If you own shares in a company that declares war on short-sellers, sell your stake.
That's the message in a new study by Owen A. Lamont, associate professor of finance at the University of Chicago's graduate school of business. He analyzed returns at 270 companies that waged public battles with short sellers, investors who bet on a stock's fall. He found that their stocks lagged the market by 2.34 percent in each of the 12 months after the battles began.
The study, which covers 1977 to 2002, shows not only that the stocks of companies who try to thwart short-sellers are generally overpriced, but also that short sellers are often dead right.
The study divides the tactics used against short sellers into three types: belligerent statements, which include claims of a short sellers' conspiracies or of lies spread by the pessimists; taking legal or regulatory action against short-sellers; and making technical moves to prevent short selling, like urging shareholders to register stock in their names rather than in those of their brokerage firms, so that shares cannot be lent to short-sellers. Companies also try to get big stakes into friendly hands, so short sellers cannot borrow them.
The negative returns varied depending on the strategy, the study showed. Companies that urged shareholders to take delivery of their stock lagged the market by 3.17 percent a month in the following year. Those that worked to get their stock into friendly hands underperformed the market by almost 5 percent a month.
During the 25 years that Lamont tracked, he found 326 incidents at some 270 companies. Among them were Conseco, the insurance giant that filed for bankruptcy protection last month, and Samsonite, the luggage maker, whose shares traded at US$0.40 last Friday. MicroStrategy Inc, a software company whose chairman settled accounting fraud accusations brought by regulators in December 2000, also figured in the study. Its shares peaked at US$333 a share in 2000, but closed Friday at US$1.58, adjusted for a reverse split.
In recent months, executives at Allied Capital, a small business lender, MBIA Inc, a securities guarantor, Farmer Mac, a maker of agriculture loans, and Pre-Paid Legal Services, a provider of legal assistance plans, have whined about short sellers or tried to instigate action against them.
When stock prices fall, Lamont said, companies, investors and even regulators often attack short-sellers.
"You tend to see when stock prices go down a wave of harassment and government suppression of short selling," he said.
It's irrational, he added, and an example of the limited good concept, where someone's success is seen as having come at the expense of others.
But short-sellers are not the enemy of investors -- they are often right about their targets. Lamont noted, "Many firms accuse short sellers of fraud, but are in fact themselves guilty of fraud."
The fact is, short-sellers actually reduce volatility in the market. Their selling helps keep stocks from flying too high, and when they close out their trades, the buying often gives beleaguered stocks support.
"If there had been more short-selling of tech stocks in 1999, the market wouldn't have gone up so much," Lamont said. "And it wouldn't have gone down so much because short-sellers would have provided a floor."
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