Do Short Sellers Know More? Evidence from a Natural Experiment

48 Pages Posted: 21 Mar 2005

See all articles by Zhaojin Xu

Zhaojin Xu

Virginia Polytechnic Institute & State University - Department of Finance, Insurance, and Business Law

Vijay Singal

Virginia Tech

Date Written: March 2005

Abstract

Prior research has generally found that stocks with a high level of short interest perform poorly suggesting that short sellers have superior information. However, it is known that stock prices can affect corporate performance due to resource allocation: that is, a low stock price can negatively affect firm performance by denying the company capital or other resources needed for efficient operation (Subrahmanyam and Titman, 2001). Thus, it is not clear whether the excess returns to short sellers are a result of superior information or resource constraints imposed by a depressed stock price.

We examine the informativeness of short sales following introduction of Rule 10b-21 that limited the ability of market participants to short sell prior to an SEO. Using recent research, we are able to categorize SEO-issuing firms into short sale constrained and short sale unconstrained stocks. We find that the underpricing of SEOs by firms that are short sale constrained increases after the rule. We believe that the higher cost of short selling reduces the level of short selling that makes the prices less informative and increases underpricing. On the other hand, there is no change in the level of underpricing for SEOs by firms where short sales are unconstrained. The underpricing does not decline which is consistent with absence of manipulative short selling. Thus, our evidence is consistent with the notion that short sellers possess superior information. Finally, we find that the post-issue underperformance occurs only for SEOs where short sales are constrained.

Keywords: Short sales, seasoned equity offerings, rule 10b-21, short sellers, information

JEL Classification: G14, G33

Suggested Citation

Xu, Zhaojin and Singal, Vijay, Do Short Sellers Know More? Evidence from a Natural Experiment (March 2005). Available at SSRN: https://ssrn.com/abstract=687795 or http://dx.doi.org/10.2139/ssrn.687795

Zhaojin Xu

Virginia Polytechnic Institute & State University - Department of Finance, Insurance, and Business Law ( email )

1016 Pamplin Hall (0221)
Blacksburg, VA 24060-0221
United States

Vijay Singal (Contact Author)

Virginia Tech ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States
5402317750 (Phone)

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