Does Stock Manipulation Distort Corporate Investment? The Role of Short Selling Costs and Share Repurchases
63 Pages Posted:
Date Written: August 7, 2020
We characterize the effect of short selling costs on interactions between informed and uninformed speculators, showing how this dynamic impacts corporate decisions such as investment and stock repurchases. Low shorting costs allow for manipulation to coexist with informed trading, reducing price informativeness and investment. Manipulation becomes less profitable as shorting costs increase, making prices more informative and boosting investment when speculators are less likely to be informed. At high shorting costs, informed shorting is unprofitable even in the absence of manipulation threats, resulting in low price informativeness and constraining firms' access to financing. Our model shows that the ability to pre-commit funds before prices reflect speculators' information yields a negative relation between investment and shorting costs. Critically, it demonstrates how managers can stop manipulative shorts through stock repurchases, leading to efficient investment. Stock liquidity, cash flow uncertainty, and management--creditor agency problems are shown to shape the impact of short selling costs on corporate policies.
Keywords: short selling costs, stock manipulation, informed trading, corporate investment, share repurchases
JEL Classification: G23, G32, G35
Suggested Citation: Suggested Citation