Shorting Down Value: The Toxic Effect of Insufficient Internal Liquidity

Abstract:     
Within the context of fundamentally efficient markets, this paper demonstrates analytically how short sellers can put non-transitory downward pressure on the stock market prices and intrinsic values of companies that need to raise external capital because of insufficient internal liquidity. The model presented helps explain anomalous empirical findings in the extant literature on shorting and related issues. Empirical tests are also conducted in this research that provide evidence consistent with the theory. The model's implications yield important normative conclusions that supply justification for the sizable cash reserves held by corporations and their reluctance to raise external capital.

Number of Pages in PDF File: 57

Keywords: Shorting, Liquidity, Distress Valuation

JEL Classification: G12, G33

working papers series