OWNERSHIP STRUCTURE, EXPECTATIONS, AND SHORT SALES ON THE NASDAQ

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

A variety of other factors affect the level of short interest in a particular stock, and one of the most important is the existence of exchange-traded options on the stock. Figlewski and Webb (1993) find increased short-selling activity for optionable stocks, and this is attributed to the options reducing the effect of short-sale constraints. Danielson and Sorescu (2001) affirm these results and document a connection between the price effect of option introductions and shortinterest changes. Evans et al. (2002) find that options on hard-to-borrow stocks trade for parity as option market-makers extract profits from their unique ability to sell short without borrowing stock.

Also likely to influence the amount of short interest is the presence of convertible securities; the importance of convertibles in the short sales story is highlighted by Asquith et al. (2005), where stocks with convertibles are found to more likely have a 'high level" of short interest than a "random" stock. Hedge funds can sell short the underlying stock, thereby neutralizing the impact on the convertible of movements in the stock, and generate a cash flow from the convertible's coupon or dividend. As well, hedging models often suggest short selling when a convertible is closer to being "in the money." Likewise, Howe et al. (1998) document arbitrage opportunities buying the convertible preferred and simultaneously selling the underlying common - for marketmakers at the time of and subsequent to the announcement of conversion-forcing calls of convertible preferred stocks.

The amount of short interest may also be impacted by the divergence of investors' views on future corporate performance. When there are constraints on short sales, Boehme et al. (2006) affirm that stock prices will reflect the optimistic views of investors who purchase the stock but not opinions of the relatively pessimistic who avoid costly short selling. Using the dispersion in analysts' earnings forecasts to proxy for differences of opinion, Diether et al. (2002) find that stocks with controversial prospects underperform those with the least amount of forecast diversion.

Data and Methodology

We assemble a sample consisting of the largest 200 firms on the Nasdaq. These firms are used because of their greater data availability. Size is measured as the market capitalization at the end of each year. Our sample period is from July 1991 to December 1998. It changes at the beginning of each year to reflect the new year-end market capitalizations. The sample is restricted to stocks with available CRSP, Compustat, Standard & Poors, and Compaq Disclosure data. securities that are delisted (due to acquisition, for example) are dropped from our analysis when removed from the Nasdaq. securities that continue to be listed after acquisition activity are retained in the study.

Our analysis focuses on the short-selling activity in our sample, and this data is drawn from a comprehensive report of all monthly short selling on the Nasdaq.4 Short-selling activity is measured using the short-interest ratio, which is a firm's reported short interest divided by its shares outstanding. Statistics on the cross-sectional variation in the short-interest ratio for our sample are given in Table 1. The mean, median, 25th percentile, and 75th percentile of the shortinterest ratio are provided for each year; the data are positively skewed.