Efficient Governance, Inefficient Markets: Short Selling with Takeover Risk

65 Pages Posted: 14 Jun 2018 Last revised: 10 Jan 2019

See all articles by Costanza Meneghetti

Costanza Meneghetti

West Virginia University

Ryan Williams

University of Arizona - Department of Finance

Steven Chong Xiao

University of Texas at Dallas - Naveen Jindal School of Management

Date Written: May 30, 2018

Abstract

We hypothesize that takeover risk creates significant limits to short selling. A target firm’s stock price often increases substantially upon a takeover announcement, resulting in trading losses to short sellers. Therefore, short sellers should require higher rates of return when takeover likelihood is higher. Consistent with this prediction, the return predictability of monthly short interest increases with industry-level takeover activities and decreases with the implementation of takeover defenses. The risk of activist intervention also creates similar limits to short arbitrage. Our results suggest that efficient markets for corporate control may have unintended effects in creating stock market inefficiencies.

Keywords: Short Selling, Limits to Arbitrage, Takeover

JEL Classification: G12, G14, G34

Suggested Citation

Meneghetti, Costanza and Williams, Ryan and Xiao, Steven Chong, Efficient Governance, Inefficient Markets: Short Selling with Takeover Risk (May 30, 2018). Available at SSRN: https://ssrn.com/abstract=3187447 or http://dx.doi.org/10.2139/ssrn.3187447

Costanza Meneghetti

West Virginia University ( email )

PO Box 6025
Morgantown, WV 26506
United States
304-293-7889 (Phone)

Ryan Williams

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States

Steven Chong Xiao (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

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