Short selling improves companies by making management accountable and forcing checks on priorities, strategies and analysis to improve operations and increase shareholder value.
What you learn:
Short selling may signal a weak company or one with operating trouble. It may also flag an investment opportunity or sector that can put money in your pocket. Selling when short interests show can avoid losses, while buying when shorts cover may help investors catch a growth opportunity.
FAQs investors asked about how short selling improves companies
These questions and answers about how short selling improves companies have overlapping answers which help investors understand how stock markets, investing, and money-making interrelates.
Does short selling hurt a company?
Short sellers seek to profit by finding overvalued stocks of weak or vulnerable companies.
But not all overvalued companies are poorly run, so savvy traders don't attack well-run companies. Instead, the best short targets have multiple flaws, such as fraud, capital weaknesses, poor operations, or incompetent management.
When attacked, share prices plummet and can force management reviews and changes. But the exposed weaknesses can also trigger a company failure or restructuring, which can be a disaster for existing shareholders.
But a failure or restructuring moves capital from weak to strong players and, when well done, creates more shareholder value in a better business. So, as short sellers profit, market forces remove weak players to strengthen markets and capitalism.
How does short selling improve companies?
Short sellers target companies with overvalued shares and operational issues, such as poor management, unrecognized fraud, or other financial and operating problems.
When short sellers accurately identify operational issues and attract more sellers, they can significantly lower share prices. This can lead to management or operating changes, offering a glimmer of hope for improvements. And these improvements are not just a possibility, they are a reality that we see happening.
Most short sellers seek a profitable trade by exposing overvalued shares of flawed or weak businesses. However, the majority are indifferent to forcing improvement or change. These opportunistic short-term traders quickly take profits and move on.
Do short seller attacks change companies?
Short seller attacks can change a company and attract more sellers, increasing pressure to change or improve operating weaknesses.
Changes may include cleaning up fraud or financial issues, new or strengthened management, refinancing, selling, or merging.
Short selling pressure can resolve company problems or force a merger, sale, or liquidation. That strengthens surviving companies, improves markets, and moves capital to stronger hands.
However, shareholders suffer share value loss in short attacks, and any mergers or financing arrangements bring significant shareholder dilution.
As a result, existing shareholders are hostile to profit-driven, indifferent, and impatient short sellers unconcerned about company issues.
How Short-Selling Can Improve Companies and the Market
For some investors, short-selling carries a negative connotation. However, it can have several positive impacts on companies and the market. Here's how short-selling can potentially improve companies and contribute to a healthier financial ecosystem:
Enhancing Market Efficiency
Price Discovery
Short-selling plays a crucial role in price discovery, ensuring stock prices accurately reflect a company's value. Price discovery prevents overvaluation and encourages investors to be more discerning and analytical in their investment choices.
Liquidity
Short-sellers' participation in the market increases liquidity, making it easier for investors to buy and sell stocks. Enhanced liquidity can lead to more stable and efficient markets.
Promoting Management Discipline
Accountability
The presence of short-sellers exerts a positive pressure on company management to perform better and operate more transparently. The knowledge that investors benefit from exposing weaknesses or mismanagement can serve as a powerful incentive for executives to enhance their performance and make more informed decisions, thereby fostering better corporate practices.
Corporate Governance
Short-sellers often engage in extensive research to identify companies with poor governance, accounting issues, or other problems. Their findings can lead to greater scrutiny and improvements in corporate governance practices.
Detecting Fraud and Mismanagement
Uncovering Fraud
Short-sellers, acting as vigilant watchdogs, have a crucial role in unearthing fraudulent activities and financial irregularities within companies. Their efforts have been instrumental in exposing high-profile cases, such as Enron and WorldCom, thereby safeguarding market integrity and protecting investors.
Improving Transparency
Short selling can act as a catalyst, driving companies to enhance transparency and accuracy in financial reporting. This proactive approach can help companies avoid attracting short-sellers, instilling a sense of confidence in investors.
Market Corrections
Counteracting Overvaluation
Short sellers, by their actions, can effectively bring overvalued stock prices back to a more reasonable level. This crucial role in preventing market bubbles and reducing the risk of sudden, severe corrections underscores their contribution to maintaining market stability, which ultimately benefits all investors.
Reducing Volatility
While short-selling can sometimes increase short-term volatility, it can also contribute to long-term market stability by preventing excessive run-ups in stock prices.
Highlighting Risks
Short sellers, by taking short positions, bring to light potential risks and issues that other investors might overlook. This leads to more informed investment decisions and a healthier investment environment, ensuring that everyone is aware of the risks involved.
Consequences
While short-selling can be controversial and sometimes lead to significant market movements, its role in enhancing market efficiency, corporate governance, and transparency can contribute to the overall improvement of companies and the financial markets.
By ensuring that stock prices more accurately reflect actual value, promoting better management practices, detecting fraud, contributing to market corrections, and educating investors, short-selling can play a vital role in fostering a healthy and resilient financial system.
Embracing the positive aspects of short-selling can lead to a more balanced and fair market, ultimately benefiting all participants.
4 ways short selling improves companies
This lesson discusses four ways short selling improves companies:
- Management Accountability
- Forced Priority Changes
- Contrarian Expressions
- Unique Analytics
Falling stock prices get attention
Short selling attacks are stock market activities that can trigger sharp price drops. Those drops get the attention of markets, investors, shareholders, boards and management. Having the attention of management can begin the process of forcing their accountability. The pressures to respond effect both management and boards.
Understandably, management under a short attack, detest short sellers. After all, the short seller actions, if not always their words, broadcast that in the opinion of the short, the company has bad management and produces poor or less than optimal results.
For managers, being identified as bad guys making decisions that produce bad results, the attack gets very personal. Most certainly their job, reputation and careers are put on the line.
Shorts are not always right. But management almost always seems compelled to forcefully, publicly and quickly respond. Even when shorts misinterpret or have the facts wrong or support unfounded rumors, shareholders expect the CEO to lead a strong defense of the company.
Short selling can produce stock price drama
Dramatic falls of share prices can quickly become the top management priority. Shareholder howls of protest can come quickly, be loud and persist. Lower share values can force management to acknowledge and address issues. Should facts support the short activity, changes can quickly come.
But sometimes the issues raised are simply legitimate differences of business opinion or strategy and not facts. However, manipulations based on unfounded rumors do happen.
Short sellers can raise or imply almost any issue as material to the future value of the company. The conflict loving media, always receptive and hungry for a conflict story, may give the issue wide public attention.
Alternatively, management making a strong, compelling and public case against false or unfounded claims can get ahead of the issue. However, chasing smoke or refuting rumors can be impossible challenges for the best of leaders.
Such battles can seem more like political and philosophical debates, than business conflicts. However, the money is real and most investors quickly run away from conflict or controversy. With the right or even the wrong facts, investors running away and avoiding the company can favor the short side.
Most investors tend to want quiet, drama free, money-making portfolios. The shorts can aggressively seek media attention with belligerent statements and behavior. It can get ugly and keep lots of lawyers busy.
Media noise, drama and coverage
Greater amounts of noise, drama and media coverage, works to the advantage of a short seller. Knowing this, management wants to quickly put any short challenge to rest. Both sides can influence inexperienced media people who are interested in drama but not particularly concerned about right, wrong or the facts.
When the fights get loud and public, boards must speak up. Boards are always in the fight but most often out of the public sight. When it gets public, they must publicly respond.
As the group responsible for selecting and holding the CEO accountable, boards typically stand shoulder to shoulder with management. But not always. Cracks and factions develop.
Public nastiness can air dirty laundry
Betrayals do happen. At times dirty laundry gets aired to the glee of the short sellers. Should fractures develop, substantive changes become inevitable. In most cases, at least some changes follow any significant short attack.
Managements under attack can get thrown under the bus. They often fare poorly and become sacrificial offerings to bring peace. In such cases both sides, the company board, insisting there be no change in control, and the shorts, claiming management change occurred, each claim victory.
In the end, once the smoke clears, all investors, long or short, benefit from any resulting increased public accountability and greater transparency.
Short sellers can change corporate priorities
Under short selling pressure, basic business, operations, market, environmental or social issues, can become major issues for management.
Once a short attack begins, the shorts and media often put into play endless questions and issues. Previously, management may have been able to ignore or dismiss such inquiries.
That quickly changes when significant share price declines happen. Then management must pay attention or risk a shareholder or board revolt.
Relevant or not, any question or issue can take on a life of its own that demands management time, energy and attention. The relentless attacks wear.
Short selling is all about the money
Ultimately, short selling attacks are conflicts all about money. All involved in either attacking or defending are very motivated by a personal financial interest.
Management must respond to any substantive issue raised by a short seller with a large position. To put any significant issues to rest, management usually must convincingly demonstrate action or credible commitments to substantive acts or changes.
Short sellers can force a new agenda. They can pressure management to respond to matters ignored, overlooked or that they formerly considered unimportant.
With the ability to force a change in priority, short selling pressure can quickly make new items a major corporate focus. That means short sellers can often push items and issues not otherwise or before addressed, to the very top of the agenda.
For good or bad, management most often must change their approach to the issues. That can produce benefits that go well beyond the company and the shareholders.
Short sellers have contrarian views
By the simple fact that they sell short, short sellers express a contrarian view. Obviously, they sell short thinking the stock is overvalued.
Or they think that they can show information that will drive the price down. At the time when shorts sell, they think the stock sits at an overvalued price.
That selling of borrowed stock, becomes an aggressively expressed contrarian view. Once the contrarian issue becomes public, it invites other investors to consider the contrarian view.
All shareholders and investors get to consider very basic questions. Is it possible the new information or contrary point of view will ultimately be right? Will the market react to produce lower stock prices?
Short selling improves companies
That can mean mainstream investors reconsider their long positions. Has the herd of long investors missed something? Can or will a lower price and value become the “new normal”?
All other investors can place bets. Those that position themselves to profit when the market realities the shorts are right; can join in selling out long positions or even switch sides and sell short.
Those that disagree with the shorts can stay or play by aggressively buying long. Then, should that be right, they will enjoy and profit from the spectacle of a short squeeze.
Quick profits will come when the shorts acknowledge their bet is wrong. Time will tell who is right and thus which side profits as the winner.
Short selling produces unique analytics
All short selling activity produces records, volumes and prices. As you might expect, analyzing those records can produce useful information. That information can add value for both short and long investors. That will be our topic for our next lesson.
Question Answered!
Knowing short selling improves companies answers the question, does short selling hurt companies? Knowing and understanding the effects of a short selling attack on a company gives you greater awareness of stock market action. That helps improve your investment skills, which improves your investing opportunities and performance.
Lesson takeaways,
Short selling improves companies:
Short selling improves companies by making management accountable and forcing checks on priorities, strategies and analysis to improve operations and increase shareholder value.
- Corrections with 10% price drops happen regularly.
- Dips and corrections generate much meaningless market noise.
- Corrections are quick 2 to 14 week events about once a year.
- Cause, effect and timing of corrections has not been discovered.
Other lessons related to: Short selling improves companies
Thinking investors grow wealth
Sorting US & Canadian stock markets
Financial statement numbers exposed
Investor homework grows profits
Dangerous dividend warning signs
Comments and questions welcome
Email me at [email protected].
Subscribe free and get White Top Investor lessons in your inbox!
Make money work for you by knowing how investors think, feel and act. Learn here The Investor Mind.
White Top Investor lessons, website layout and organization: click here.
Make money work for you
Become a knowledgeable, comfortable, and confident investor using White Top Investor lessons. Learn to invest one small step at a time at your own pace to become the master of your financial security and independence. White Top Investor never sells or shares our email list. Learn more.
Lesson links to:
Short story shorting stocks:
Short selling stock explained Lesson 1
Short selling improves markets Lesson 2
Short selling improves companies Lesson 3
9 Short seller facts align Lesson 4
Making money selling short Lesson 5
Shorting stocks has risks Lesson 6
Who’s selling your stock? Lesson 7
Short seller skill sophistication knowledge Lesson 8
Short seller cost control Lesson 9
Short selling has rules Lesson 10
Next lesson 4:
9 Short seller facts align
Let’s connect, follow me; Twitter LinkedIn Facebook
Share:
Short selling improves companies
Buttons below let you share this lesson with family and friends!
Images courtesy FreeDigitalPhotos.net
Lesson code: 505.03.
Copyright © 2011-23 Bryan Kelly
WhiteTopInvestor.com
