Efficient Governance, Inefficient Markets: Short Selling with Takeover Risk
65 Pages Posted: 14 Jun 2018 Last revised: 10 Jan 2019
Date Written: May 30, 2018
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: Suggested Citation