Why Do Firms Disagree with Short Sellers? Managerial Myopia versus Private Information

Abstract

Though short sellers on average succeed at identifying overvalued equity, firms often signal disagreement with short sellers by repurchasing stock when short interest increases. We investigate whether this disagreement reflects a myopic defense of inflated prices, or positive private information. These repurchases appear motivated by managers’ private information, not agency issues, even when managerial benefits to short-termism are enhanced or monitoring is weaker. Managers’ informational advantage relates to subsequent news, earnings, and risk, but is attenuated if activists target management or insiders sell. A trading strategy based on our findings earns 7.5% annually.

Firm, institutional and short sellers’ trading behavior around share repurchases

“…Further, we find evidence of immediate steep increases in abnormal returns after the share repurchase with a weaker upward trend thereafter. This evidence is consistent with Bargeron and Bonaimé (2020) who find that firms disagreeing with short selling subsequently have positive abnormal returns. Taken together, our results lend support for the undervaluation motive that drives firm’s management to increase repurchasing activity.…”

“…Using increasing short-selling activity as an indication for equity overvaluation, they show that share repurchases are used to provide price support for a stock that remains overvalued. Bargeron and Bonaimé (2020) also find a positive association between firm’s repurchasing activity and short selling but offer an alternate explanation of firms and active short sellers both disagreeing with the stock’s valuation. More specifically, these authors show that on average short sellers increase their short positions based on incorrect perceived stock overvaluation, while firms increase their repurchasing activity to support their undervalued stock.…”

“…We anticipate this to be the case based on the following three conditions: (1) a firm’s share repurchase announcement is generally associated with a positive information signal resulting in a share price increase (Ikenberry et al , 1995; Peyer and Vermaelen, 2009), (2) assessing the intrinsic value of a stock around a share repurchase program can be very complex and can lead to a disagreement among sophisticated investors. For example, research has shown that short sellers while informed do not have superior access to private information compared to the firm’s management, who are privy to intimate knowledge of the firm’s performance, prospects and risks by the nature of their position within the firm (Bargeron and Bonaimé, 2020) [6]. Institutional investors have also been shown to have an informational advantage over short sellers, as they typically hold many of the shares and tend to have better relationships with the firm’s management (Berkman and McKenzie, 2012; Hendershott et al , 2015) [7], and (3) recent evidence finds that firms use share repurchases to fight short sales (Muzere, 2019).…”

“…Based on the above conditions, when the firm believes that its stock is undervalued and repurchases its own shares, it is possible for short sellers to increase their trading activity based on perceived overvaluation, leading to disagreement with the firm (Bargeron and Bonaimé, 2020). Driven by the belief that the repurchasing firm remains overvalued and unbeknownst to short sellers, they may continue to actively trade against firms that are repurchasing their undervalued stock [8].…”

“…4. Previous academic studies analyze the trading relationships between the firm itself and institutions (see Huang and Zhang, 2012; Harvison, 2019; Jain et al , 2020) and those between the firm itself and short sellers (see Bageron and Bonaimé, 2020; Liu and Swanson, 2016). Section 2 provides a more detailed discussion of these studies.…”