Short Selling Constraints and Real Price Efficiency

• In Event: Economic Impact and Market Reactions

Abstract

Using a regulatory experiment—Regulation SHO pilot program—that temporarily removes short selling constraints in 2005−2007 on a random sample of firms listed in the Russell 3000 index, I find that the reduction in the sensitivity of corporate investment to price is greater for the pilot firms than for the non-pilot firms with the short selling constraints. I also find that the amount of private information revealed by price, measured by the probability of informed trading (PIN), is lower for the pilot firms and that their future operating performance is less profitable to the extent that the pilot firms’ managers learn less from their firms’ stock price. These findings are consistent with the premise that the removal of short selling constraints reduced the extent to which price reveals information that is useful for managers’ investment decision-making, which led to a negative effect on future operating performance. Additional analyses suggest that these findings are unlikely to be driven by alternative explanations such as the financial constraint channel and the attenuation bias due to measurement error in price.

Author

• You-il (Chris) Park, Duke University