OWNERSHIP STRUCTURE, EXPECTATIONS, AND SHORT SALES ON THE NASDAQ

Journal of Economics and Finance, Spring 2007 by Graham, J Edward, Hughen, J Christopher

In Panel A, 20-day short-run returns have a negative relation with the short-interest ratio, and this affirms the results of previous studies. The reported level of short interest has a statistically significant relation with subsequent short-run returns even in the presence of the unanticipated short-interest variable. The unexpected component of aggregate short interest does not contain the more powerful signal about future stock returns that we expected. Equations 1b and 2b in Panel A of Table 4 suggest the unanticipated short interest ratio does have some explanatory power, independent of the raw short interest measure, but that the power of the unexpected levels of short selling is displaced when the absolute measures of short selling are included factors.

These results for the unanticipated short interest measure are broadly confirmed in Panel B of Table 4, where we consider 180-day long run returns subsequent to the release of short interest data; the unanticipated factor is modestly significant in Equation 2c of Panel B, but is still less significant than the short interest ratio. As we discover with the short-run returns, higher short interest is typically followed by lower returns. Tests reveal that unexpected short interest provides a less significant signal of future returns than the simple short-interest measure. The evidence generally shows that the unadjusted short-interest ratio better explains, than the unanticipated component of short sales, subsequent returns. While excluding the Fama-French factors allows the unanticipated level of short selling to displace the raw measure in terms of statistical significance, the inclusion of those factors reveals that the first-observed dominance of the unanticipated short-selling factor is not robust.

Conclusions

We augment recent research on short selling. We examine the 200 largest Nasdaq stocks and find that the shorting activity in these stocks is negatively associated with institutional ownership and positively related with inside ownership; we discover that the unexpected level of short selling, as we measure it, is less meaningful in describing later returns than are simple measures of changing short selling activity. We confirm that the most costly stocks to short are the least likely to be shorted.

We interpret our analysis of ownership structure as evidence that short sellers exploit several relations between returns and inside and institutional ownership. The relation between inside ownership and short interest may reflect short sellers attempting to profit from the lower stock returns associated with management entrenchment. Another plausible explanation is that higher levels of short selling may result from insiders hedging their stock holdings.

Our findings are not an artifact of the non-monotonic relationships between firm values and ownership concentration described in earlier research; rather, we find average increases in short selling as inside ownership increases, independent of the relative concentration of ownership. As well, we find declinations in short selling as institutional ownership rises. This runs counter to some recent research, as institutions are arguably the largest source of stock for selling short. However, our selection of a sample of the largest firms on the Nasdaq, for whom institutional ownership is likely not a binding constraint on stock availability for selling short, may explain this result. As well, short sellers may be less active in stocks with higher institutional ownership, as those institutional investors have exhibited superior selective ability with stock investments. This may not be the case in studies of stocks outside the largest 200 firms on the Nasdaq, but is the case with our reported and unreported tests.