Does short-selling threat potentially influence corporate risk-taking? Evidence from equity lending supply

Abstract

This study examines whether the equity lending supply strengthens or weakens corporate risk-taking behaviors. The evidence shows that ex-ante short selling can unintentionally function as an external governance mechanism to discipline self-interested, risk-averse managers. This showed an increase in long-term risk-taking among U.S. firms from 2006 to 2017. The robustness of our findings is confirmed by the consistent results obtained using alternative dependent variables and varying data sampling frequencies, which was further reinforced by causality checks through external shocks and instrumental variables. Cross-sectional tests indicate that the disciplinary role played by short sellers is stronger in firms with weaker corporate governance, greater financial constraints, and less incentivized managers. After excluding alternative explanations, we find that the positive impact of short selling on corporate risk-taking is determined by investor attention drawn by short sellers, confirming the disciplinary role of the market's invisible hand. More tests confirm the positive effects of our primary findings. This study provides robust empirical evidence that short sellers have an impact on favorable long-term corporate risk-taking and offers valuable insights for fiscal policy and academic discussion.