The Rise of the Equity Lending Market: Implications for Corporate Financial Policies
44 Pages Posted: 15 Dec 2015 Last revised: 5 Jan 2016
Date Written: December 28, 2015
Ever increasing competition and search for yield have prompted institutional investors to routinely lend their equity holdings, making them the largest suppliers of stocks used for short selling. Shorting depresses stock prices, making it harder for firms to plan their payout policies, investments, merger deals, and employee compensation. We exploit the framework of institutional investing to show how shifts in the supply of lendable (shortable) stocks affect corporate policies. Firms react promptly to increases in lendable stocks by repurchasing shares and building cash reserves. The relations we document appear to be causal and consistent with the argument that firms shore up defenses against shorting activity. To fund their responses, firms pay fewer dividends, issue debt, and reduce investment spending. Firm responses are more pronounced when stocks are ex-ante more liquid, relatively overvalued, have higher pent-up shorting demand, and whose managers' personal compensation is more sensitive to stock prices.
Keywords: Equity lending market, cash holdings, share repurchases, short sales constraints, institutional ownership, instrumental variables
JEL Classification: G23, G32, G35
Suggested Citation: Suggested Citation