Deploying Narrative Economics To Understand Financial Market Dynamics: An Analysis of Activist Short Sellers' Rhetoric*

We investigate how activist short sellers (AShSs) expose publicly listed firms in an increasingly popular form of "research reports" openly denouncing alleged frauds, flawed business models, accounting irregularities, and wrongdoings. We focus on six AShSs that issued research reports that often led to a strong negative market reaction. Our empirical analysis exploits both qualitative and quantitative methods for a comprehensive data set of 383 research reports targeting 171 unique firms, and 3 firsthand interviews with AShSs. Drawing on Aristotle's rhetoric, we first examine how AShSs use narratives in striving to convince other investors that the target firms are overvalued. Specifically, we search the documents produced by AShSs for stylized narratives related to credibility-based (ethos), emotions-based (pathos), and logic-based (logos) rhetorical strategies. To assess the impact of these strategies, we examine the extent to which the AShSs' rhetorical strategies resonate in 3,665 press articles. As expected, the press often refers to logos-based arguments. Interestingly, the press also frequently brings up pathos-based and ethos-based statements. Considering the importance of the press in shaping investors' opinions, our study points to AShSs' narratives playing a major role in policing financial markets. Theoretically, we show that AShSs, as dissenting market participants, produce narratives that go beyond the language of formal rationality-as they strive to reveal new information and frame it persuasively, in order to destabilize the extent of trustworthiness surrounding target firms.