Short selling, agency, and corporate investment

In this article, we examine corporate investment decisions in a model with short selling. We show that high short-selling activities can cause firms to overinvest and that the agency problems between managers and shareholders drive this overinvestment. Empirically, we find that short interest is positively associated with subsequent corporate investment and that the effect of short-selling activities on investment is stronger when the sensitivity of chief executive officer compensation to stock price performance is greater. The results are not explained by short-sale constraints or firm overvaluation. Additionally, short-selling-induced corporate investments can partly explain the negative relation between both short interest and corporate investment with subsequent stock returns.