The Real Effects of Short-Selling Constraints

Abstract

We use a regulatory experiment (Regulation SHO) that relaxes short-selling constraints on a random sample of US stocks to test whether capital market frictions have an effect on stock prices and corporate decisions. We find that an increase in short-selling activity causes prices to fall, and that small firms react to these lower prices by reducing equity issues and investment. These results not only provide evidence that short-selling constraints affect asset prices, but also confirm that short-selling activity has a causal impact on financing and investment decisions.

Keywords: Corporate Investment, Financing Decisions, Short-selling Constraints, Financial Constraints, Bear raids,

JEL Classification: G31, G32, G12