Short Selling Constraints and their Impact on Corporate Investment Decisions

Abstract

How do short selling constraints impact corporate investment decisions? We analyze two forms of short-sale constraint (short-sale ban and cost) in a model where firm value is endogenous to trading, due to feedback from the financial market to corporate investment decisions. We show that, compared to an economy with no constraint on short selling, introducing a cost on short sellers can increase firm value, but a large cost or a short-sale ban always harms it. Our model suggests that the impact of short-sale friction extends beyond trading in secondary markets.

Keywords: Short selling constraints, Market manipulation, Feedback effect, Corporate investment

JEL Classification: D82, G14, G32