The Response to Share Mispricing by Issuing Firms and Short Sellers

Paul Schultz

Short sale constrained stocks are overpriced on average. I show that firms exploit mispricing by selling shares when their stock is short sale constrained and repurchasing shares when their stock is easily shorted. Stocks underperform following SEOs if and only the stock is difficult to short. This suggests that some SEOs are motivated by mispricing while others are not. Short selling costs make it difficult for investors to profit from the poor performance following SEOs. Short selling and SEOs are alternative ways to supply shares to investors and firms become the low cost share provider when short selling is costly.