Short-Sale Constraints and the Informativeness of Stock Price for Default Prediction
Mark G. Maffett
University of Chicago - Booth School of Business
Edward L. Owens
Emory University - Department of Accounting
National University of Singapore - Department of Finance
October 12, 2015
This paper examines how short-sale constraints affect the usefulness of stock price in assessing a firm’s likelihood of default. We document that the overall informativeness of equity-market-based default predictors is lower where short selling is more constrained. This informational cost is driven primarily by a reduced ability to accurately identify defaulting firms in the presence of short-sale constraints. In contrast, our results suggest that short-sale constraints actually improve the usefulness of price in identifying non-defaulting firms, particularly during periods of high economic uncertainty. In addition, we find that accounting information mitigates both of these informational costs, particularly where reporting transparency is high. However, using an exogenous shock to short-sale constraints, we document that short-sale constraints are associated with higher credit prices, which suggests that the reduced informativeness of equity price is not fully offset by alternative sources of default-risk-relevant information.
Number of Pages in PDF File: 56
Keywords: Short-sale constraints; Default prediction; Financial reporting transparency; Credit spreads
JEL Classification: G15, G33, G38, M41
Date posted: July 23, 2013 ; Last revised: October 13, 2015
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