Short-Sale Constraints and Stock Price Crash Risk: Causal Evidence from a Natural Experiment
We argue that short？sale constraints do not reduce, and in fact exacerbate, the likelihood of an abrupt, large？scale decline in stock prices (stock price crash risk). Lifting of short？sale constraints reduces the likelihood of stock price crashes because short sellers serve as a monitoring function and provide stock market feedback. Because most of the short sellers are sophisticated institutional investors and thus have the ability to detect bad news promptly or to gain privileged access to private information, they can help expedite the price？discovery process and improve the informational efficiency of stock prices via their shorting activities. By facilitating a timelier incorporation of information (especially negative news) into market prices, their trading activities can deter or slow down the within？firm hoarding of bad news, which in turn decreases a firm’s stock price crash risk.