Family Controlled Firms and Informed Trading: Evidence from Short Sales

Abstract

We investigate the relation between family ownership and the informational content of short sales in U.S. publicly-traded firms. Our analysis indicates that family firms, in aggregate, experience a substantially higher volume of abnormal short sales prior to negative earnings shocks than nonfamily firms, suggesting extensive informed trading. Additional testing indicates that family-control characteristics, such as board involvement, seem to intensify the informed short sale results. The analysis also suggests that daily short-sale interest in family firms contains useful information in forecasting stock returns; however, we find no discernable effect in nonfamily firms. An investment strategy of buying family firms with the lowest level of short sales and shorting family firms with the highest level of short sales generates monthly abnormal returns of 61 basis points, indicating an economically profitable trading strategy. One inference is that regulations designed to limit trading by those with access to material, non-public information appear ill-suited for family firms. Although our data does not allow a specific identification of short sellers, the analysis provides compelling evidence that informed trading via short sales occurs more readily in family firms than in nonfamily firms.

Keywords: Short Sales, Informed Trading, Family Ownership, Hedge Funds