Does Mandatory Short Selling Disclosure Lead to Investor Herding Behavior?
41 Pages Posted: 16 Sep 2021 Last revised: 9 Aug 2022
Date Written: August 8, 2022
Prior literature documents that short sale activity clusters around mandated short sale position disclosures. We investigate two competing hypotheses for this finding in the UK market: herding- versus information-based trading. First, using an entropy-balanced matched sample of stocks, we find that future firm-level short interest exhibits a significantly smaller reversal for stocks that had short-sale disclosures than for non-disclosure stocks. We also find that the cumulative stock returns after the disclosure are lower for disclosure stocks relative to non-disclosure stocks in the short-run but recover over time. The recovery in stock prices for disclosure stocks is consistent with the initial excessive short-selling pressure abating and fundamental investors buying the dip, a result consistent with herding-based trading but inconsistent with information-based trading. Second, we explore the role of new information about firm fundamentals on short selling activities and find that the degree of short-sale disclosure clustering is similar across the pre-earnings announcement, post-earnings announcement, and no-news periods, regardless of whether the earnings news is good or bad, suggesting that information shocks are not driving short-sale disclosure clustering. Overall, the evidence is consistent with short sellers herding into short positions after observing short-sale disclosures.
Keywords: Short sale, herding, disclosure, firm fundamentals, stock returns
JEL Classification: G12, G14, G41, M41
Suggested Citation: Suggested Citation