Short Sellers and Capital Structure Dynamics

Abstract

Managers tend to issue equity when a firm is overvalued. Short selling is generally frequent among overvalued firms. By conditioning short selling on firm overvaluation, we show that short selling reduces managerial equity market timing and increases leverage. This moderating impact of short selling on market timing is more pronounced in firms with independent boards and with an increased likelihood of misvaluation, is primarily driven by overvaluation relative to long-run value, and occurs mainly through changes in equity issuances. The analyses that utilize the exogenous shock to the short selling environment from the SEC’s Reg SHO pilot program suggest that these results are causal.

Keywords: Capital Structure, Equity Market Timing, Short-sellers, Corporate Governance, Ownership Structure

JEL Classification: G14, G18, G32, G38