Informed short selling: evidence from economically linked firms

Purpose This paper examines how sophisticated and better-informed investors, such as short sellers, trade on information along the supply chain. Given the economic linkages between suppliers and customers, one would expect short sellers to trade on such information and to capitalize on investors' inattention to such economic links. Design/methodology/approach This paper uses both multivariate regression analysis and portfolio analysis where the time series averages of equally weighted monthly portfolio returns are reported to explore the abnormal returns of long-short trading strategies. Findings Results indicate that short interest predicts unexpected earnings news, consistent with short sellers extracting information from economic relationships. There is a strong negative relationship between short interest in the supplier firm and the one-month future stock return of the customer firm. This negative relation significantly persists for at least 12 months. One plausible channel explaining the information content of supplier (customer) firm's short interest for the customer (supplier) firms is the short sale constraints on the customer (supplier) firms. Originality/value The paper addresses a gap in the literature by examining whether short selling in a firm in the months leading up to a customer's (supplier's) negative shock is negatively correlated to the customer's (supplier's) future performance. Overall, the findings suggest that short sellers play an important role in the price discovery of related firms in the supply chain, which is beyond the direct effects documented in prior literature.