Short Interest as a Signal to Issue Equity

Abstract

This paper examines whether corporate managers follow the collective actions of arbitrageurs, measured by short interest, in deciding whether to conduct seasoned equity offers (SEOs). We find that short interest predicts future SEOs and has a marginal impact comparable to well-known predictors. In economic terms, the probability of an SEO announcement increases by 36% for firms in the top quintile of short interest and decreases by 61% for firms in the bottom quintile. Importantly, we identify a causal impact of short interest on SEO issuance using a novel instrument for short interest based on future litigation events that are likely known by outsiders better than by insiders. Further evidence demonstrates that high short interest leads to a share price correction in the coming months, thereby signaling to managers a closing window of opportunity to issue overpriced shares. Taken together, our findings suggest that the secondary market has a significant impact on real corporate decisions through the observed arbitrage activities of sophisticated investors.

Keywords: Real effects of arbitrage activities; short interest; seasoned equity offer; litigation; insider trading

JEL Classification: G14, G32