Abstract

This thesis consists of three essays. The first essay (thesis chapter two) examines the relationship between short sales and governance. A contribution is made to the literature on short sales by providing evidence that the level of shorting is reversely linked to the overall quality of the corporate governance of a firm and that sellers react contemporaneously to changes in such governance. Short traders may also be able to forecast changes in corporate governance and adjust their portfolios asymmetrically prior to the said changes, with a pronounced increase in short positions for actual and anticipated negative events and a more subdued repurchase of shorted stock for positive expectations.
The second essay (thesis chapter three) introduces a new taxonomy that classifies short-sales constraints into tangible and intangible categories. It includes the development of a theoretical framework relating overpricing and implementation drag to empirically estimate the four tangible constraints. The literature underestimates these constraints with taxes representing the largest drag on short-selling, followed by direct trading costs, the lending fee and dividend repayments. The commonly used lending fee is a poor proxy for short-selling constraints both in magnitude and variance. Overpricing generally exceeds the implementation drag from tangible short-sales constraints except during periods of rapid price contraction.
The third essay (thesis chapter four) extends the overvaluation model based on heterogeneous expectations and short-sales constraints. Seven intangible restrictions are identified and their effect is empirically assessed using two measures of mispricing; absolute and relative. The recall risk, search frictions and investor sentiment increase mispricing while institutional ownership and the existence of options reduce it. Firm-based restrictive tactics initially increase overpricing but signal to the market that the stock is under selling pressure. Since such tactics are rarely effective, firm-bullying becomes negatively related to mispricing. Short-sellers should limit their holding period to a minimum as the monthly-equivalent short returns decline with longer trades and they would benefit by concentrating on firms that are smaller in size, relatively poorly managed with lower institutional ownership, higher systematic risk, no options, higher price-earnings multiples and lower market-to-book ratios.