagement in CSR practices in the presence of short-selling
interest. Hou, Meng, Zhang, and Chan (2019), using data from China, find that a firm is more
likely to engage in corporate philanthropic (CP) activities when there is a surge in short selling.
Their evidence appears to support the impression management hypothesis, as they argue that,
in the short run and in the presence of short-selling pressure, a firm might shift into CP activities
to divert attention from the firm’s negative information. However, their CP variable fails to
39
capture the much bigger dimension of CSR activities (e.g. improvement in the workforce
environment), thereby warranting future research. Similarly, Brockman, Luo, and Xu (2019)
find that Reg SHO pilot firms significantly improved their employee relations in response to
an increased threat of short selling. The authors further document that such firms experienced
improved stock performance during the post-Reg SHO period after improving the workforce
environment.
5.2. Endogeneity and Attempted Solutions
The endogeneity threat is massive in the short-selling literature. For example, endogeneity due
to reverse causation is a serious concern in studies examining the relationship between financial
reporting quality (FRQ) and short selling. On the one hand, a stream of literature finds that
short sellers often target firms exhibiting poor FRQ; hence, those studies indicate FRQ as the
predecessor of short selling. On the other hand, the literature demonstrates that a short-selling
threat has profound implications for FRQ. Endogeneity pertinent to self-selection bias occurs
if short sellers choose firms with poor FRQ to short in the first place, which results in the
subsequent disciplining effect of short sellers that the studies observe. We note a stark contrast
whereby Jain et al. (2019) and Jin et al. (2018), respectively, identify the same FRQ proxy as
a determinant and a consequence of short selling. While Jain et al. (2019) demonstrate that
short sellers are less interested in shorting stocks of firms with more reporting conservatism,
Jin et al. (2018) find that short-selling threats prompt firms to report more conservatively, using
China’s short-selling pilot program as an experimental setting.
Reverse causality also confounds the relationship between short selling and stock price
crash risk, as shown in the contradictory results that some studies provide. For example, Callen
and Fang (2015) document an increase in price crash risk, while Deng, Gao, and Kim (2020)
40
find that the removal of short-sale constraints during Reg SHO led to a significant decrease in
price crash risk.
To overcome this potential endogeneity problem, Deng et al. (2020) and Fang et al.
(2016) conduct a quasi-natural experiment with the DiD test on pilot firms during Reg SHO as
the treatment sample, while Massa et al. (2015) employ an instrumental variable approach
along with a similar DiD test using US and Hong Kong sub-samples. Although these tests
alleviate the endogeneity concern, a puzzling question is whether firms with a history of poor
FRQ attract short sellers in the first place and then the short selling disciplines their future
financial reporting activities at a later stage. To answer questions of this kind, a well-designed
study can utilize specific events such as financial restatement announcements and fraud
revelations to examine the ensuing (increase in) short interest and subsequent improvement in
FRQ as a result of the spike in short interest. Cheng et al.’s (2019) recent study advances the
methodology in this direction. It documents that, on the one hand, short sellers are attracted to
firms with less comparative accounting information; on the other hand, they motivate firms to
enhance future accounting comparability.
Meanwhile, although it is possible to use a two-stage instrumental approach, the
selection of an appropriate instrumental variable raises enormous challenges. Research often
uses financial institutional ownership as a proxy for the ease of short arbitrage (e.g. Hirshleifer
et al., 2011). However, this approach is questionable and may not be valid in many cases,
because institutional shareholding is often significantly associated with the dependent
variablefor example financial reporting quality—due to its monitoring function. Hence, the
literature (e.g. Massa et al., 2015) introduces an alternative instrumental variable, the
ownership of exchange-traded funds (ETFs). ETFs also supply lendable shares to the short-
selling market and are unlikely to become active monitors of the firms as passive investors,
thereby upholding a low-fee trading strategy (Massa et al., 2015). However, the majority of
41
short-selling studies do not yet employ ETFs as an instrument, perhaps due to the lack of access
to the data. Instead, many short-selling consequence studies conduct DiD tests using the US,
China, or Hong Kong as their context, because short sales have experienced regulatory changes
in these equity markets. The benefit of DiD tests is apparent, as the regulations simulate a
natural experiment that frees the tests from the endogeneity concern. Nevertheless, this
approach is restricted to markets that have enforced short-selling regulations over the selected
sample period, which explains the lack of short-selling research using other equity markets.
Furthermore, refining the proxies for short-selling measures may provide a potential
solution to the problem of reverse causality. For example, Cheng et al. (2019) regress the
residual short-selling interest on contemporaneous accounting comparability and then regress
the lead accounting comparability on the ex-ante short-selling pressure measure.
5.3. Information Black-Box Issues
The research on short selling over the last 50 years provides considerable knowledge. We have
seen research on short sellers’ use of both public information and private information and learnt
that short sellers not only conduct independent research using fundamental analysis of
financials but also receive tips from insiders and financial analysts so that they front run those
parties by taking a short position before the negative information event (Christophe et al.,
2010). However, from a broad perspective, whether and how short sellers analyze firms’
business strategies, operational risks, supply chain stability, and prospects of M&A are
unknown. For instance, in addition to the information tips from insiders and analysts, do short
sellers have superior access to other information? How do they collect the private information
that they use to facilitate their stock analysis? Alternatively, is it possible that short sellers run
different prediction models from analysts and news reporters or are they simply quicker and
more effective at processing and interpreting information than other investors? All in all,
42
elucidating the source of short sellers’ information advantage is a meaningful avenue for future
research.
While many studies adopt a piecemeal approach to proving short sellers’ acquisition of
a specific type of information, such as credit rating downgrades (Shi et al., 2017) and asset
write-downs (Liu et al., 2012), they do not address the pecking order and the weighting of the
information that short sellers use. Research has yet to explore which types of information are
of greater importance and whether short sellers use a shotgun approach to identifying potential
targets or a more holistic and analytical approach based on broad information sets.
In addition, an interesting line of further research is to investigate whether short sellers’
information advantage and informed arbitrage was stronger prior to the Regulation FD that the
SEC promulgated than after the regulation. Since Regulation FD prohibits private information
communication between firms and market participants, research reports that public information
is becoming the main source of firm-specific information post-Regulation FD (Heflin, Kross,
& Suk, 2016). This restriction of private information communication between firms and other
investors could provide stronger incentives for short sellers’ private information seeking
because of the potential arbitrage gain against other relatively uninformed investors, although
Regulation FD may also restrict the possibility of short sellers gaining tips from other
information sources when their sources have disappeared. Among the studies reviewed, that by
Henry et al. (2015) is the only one making strides in this direction, finding an increase in the
abnormal short interest prior to a bond rating downgrade, which is stronger after Regulation
FD, indicating short sellers’ information advantage.
5.4. Are Short Sellers Homogeneous?
The other area that we identify as being under-researched concerns different types of short
sellers and their trading activities. For example, we cannot identify many studies that provide
43
evidence on the various categories of short sellers (e.g. informed versus manipulative and
predatory short sellers) or determine whether a specific type of short seller results in less
informative stock prices (Goldstein & Guembel, 2008) or causes overshooting of prices
(Brunnermeier & Pedersen, 2005). Comerton-Forde, Jones, and Putniņš (2016) document two
distinct types of short sellers—those who provide liquidity and those who demand it. Liquidity-
supplying short sellers trade when spreads are wide, whereas liquidity-demanding short sellers
trade when there is a narrow spread and when the short-term price declines. Reed, Samadi, and
Sokobin (2019) investigate how short sellers exploit their information advantage by trading at
different trading venues, namely exchange versus dark pools. They find that, although all venue
short sales are informative about future prices, exchange short sales are the most informative.28
Chague, De-Losso, and Giovannetti (2019) differentiate skilled institutional and individual
short sellers from unskilled ones. The authors find that skilled short sellers trade with short-
term horizons and follow momentum strategies, whereas unskilled short sellers display the
disposition effect, riding losses and realizing gains to cover a winning position quickly. We
contend that different types of short seller following the arbitrage strategy may utilize different
types of information (e.g. seeking information tips from other insiders) from those focusing on
firms’ fundamentals and conducting a thorough stock analysis. The specific information sets
that different types of short seller use warrant further investigation.
Meanwhile, we also observe the need for more empirical cross-country studies. Many
studies focus on a single country, including the US and China, and a few developed markets,
including Australia (e.g. Comerton-Forde et al., 2016) and Hong Kong (Bai & Qin, 2014, 2015;
Chang et al., 2007; Chen & Rhee, 2010). We also find a few cross-country studies that provided
insights into short-selling regulations and institutional feasibility across countries (Bris et al.,
28. It is possible to submit exchange orders for immediate execution even if the execution prices fall outside the
prevailing National Best Bid and Offer (NBBO). In contrast, dark pools are necessary to match orders at prices
within the NBBO. Although this matching can reduce the bid–ask spread costs, if no match is available within the
NBBO, then no trade takes place (Reed et al., 2019).
44
2007); the consequences of short-selling bans during the 2007–2009 global financial crisis
(Beber & Pagano, 2013); and the disciplining functions of short-selling threats on financial
reporting quality (Jiang et al., 2020; Massa et al., 2015). Given the difference in institutional
factors, the extent of market efficiency, and investors’ financial literacy worldwide, future
research in the area of short selling could focus on the heterogeneities of short sellers and
institutional settings to examine some of the issues that the short-selling literature investigates
to enrich our understanding.
Given the information roles and the disciplinary functions of short selling that the
literature reveals, many studies uphold an anti-regulation proposition and advocate the removal
of short-selling constraints (Diether et al., 2009a). However, the regulators appear to be much
more cautious in supporting such an anti-regulation perspective. These contrasting views raise
an important research question—whether and how much the academic short-selling literature
has informed regulators and, if not, what obstacles prevent regulators from adopting a more
liberal approach regarding short-selling regulation. International studies would best answer
these questions, investigating the variation in institutional factors such as the strength of
shareholder protection and the maturity of the stock markets to provide potential answers.
6. Conclusion
The goal of this literature survey is to summarize and highlight the advances in the research
areas pertinent to short selling. A key theme in our survey is that short sellers conduct intensive
information collection using both public and private information to facilitate their trading
decisions and that this has fundamentally shaped information dissemination, stock price
discovery, and managerial decision making. We follow this theme to select papers for the
survey and highlight areas requiring additional research to further our understanding of short
sellersrole in capital market development.
45
The first part of the review reveals the controversies in the short-selling literature by
demonstrating contradictory findings and the evolving nature of the regulations worldwide. To
facilitate the understanding of the empirical literature that the later sections cover, section 2
also provides a critical discussion of the commonly used short-selling measurements. Because
of our focus on short sellers’ information collection and sharing, we organize a large volume
of literature concerning the information roles of short selling into three sub-sections to
demonstrate short sellers’ information sources, the firm characteristics of the targeted stocks,
and the information roles of short selling in the equity markets. Section 4 analyzes and points
out the evolving nature of the short-selling literature, demonstrating a focus on the managerial
actions taken as a response to short-selling threats. This new stream of literature shows an
intersection between short selling and corporate decision making.
Our major observation of the literature indicates that, although many papers appear in
finance journals, there is also a sizeable number of accounting papers on short sellers’
information collection and the interplay between short selling and corporate decisions,
especially corporate disclosure choices. A critical summary of the literature highlights a few
limitations of the current research, including the lack of studies focusing on the motivations for
short selling; the insufficient insight into whether short sellers obtain private information, how,
and of what type; and the endogeneity concerns confounding the causal relationships between
short selling and various outcome variables. We also call for research in an international
setting, because it potentially offers richer insights into the interplay between institutional
factors and short selling.
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Online Appendices
List of Tables
Page
2
22
23
26
54
TABLE A1. Summary of research on short sellersinformation production and the securities that short sellers target
Author(s)/year
Research issue(s)
Sample
Findings
Ackert and Athanassakos (2005)
Short interest and
stock returns.
Canada: sample periods:
1991–1994 and 1998–1999;
sample size: 72,021
observations for 1789 firms.
Short sales and excess returns are negatively correlated in Canada. In
addition, this negative relation is more pronounced for small firms but less
pronounced for shorted stocks with options and convertibles. The evidence
suggests that less restrictive regulation of short sales improves market
efficiency.
Aitken, Frino, McCorry, and Swan
(1998)
Market reaction
to short sales.
Australia: sample period:
1994–1996; sample size:
4,773 and 10,548
observations pertaining to
market orders and limit
orders, respectively.
Short selling is related to significantly negative abnormal stock returns in a
market setting in which short sales are transparent immediately following
execution. Furthermore, short sales executed near the end of the financial year
and those related to arbitrage and hedging activities are associated with a
smaller price reaction. However, short sales near information events are
related to larger price reactions.
Akbas, Boehmer, and Erturk (2017)
Short selling,
stock returns, and
unfavorable
information.
US: the test for short
interest and future returns
covers the period 1998–
2010, while the test for short
interest and future public
news covers 267,971 stock-
month observations
spanning the period 2000 to
2010.
Short selling is related to future negative earnings surprises, bad public
news, and downgrades in analyst earnings forecasts. The information role of
short selling is stronger for stocks that are harder to short. Short interest
increases gradually during the 12 months immediately preceding the public
release of negative information but then declines. The results suggest that
short interest predicts future returns, partly due to short sellers’ ability to
uncover unfavorable information about firms.
Anderson, Reeb, and Zhao (2012)
Organization
structure and the
information
content
of short sales.
US: 1,571 firms covering
the period from January
2005 through July 2007.
Family-controlled firms experience substantially higher abnormal short sales
prior to negative earnings shocks than nonfamily firms. Moreover, daily
short-sale interest in family firms contains useful information for forecasting
stock returns. Overall, the findings suggest that informed trading via short
sales occurs more readily in family firms than in nonfamily firms.
Andrikopoulos, Clunie, and Siganos
(2012)
Short selling and
firm performance.
UK: weekly short-selling
activity in 1,645 UK firms
between 2004 and 2012.
High short-selling firms tend to underperform their low short-selling
counterparts weakly. However, UK short sellers tend to predict firms’
performance successfully during the financial crisis, particularly for
bankrupt firms. After excluding those firms, arbitrage portfolio returns
disappear, revealing that short sellers’ ability to predict firm performance is
driven by a small number of struggling firms.
55
Author(s)/year
Research issue(s)
Sample
Findings
Asquith, Pathak, and Ritter (2005)
Short interest,
institutional
ownership, and
stock returns.
US: a sample of NYSE and
Amex stocks from 1980 to
2002 and Nasdaq National
Market System (NMS)
stocks from July 1988 to
December 2002.
Portfolios of stocks with high short interest underperform the market. When
short interest portfolios are ranked by institutional ownership, more negative
portfolio abnormal returns are observed for portfolios with lower
institutional ownership.
Au, Doukas, and Onayev (2009)
Short selling,
idiosyncratic risk,
and stock returns.
UK: a sample of daily FTSE
350 stock-lending data from
September 2003 through
September 2006.
Using daily UK short-selling data, the authors find that stocks with low
levels of short interest experience significant positive abnormal returns on a
value-weighted basis: equally weighted portfolios composed of highly
shorted stocks exhibit positive but statistically insignificant abnormal
performance. The authors further document a negative relation between
short interest and returns among stocks with high idiosyncratic risk and
show that short-selling activity is mostly concentrated in stocks with low
idiosyncratic risk, which are less costly to arbitrage with respect to those
with fundamental risk.
Bai and Qin (2014)
Impact of short-
sale constraints
on liquidity
for individual
stocks.
Hong Kong: 1364
constraint-repealing and 845
constraint-imposing events.
Following the repealing of short-sale constraints, only large, illiquid, and
inactively traded firms increase in liquidity, while other firms experience a
significant drop in prices and liquidity. When short-sale constraints are
imposed, only inactively traded stocks significantly increase in liquidity and
prices.
Bai and Qin (2015)
Short-sale
constraints and
stock price
adjustments to
Hong Kong: the sample
covers the period between
January 1, 1994 and
December 31, 2011.
Shortable stocks adjust to private bad information more quickly than non-
shortable stocks. In addition, although non-shortable stocks are overpriced
before negative earnings announcements, these stocks react more strongly to
the publication of bad information than shortable stocks. Overall, the
Bao, Kim, Mian, and Su (2019)
Residual short
interest and
managerial
tendency to
disclose or
withhold bad
news.
US: 152,614 firm-quarter
observations between 2001
and 2010.
Residual short interest is negatively associated with the frequency of bad-
news disclosure, implying that managers, in general, withhold bad news.
This documented negative relation is weaker when firms are exposed to
higher litigation risk but stronger when managers have greater incentives to
inflate the stock price.
56
Author(s)/year
Research issue(s)
Sample
Findings
Beber and Pagano (2013)
Effect of
worldwide short-
selling bans on
liquidity, price
discovery, and
stock prices.
Global data: the sample
consists of daily data for
16,491 stocks in 30
countries, from January
2008 to June 2009.
Imposing bans or regulatory constraints on short selling (i) is detrimental to
liquidity (e.g., an increase in bidask spreads), especially for stocks with
small capitalization and no listed options; (ii) slows price discovery,
especially in bear markets, and (iii) is not associated with better stock price
performance, the only exception being the US.
Beneish, Lee, and Nichols (2015)
Economic
determinants and
stock price
consequences of
the level of short-
sale supply.
US: 299,535 firm-month
observations spanning 114
months (July 2004–
December 2013).
The lendable supply increases with expected borrowing costs and decreases
with firm characteristics associated with equity overvaluation. In addition,
(1) when the lendable supply is binding (non-binding), the short-sale supply
(demand) is the main predictor of future stock returns, (2) abnormal returns
to the short side of nine well-known market anomalies are attributable solely
to “special” stocks, and (3) loan fees significantly reduce the profitability of
the short side and several of these anomalies cease to be profitable.
Bergsma and Tayal (2019)
How lottery-like
characteristics are
associated with
high and low
short-interest-
related
mispricing.
US: 479 (504) high (low)
relative short-interest firms
spanning from 1989 to
2015.
High relative short interest (RSI) stocks’ overvaluation and low RSI stocks’
undervaluation are the strongest among lottery stocks. As stocks become
more lottery-like, the arbitrage risk increases, resulting in more overpricing
(underpricing) in high (low) RSI stocks.
Berkman and McKenzie (2012)
Trading behavior
of institutional
investors and
short sellers
around earnings
announcements.
US: 14,656 earnings
announcements from 2,695
firms covering the period
from August 2006 to May
2008.
Institutional investors and, to a lesser extent, short sellers successfully
anticipate earnings news. In the period immediately after an earnings
announcement, short sellers are quick to increase their short positions when
a company releases bad news, while institutional traders react more slowly
in the period following the announcement.
Berkman, McKenzie, and
Verwijmeren (2016)
Trading behavior
of short sellers
around private
placements.
US: 323 (339) convertible
bond (common stock) issues
by 536 unique firms for the
period January 2007 to
August 2011.
There is a significant increase in short interest in the pre-announcement
period: evidence of information leakage. In addition, the change in short
interest in the pre-announcement period is negatively related to the abnormal
return at the time of the public announcement of the private placement. The
pre-announcement short selling is particularly informative when the number
of buyers is high and when there is a high degree of hedge fund
participation.
57
Author(s)/year
Research issue(s)
Sample
Findings
Boehmer and Wu (2013)
Short selling and
informational
efficiency of
stock prices.
US: The sample includes the
daily average of 1,361
NYSE-listed common
stocks from January 2005 to
December 2007.
Short selling improves the intraday informational efficiency of stock prices
by accelerating the incorporation of public information into prices.
Moreover, a greater shorting flow reduces post-earnings announcement drift
for negative earnings surprises. Finally, short sellers change their trading
around extreme return events in a way that assists price discovery and
reduces the divergence from fundamental values.
Boehmer, Jones, and Zhang (2008)
Informativeness
of different types
of short sales.
US: Daily average of 1,239
NYSE‐listed common
stocks between 2000 and
2004.
The authors report a large amount of shorting activity across both large and
small NYSE stocks, suggesting that shorting constraints are not widespread.
Heavily shorted stocks underperform lightly shorted stocks by a cumulative
1.16% on average on a risk‐adjusted basis (15.6% annualized). Institutional
nonprogram (program trade is defined as simultaneous orders to trade 15 or
more securities with an aggregate total value of at least $1 million) short
sales are the most informative; stocks that are heavily shorted by institutions
underperform by 1.43% in the next month (19.6% annualized).
Boehmer, Huszar, and Jordan (2010)
Absence of short
selling and
informativeness
of future returns.
US: 930,109 stock-month
observations from June
1988 to December 2005.
Portfolios of lightly shorted stocks have significant positive abnormal
returns. These returns are often larger (in absolute values) than the negative
returns on the portfolios of heavily shorted stocks.
Boehmer, Jones, and Zhang (2013)
Effect of a
shorting ban on
market quality,
shorting activity,
and stock prices.
US: 727 stocks in a sample
from August 1 to October
31, 2008.
During the shorting ban, shorting activity dropped by an average of 77% in
affected large-cap stocks. Although small-cap stocks were largely
unaffected, large-cap stocks that were subject to the ban suffered a severe
degradation of market quality, as measured by quoted and effective spreads,
price impacts, and realized spreads.
Bris, Goetzmann, and Zhu (2007)
Short-sale
restrictions and
market efficiency.
Global data: 668
observations pertaining to a
sample of 46 countries
during the period 1990–
2001.
To some extent, prices incorporate negative information faster in countries
in which short sales are allowed and practiced. The lifting of short-sale
restrictions is associated with increased negative skewness in market returns.
However, short sales have no significant impact on the frequency of crashes.
These two results imply that extreme returns become more negative but not
more frequent.
Callen and Fang (2015)
Relationship
between short
interest and stock
price crash risk.
US: 40,660 firm-year
observations for
the years 1981–2011.
Short interest is positively related to future stock price crash risk. This
positive relationship is more pronounced for firms with weak governance
mechanisms, excessive risk-taking behavior, and high information
asymmetry between managers and shareholders.
58
Author(s)/year
Research issue(s)
Sample
Findings
Chague, De-Losso, and Giovannetti
(2019)
Short-selling skill
of institutions and
individuals.
Brazil: 3,341,213 loan
contracts involving 357
different stocks by 4,107
institutions and 35,338
individuals from 2012 to
2014.
Only 8.9% of institutions consistently profit from shorting; these are
responsible for 31.5% of the total shorting volume and 26.7% of the total
number of shorting deals. On the other hand, only 4.2% of individuals
consistently profit from shorting, and they are responsible for 0.3% of the
total shorting volume and 2.5% of the total number of shorting deals. Skilled
short sellers follow short-term momentum strategies; they are more likely to
pick value, liquid, short- and long-term losers, and high-volatility stocks;
and they initiate a short position after price drops, prior to earnings
announcements, and around sell recommendations.
Chakrabarty and Shkilko (2013)
Short-seller
informedness
about recently
completed (or
ongoing) insider
sales.
US: an average of 820 short
trades per day with an
average daily short volume
of 269,424 shares between
May 2005 and December
2006.
A significant increase in short positions is observed on days when company
insiders sell their firms’ shares. Short selling increases before insider sales
are publicly reported and often before insiders finish selling. Short sellers’
superior timing is consistent with (i) monitoring the order flow and (ii)
obtaining price-relevant information from brokerages that execute insider
sales.
Chang, Cheng, and Yu (2007)
Short-sale
constraints and
stock
overvaluation.
Hong Kong: 383 events
clustered across 18 short-
sale restriction change dates.
Short-sale constraints tend to cause stock overvaluation, and the
overvaluation effect is more dramatic for individual stocks for which wider
dispersion of investor opinions exists. When short sales are allowed, there is
higher volatility and less positive skewness of individual stock returns.
Chang, Luo, and Ren (2014)
Effect of lifting
the short-selling
ban on price
efficiency.
China: January 1, 2010 to
December 31, 2012; 285
stock addition events.
Stocks experience negative returns when they are added to the short-selling
list. After the lifting of the short-selling ban, the price efficiency increases
while the stock return volatility decreases.
Chen (2016)
Informational role
of short sellers for
US-listed Chinese
firms.
China: 1,314 (426) firm-
year observations during the
2007–2014 period.
Short sellers tend to issue reports on firms that have financial reporting red
flags and that exhibit good reported operating performance and high stock
valuations. Targeted firms experience an average three-day cumulative
abnormal return (CAR) of 6.4% and 13.6% for the initial coverage of the
firm, whilst nontargeted firms suffer a negative spillover effect, especially
when they hire the same non-Big 4 auditors as targeted firms.
Chen and Rhee (2010)
Speed of price
adjustment to new
information for
stocks included in
Hong Kong: a total of 86
stocks for the period
December 2001 to 2004.
Short sales contribute to market efficiency by increasing the speed of price
adjustment not only to private/public firm-specific information but also to
market-wide information. Shortable stocks are characterized by weaker trade
continuity and stronger quote reversals and adjust more quickly to new
information than their non-shortable counterparts.
59
Author(s)/year
Research issue(s)
Sample
Findings
the shortable
stock list.
Chen, Kadapakkam, and Yang
(2016)
Short selling and
the incorporation
of new
information into
prices.
China: the sample periods
include the pre- and post-
eligibility periods starting
on January 1, 2007 and
ending on March 31, 2014.
There is a positive association between the degree of information efficiency
of stock prices and the intensity of short selling and margin trading. Short
selling escalates during the 5 days immediately before significant negative
information events, suggesting that short sellers anticipate forthcoming
news.
Cheng, Yan, Zhao, and Chang
(2012)
Short selling, IPO
price efficiency,
and the
fundamental
value of IPO
stocks.
Taiwan: 139 IPOs on the
TWSE between January 1,
1997 and December 31,
2005.
Price efficiency is improved with increased short selling after the lifting of
short-sale constraints on IPO stocks; short sellers tend to target IPO stocks
with low fundamental ratios but simultaneously avoid IPO stocks with high
transaction costs.
Chi, Pincus, and Teoh (2014)
Mispricing of
book–tax
differences
(TI/BI) and the
trading behavior
of short sellers.
US: sample period 1988 to
2009, with a total of 78,320
firm-year observations for
the short-selling test.
TI/BI incrementally predicts future earnings growth and future abnormal
stock returns. A TI/BI trading strategy earns an annualized return of
approximately 9 percent, adjusted for standard risk characteristics: strong
evidence of mispricing by the market. The authors(s) find that short interest
decreases by an economically large 33 percent moving from the lowest to
the highest quintile of TI/BI. Further evidence suggests that mispricing of
TI/BI is not fully eliminated because short arbitrage is costly.
Choy and Zhang (2019)
Impact of short-
sale restrictions
on stock
price efficiency
when firms make
public earnings
announcements.
Hong Kong: a total of 9882
firm-announcement
observations, with 6537
from short-prohibited firms,
between 1 January 1994 and
31 December 2012.
Stocks that are prohibited from short selling experience significantly lower
post-announcement returns for both positive and negative news shocks. The
informational inefficiency due to short-sale restriction is particularly severe
for firms that experience negative announcement period shocks and are
subject to greater differences of opinion.
60
Author(s)/year
Research issue(s)
Sample
Findings
Christensen, Drake, and Thornock
(2014)
Pro forma
earnings
disclosures and
short selling.
US: 1,908 quarterly
earnings announcements
containing adjusted
earnings numbers over the
2005–2007 period.
Short selling is significantly high around earnings announcements
containing pro forma earnings disclosures, a finding that suggests that short
sellers view pro forma earnings disclosures as a strong signal of poor
reporting quality or overvaluation. Additional analysis shows that short
sellers are particularly active in shorting stocks of firms that exclude
recurring items. Finally, the authors reveal that highly shorted stocks
containing pro forma disclosures exhibit significantly more negative
subsequent market-adjusted abnormal returns than those without pro forma
disclosures.
Christophe, Ferri, and Angel (2004)
Short-selling
transactions in the
five days prior to
earnings
announcements.
US: 913 Nasdaq-listed firms
for the period from
September 13 to December
12, 2000.
Abnormal short selling is significantly linked to post-announcement stock
returns. Short sellers are typically more active in growth stocks than in value
stock or stocks with low standardized unexpected earnings, as those stocks
provide better opportunities for substantial declines in price over time. The
pre-earnings announcement short-selling activities appear to reflect firm-
specific information rather than these fundamental financial characteristics.
Christophe, Ferri, and Hsieh (2010)
Short-selling
activities prior to
the release of
analyst
downgrades.
US: 670 downgrades of
Nasdaq stocks between
2000 and 2001.
There are abnormal levels of short selling in the three days before the public
announcement of downgrades. The pre-announcement abnormal short
selling is significantly related to the subsequent share price reaction to the
downgrades, especially for downgrades that prompt the most substantial
price declines.
Comerton-Forde, Do, Gray, and
Manton (2016)
Nature and source
of information
reflected in short-
selling metrics,
namely short flow
and short interest.
Australia: 629 daily
observations of stock-level
short flow and short interest
over the period spanning
January 2012 to June 2014.
Short sellers are heterogeneous with respect to their information and
investment horizon. The short flow is strongly related to recent returns and
buy–order imbalance, anticipates imminent price-relevant announcements,
and reacts to news, increasing (decreasing) following bad (good) earnings
news. Short sellers target overpriced stocks and are adept at avoiding
underpriced stocks. There is no evidence that the short flow is related to
mispricing.
Comerton-Forde, Jones, and Putninš
(206)
Price discovery
and liquidity
provision by
liquidity-
supplying and
liquidity-
US: short sales executed on
the NYSE or Nasdaq from
January 1, 2008 through
August 31, 2008 for a
sample of 350 stocks.
There are two very distinct types of short sales: those that provide liquidity
and those that demand it. Liquidity-demanding short sales are likely to arise
from informed traders, whereas liquidity-supplying short sales can arise
when a market maker provides liquidity to an incoming buy order. Short
sellers with a liquidity-supplying motive act when spreads are unusually
wide, which is when market participants most highly value liquidity. They
are also strongly contrarian: they initiate or increase a short position after
61
Author(s)/year
Research issue(s)
Sample
Findings
demanding short
sellers.
fairly sharp share price rises over the past hour or so. Liquidity-demanding
short sellers, on the other hand, are momentum traders, as their shorting
activity tends to follow a price decline over the previous 24 hours.
Curtis and Fargher (2014)
Whether short
selling amplifies
price declines or
aligns stocks with
their fundamental
values.
US: 576,640 firm-month
observations over the period
1995–2011.
The increases in short interest for firms following a price decline are
associated with measures of overpricing based on financial statement
analysis. The finding supports the idea that the profitability of short selling
following price declines is driven by valuation-based positions. Limiting
short selling following price declines is likely to impede efficient price
discovery.
Daouk, Lee, and Ng (2006)
Capital market
governance and
market
performance.
Global: the sample period is
from 1986 to 1998 for 32
countries with 4,375 firm
year observations.
An improvement in the composite capital market governance (CMG) index
(the degree of earnings opacity, the enforcement of insider laws, and the
effect of removing short-selling restrictions) is associated with decreases in
the cost-of-equity capital, increases in market liquidity, and increases in
market pricing efficiency (IPO underpricing).
Dechow, Hutton, Meulbroek, and
Sloan (2001)
Relationship
between the
trading strategies
of short sellers
and the ratios of
fundamentals to
market prices.
US: 24,91333,724 firm-
year observations. NYSE
and AMEX firms in the
years 1976–1993.
Short sellers position themselves in the stock of low ratios of fundamentals
(such as earnings and book values) to market values that have systematically
lower future stock returns. Short sellers refine their trading strategies to
minimize their transaction costs and maximize their investment returns.
Desai, Ramesh, Thiagarajan, and
Balachandran (2002)
Relationship
between the level
of short interest
and the stock
returns.
US: 329 to 2,726 sample
observations of Nasdaq
firms from June 1988
through December 1994.
Heavily shorted firms experience significant negative abnormal returns and
are more likely to be delisted than their size, book-to-market, and
momentum-matched control firms.
Desai, Krishnamurthy, and
Venkataraman (2006)
Do short sellers
target firms with
poor earnings
quality?
US: sample period from
1997 to 2002 with 477
restating firms with
available data.
Short sellers accumulate positions in restating firms several months in
advance of the restatement and subsequently reverse these positions after a
restatement-induced share price drop. The increase in short interest is larger
for firms with high levels of accruals prior to restatement. Furthermore,
heavily shorted firms experience poor subsequent performance and a higher
rate of delisting.
62
Author(s)/year
Research issue(s)
Sample
Findings
Deshmukh, Gamble, and Howe
(2017)
Short selling
around seasoned
equity offering
(SEO)
announcements.
US: sample period 1988 to
2011 with a final sample of
7129 equity offerings by
3584 firms.
Firms with large increases in short interest prior to the SEO announcement
exhibit more negative announcement period returns, and firms with large
increases in short interest around the SEO announcement experience inferior
long-term operating and stock price performance following the equity issue.
The results highlight the informational role of short sellers in identifying
opportunistic market timers of equity issues.
Deshmukh, Gamble, and Howe
(2015)
Short selling and
operating
performance.
US: sample period from
1988 to 2012 with
1,852,832 firm-month
observations for 20,132
firms.
Firms in the top decile of increases in short interest experience a 21 percent
subsequent decline in operating performance relative to matched control
firms, a finding suggesting that short interest reflects private information
about firm fundamentals rather than other factors that may drive stock price
changes.
Diether, Lee, and Werner (2009a)
Effects of Reg
SHO on stock
markets.
US: NYSE- and Nasdaq-
listed pilot stocks over the
period from February 1,
2005 through July 31, 2005,
with a total of 2,485 firms.
Short-selling activity increases for both the NYSE- and the Nasdaq-listed
pilot stocks, but returns and volatility at the daily level are unaffected.
NYSE-listed pilot stocks experience more symmetric trading patterns and a
slight increase in spreads and intraday volatility after the implementation of
the regulation, while there is a smaller effect on market quality for Nasdaq-
listed pilot stocks.
Diether, Lee, and Werner (2009b)
Short sellers’
trading strategies.
US: 1,481 (2,372) stocks on
the NYSE (Nasdaq) market
during the period January to
December 2005.
Short sellers increase their trading following positive returns and correctly
predict future negative abnormal returns. The results are consistent with
short sellers trading on short-term overreactions to stock prices.
Drake, Myers, Scholz, and Sharp
(2015)
Short selling
around
restatement
announcements.
US: 20052007 sample
period with 740 restatement
announcements made by
648 unique companies.
The findings suggest that short sellers do not anticipate restatement
announcement dates. However, Drake et al. (2015) find a significant
increase in abnormal short selling when restatements are announced. The
two findings taken together lead them to conclude that short sellers respond
to, but do not anticipate, restatement announcements. Short sellers target
small companies characterized by weaker information environments and
companies making restatements that reduce the previously reported income.
The restating companies that short sellers target most heavily experience the
most negative subsequent abnormal returns.
Drake, Rees, and Swanson (2011)
Difference
between short
sellers and
analysts in their
US: 80,674 firm-quarterly
observations over the period
1994–2006.
Short interest is significantly associated, in the expected direction, with all
11 variables of stock valuation. In contrast, analysts tend to recommend
positively stocks with high growth, high accruals, and low book-to-market
ratios, despite these variables having a negative association with future
63
Author(s)/year
Research issue(s)
Sample
Findings
use of
information to
predict future
returns.
returns. Short interest therefore appears to capture predictive information
that investors can use in trading against analystsrecommendations to
increase returns.
Duan, Hu, and McLean (2010)
Idiosyncratic risk
and short selling
US: sample period 1988 to
2003.
High short-interest stocks generate low subsequent returns due to
idiosyncratic risk (a proxy for costs limiting arbitrage). Among high short-
interest stocks, a 1 standard deviation increase in idiosyncratic risk predicts
more than a 1 percent decline in monthly returns but does not predict returns
Edwards and Hanley (2010)
Short selling in
initial public
offerings.
US: a total of 388 IPOs
from January 1, 2005
through December 31, 2006.
Short selling occurs on the offer day in 99.5 percent of the IPOs in the
sample, and the majority of first-day short sales occur at the opening of
trading. The magnitude of short selling on the first trading day is positively
and significantly related to variables that proxy for divergence of opinion:
the change in offer price, the first-day return from the offer price to the open,
and the initial trading volume. Short-selling and first-day returns are
Engelberg, Reed, and Ringgenberg
(2018)
Short-selling risk
and price
efficiency.
US: approximately 220,000
observations at the firm-
month level for 4,500
equities over the period
2006 to 2011.
Higher short-selling risk is associated with lower future returns, decreased
price efficiency, and less short-selling activity by arbitrageurs. These effects
are more pronounced for trades with a long expected holding horizon. In
addition, short-selling risk is particularly high when there are extreme
returns.
Engelberg, Reed, and Ringgenberg
(2012)
Short sellers’
trading advantage
and public news
about corporate
events.
US: 3,167 unique firms over
the period from January 3,
2005 to July 6, 2007.
A substantial portion of short sellers’ trading advantage comes from their
ability to analyze publicly available information. The well-documented
negative relation between short sales and future returns is twice as large on
news days and four times as large on days with negative news. The most
informed short sales are not from market makers but rather from clients, and
Geczy, Musto, and Reed (2002)
Effect of actual
short-selling costs
and constraints on
trading strategies
that involve short
selling.
US: 7,144 different stocks
appear at least once over the
sample period of November
1998 through October 1999.
The loans of initial public offering (IPO), DotCom, large-cap, growth, and
low-momentum stocks are cheap, and investors who can short only stocks
that are cheap and easy to borrow can enjoy at least some of the profits of
unconstrained investors. Most IPOs are loaned on their first settlement days
and throughout their first months, and the underperformance around lockup
expiration is significant even for the IPOs that are cheap and easy to borrow.
The effect of short-selling frictions appears strongest in merger arbitrage in
that acquirers’ (especially small ones) stock is expensive to borrow.
64
Author(s)/year
Research issue(s)
Sample
Findings
Grundy, Lim, and Verwijmeren
(2012)
Whether option
strategies were
substitutes for
short sales during
the September
2008 short-sale
ban.
US: sample period 2008–
2009, with a total of 467
stocks categorized into 71
‘banned’ firms and 396
‘unbanned’ firms.
The short-sale ban is associated with a decline in trade in put options on
banned stock. The average daily put option volume for banned (unbanned)
stock declines by 3,194 (490) contracts during the ban. No evidence is found
to suggest that investors migrated to options of a particular moneyness
during the ban. The authors conclude that a ban on short sales of stock is not
overcome by trading in derivatives and that bearish derivative strategies are
not effective substitutes for short sales during a short-sale ban.
Henry and Koski (2010)
Whether short
selling around
SEOs is
informative or
manipulative
US: a sample of 456 SEOs
issued by 402 unique firms
over the period January
2005 and December 2006
Around issue dates, higher levels of pre-issue short selling are significantly
related to larger issue discounts for non-shelf-registered offerings. This
evidence is consistent with manipulative trading.
Henry, Kisgen, and Wu (2015)
Short sellers trade
by identifying
firms that have
significant
changes in default
US: NYSE, AMEX, and
Nasdaq 1,463 credit rating
downgrades from April
1995 to December 2007.
In the month before a rating downgrade, equity short interest is 40 percent
higher than one year previously. Short sellers predict changes in default
probabilities that lead to downgrades by focusing on firms with inaccurate or
biased ratings. This strategy is profitable for short sellers primarily since
downgrades are associated with significantly negative equity returns. Short