Owen A.Lamont – Go Down Fighting (Article)

This study examines battles between short sellers and firms. Firms use a variety of methods to impede short selling, including legal threats, investigations, lawsuits, and various technical actions intended to create a short squeeze. These actions create short sale constraints. Consistent with the hypothesis that short sale constraints allow stocks to be overpriced, firms taking anti-shorting actions have in the subsequent year very low abnormal returns of about −2% per month.

Short selling can be expensive, difficult, and risky. Impediments to shorting include the expense and difficulty of borrowing stock, legal and institutional restrictions, and the risk that the short position may be involuntarily closed due to recall of the stock loan. If these short sale constraints are sufficiently binding, stocks may become overpriced and thus have low future returns until the overpricing is corrected. By identifying stocks with particularly high short sale constraints, one can identify stocks with particularly low future returns. These constraints are difficult to measure, however, and researchers have struggled to find appropriate data to test the overpricing hypothesis.