CEO Confidence Matters: The Real Effects of Short Sale Constraints Revisited

Abstract

This paper investigates the role of managerial biases in the real effects of limits to arbitrage. In a natural experiment setting with Regulation SHO, we find that the lifting of short sale constraints leads to a significant decrease in CEO confidence for pilot firms, and this result is more pronounced for pilot firms with financial constraints and stronger corporate governance. We further find that the real effects of Regulation SHO documented in the literature are primarily driven by such decrease in CEO confidence. Underconfident CEOs of pilot firms tend to decrease corporate investments, reduce earnings management, and improve social performance and employee relations following the removal of short sale constraints. Overall, we identify CEO confidence as a psychological channel through which capital market frictions influence corporate decisions and CEO investment behavior.

Keywords: CEO confidence; Regulation SHO; short sale constraints; corporate investments; earnings management; corporate social responsibility; employee relations

JEL Classification: D22, G18, G31, G32, G41