Friday, February 6, 2015

Saving Long-term Investment from Short-termism: the Surprising Role of Short Selling

MASSA Massimo, WU Fei, ZHANG Bohui, ZHANG Hong
Read the working paper
INSEAD Working Paper 2015/11/FIN

We propose that the presence of short-term investors, such as short sellers, does not necessarily enhance short-termism. On the contrary, based on a sample of 11,969 firms across 33 countries over the 2003-2009 period, we observe that the threat of short selling increases long-term (i.e., R&D) investment. An instrumental variable approach and the use of several regulatory events provide consistent evidence of causality. We identify three possible channels through which short selling promotes long-term investment: improved price efficiency, enhanced disciplining impact, and a more positive feedback effect. Finally, we document that the threat of short selling reduces underinvestment as opposed to inducing overinvestment, and that it enhances the firm’s future growth, performance, and innovation output through encouraging long-term investment. Overall, a more effective short selling market helps to mitigate managerial short-termism.