Investments, tenth edition

  Short-Selling Comes Under Fire—Again 

to fall, shorts may be  anticipating  a decline in the stock 

price. Their sales simply force the market to reflect the 

deteriorating prospects of troubled firms sooner than it 

might have otherwise. In other words, short-selling is part 

of the process by which the full range of information and 

 opinion—pessimistic as well as optimistic—is brought to 

bear on stock prices. 

 For example, short-sellers took large (negative) posi-

tions in firms such as WorldCom, Enron, and Tyco even 

before these firms were exposed by regulators. In fact, one 

might argue that these emerging short positions helped 

regulators identify the previously undetected scandals. 

And in the end, Lehman and Bear Stearns were brought 

down by their very real losses on their mortgage-related 

investments—not by unfounded rumors. 

 Academic research supports the conjecture that short 

sales contribute to efficient “price discovery.” For example, 

the greater the demand for shorting a stock, the lower 

its future returns tend to be; moreover, firms that attack 

short-sellers with threats of legal action or bad publicity 

tend to have especially poor future returns. 

 

1

   Short-sale 

bans may in the end be nothing more than an understand-

able, but nevertheless misguided, impulse to “shoot the 

messenger.”  

1

See, for example, C. Jones and O. A. Lamont, “Short Sale  Constraints 

and Stock Returns,” Journal of Financial Economics, November 2002, 

pp. 207–39, or O. A. Lamont, “Go Down Fighting: Short Sellers vs. 

Firms,” Yale ICF Working Paper No. 04–20, July 2004.

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public, and, probably most important, misleading financial statements and accounting 

practices. The Sarbanes-Oxley Act was passed by Congress in 2002 in response to these 

problems. Among the key reforms are:

    • 

Creation of the Public Company Accounting Oversight Board to oversee the 

auditing of public companies.  

   • 

Rules requiring independent financial experts to serve on audit committees of a 

firm’s board of directors.  

   • 

CEOs and CFOs must now personally certify that their firms’ financial reports 

“fairly represent, in all material respects, the operations and financial condition 

of the company,” and are subject to personal penalties if those reports turn out to 

be misleading. Following the letter of the rules may still be necessary, but it is no 

longer sufficient accounting practice.