Shorting Down Value: The Toxic Effect of Insufficient Internal Liquidity

Austin Murphy (), Joe Callaghan and Mohinder Parkash
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Austin Murphy: Oakland University, SBA, Rochester, MI 48309-4493, USA
Joe Callaghan: Oakland University, SBA, Rochester, MI 48309-4493, USA
Mohinder Parkash: Oakland University, SBA, Rochester, MI 48309-4493, USA

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2010, vol. 13, issue 02, 175-202

Abstract: This paper demonstrates analytically how short sellers can put non-transitory downward pressure on the stock market prices and intrinsic values of companies that need to raise external capital because of insufficient internal liquidity. The model helps explain anomalous empirical findings in the extant literature on negative returns to stocks subjected to heavy shorting activity. The implications of the model also supply normative justification for the sizable cash reserves held by corporations and their reluctance to raise external capital. The equity pricing effects implied by the model are illustrated for a large empirical sample of companies negatively impacted by heavy short sales. Empirical tests are also conducted in this research that provide evidence consistent with the theory.

Keywords: Short sales; liquidity; new issue; equity; bankruptcy (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (1)

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DOI: 10.1142/S0219091510001901

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