Does short selling discipline overinvestment?

Abstract

We explore the disciplining effect of short selling on overinvestment. Results show that firms with more stock lending supply have higher abnormal stock announcement returns of acquiring firms, lower subsequent abnormal capital investments, and longer spells between large investments, and higher subsequent Tobin’s Q and ROA. Alleviating the endogeneity concern, our multivariate difference-in-difference analysis shows that this disciplinary force is more effective for firms in the Regulation SHO-PILOT Program. We identify two mechanisms through which short selling disciplines managers: managers’ wealth-performance sensitivity and likelihood of hostile takeovers. Additionally, the disciplinary force only exists for non-financial-constrained firms and non-all-cash M&A deals.