Public Short Selling by Activist Hedge Funds

Using a hand-collected sample of 280 public short selling campaigns, we show that voluntary disclosure of short positions by activist hedge funds has increased significantly in the last decade. Targets of short campaigns experience abnormal returns of approximately -7% around the announcement date. Campaigns are also associated with changes in the behavior of other stakeholders (e.g., litigation) that potentially harm targets. Both changes in targets’ valuations and stakeholder behavior are not explained by changes in short interest, suggesting that public short campaigns differ from non-public short sales. We consider two economic mechanisms that potentially explain this behavior: information acquisition synergies and the ability to engage in “short investor activism. ” Finally, we undertake a joint analysis of activists’ long and short positions and find that their aggregate effect on the shareholders of targets is indistinguishable from zero. The results highlight the tension between the contribution of activist hedge funds to economic and price efficiency and their effects on targets’ shareholders. The last two decades have seen a dramatic increase in the prominence and influence of activist hedge funds. The rise of activists, however, has not been without controversy. While research broadly indicates that, on average, hedge fund activism is followed by improved firm outcomes (Brav, Jiang, Partnoy, and Thomas, 2008; Bebchuk, Brav, and Jiang, 2015), some counter that campaigns often have myopic goals. Martin Lipton, for example, argues that activism promotes “short-termism” and may lead to “. very serious adverse effects on the companies, their long-term shareholders, and the American economy. ” Although the debate regarding activists centers on their long positions, recent years have seen a new phenomenon: high-profile public short selling campaigns by activist hedge funds. David Einhorn’s short of Allied Capital, a publicly traded mezzanine financing firm, provides an illustrative example. In May of 2002, Einhorn announced his short position in Allied at an investment conference, arguing the firm engaged in questionable accounting practices. Allied’s stock dropped over 10% the following day, and by the next month its short interest had increased six-fold. The SEC eventually launched an investigation into Allied that “zero[ed] in on many of the criticisms made by short-sellers. ” While the finance literature broadly finds that (at least some) short sellers are informed (e.g., Boehmer, Jones, and Zhang, 2008; Engelberg, Reed, and Ringgenberg, 2012; Cohen, Diether, and Malloy, 2007), these investors have historically avoided public disclosure of their positions. One reason for this behavior is that such disclosures may lead to accusations of wrongdoing by managers of firms or other parties. For example, in 2006, Biovail sued SAC Capital for libel, accusing the hedge fund of conspiring to drive down its share price. Public disclosure of short positions can also invite regulatory scrutiny. For example, both the Manhattan U.S. attorney’s office and the FBI investigated potential See: https://corpgov.law. harvard.edu/2013/10/28/empiricism-and-experience-activism-and-shorttermism-the-real-world-of-business/. See “SEC Is Investigating Allied Capital,” The Wall Street Journal (6/24/2004) See “Judge Dismisses Biovail’s Suit Against Hedge Fund,” The New York Times (8/20/2009)