Short selling and investment efficiency : evidence from the SHO pilot program

Abstract

In this study, I investigate how the removal of short selling constraints affects corporate investment efficiency.

I use the SHO Pilot Program to capture the removal of short selling constraints. The SHO Pilot Program was a two-year experiment, instituted by the U.S. Securities and Exchange Commission (SEC) in 2005, that temporarily suspended a short selling constraint rule, the so-called uptick rule, for one-third of stocks in the Russell 3000 Index.

Using the difference-in-differences method, I find that the removal of short selling constraints reduces corporate under-investment, increases investment sensitivity to investment opportunities, and decreases investment sensitivity to cash flow. In addition, the removal of short selling constraints increases equity issuance sensitivity to investment opportunities and decreases equity issuance sensitivity to cash flow. The effect of the removal of short selling constraints on investment efficiency is stronger for firms that issue more equity, for firms with higher ex ante business uncertainty, and for firms with higher ex ante CEO pay for performance sensitivity.

These findings suggest that the removal of short selling constraints improves corporate investment efficiency by increasing price efficiency and reducing information asymmetry. It contributes to the literature by documenting the informational role of secondary financial markets in influencing real economy.