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Short Selling and Price Pressure Around Merger Announcements

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Abstract

Prior research argues that short selling by merger arbitrageurs adds downward pressure to the stock prices of acquiring firms, particularly for firms that use stock financing. We test this hypothesis by examining daily short sale data surrounding merger announcements. Our initial results show that short selling activity surges in response to merger announcements and that abnormal post-announcement short selling is driven by those mergers that use stock financing. This result is consistent, in part, with the presence of merger arbitrage. However, additional tests show that the negative post-announcement stock returns to acquiring firms are orthogonal to the level of post-announcement short selling activity. These findings extend the current literature by showing that, while post-announcement short selling is abnormally high, this short selling does not put undue pressure on acquiring firms’ stock prices.

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Notes

  1. Evidence showing that short selling and future returns is negatively related is documented in Senchack and Starks (1993), Aitken, Frino, McCorry, and Swan (1998), Dechow, Hutton, Meulbroek, and Sloan (2001), Desai, Ramesh, Thiagarajan, and Balachandran (2002), Christophe et al. (2004), and Boehmer et al. (2008).

  2. Our results are robust (quantitatively and statically similar) when we conduct our analysis on mergers that use at least some stock in the deal and not 100 % cash.

  3. In fact, it is possible that our results occur because the quality of financial markets has improved over time. For instance, in more liquid markets, short sales might not be able to move prices in a meaningful way during the post-announcement period. To the extent that markets have become more efficient over time, there might not be an arbitrage opportunity for short sellers during the post-announcement period. Therefore, we are left to conclude that short selling does not add price pressure to acquiring firms’ stocks during the more recent time period.

  4. While we would like to examine a longer time period, the short-sale data is only available from 2005 to the beginning of 2007, so we are left to only examine the two year time period 2005 through 2006.

  5. We include the short sales that are executed on all exchanges similar to prior studies (Diether et al., 2009, for example).

  6. MPS discusses the differences in fixed-rate v. floating rate stock mergers, whereby most of the price pressure effect should be observed in the latter, due to the decoupling of the merger announcement date and the exchange ratio determination date. We identify 10 floating rate mergers which are included in our complete sample. There were no significant results when examining floating rate mergers independently.

  7. Short turnover closely resembles the monthly short interest used in several studies (e.g., Figlewski and Webb, 1993; Senchack and Starks, 1993; Desai et al., 2002).An important difference between our measure of short turnover and the monthly short interest measure used in other studies is that the monthly short interest is the amount of uncovered short volume on a particular day each month. Our measure of short turnover is the amount of uncovered or covered short volume that is executed each day.

  8. We also examine excess returns or the difference between CRSP raw returns and the CRSP value-weighted index return (Berkman et al., 2009; Christophe et al. 2010) throughout the study. For the entire sample, the average excess return is 0.006.

  9. We are only able to infer the number of public bidders.

  10. See for example, Jensen and Ruback (1983), Bradley, Desai, and Kim (1988), Mulherin and Boone (2000), Fuller et al. (2002).

  11. The results are similar when we examine excess returns (as calculated in Berkman et al., 2009; and Christophe et al. 2010).

  12. In unreported tests, we compare short selling activity post announcement for 100 % stock financed and combination financed mergers. We do not find that the short selling levels are significantly different for these two methods of payment.

  13. We also use two-day and ten-day post-announcement periods. Results are qualitatively similar.

  14. There is an observed inverse U shaped pattern on Table 4from left to right which is unintuitive. One would expect a strong linear relationship between shorting and the variable “percent cash”. In unreported results we extend Table 7 by forming a quadratic term (percstock^2). While the coefficient for percstock is positive and significant, the coefficient for percstock^2 is insignificant. This finding suggests that when controlling for other factors the u-shaped pattern of no longer is evident suggesting a liner relationship between short activity and percent cash.

  15. Recall that several mergers are financed, in part, with debt. So including the percent of cash and the percent of stock financing does not violate the full rank condition required for consistent estimates.

  16. A possible explanation for these positive, albeit modest estimates is that our out of sample tests are capturing a period when liquidity in financial markets have improved. The lack of negative estimates in columns [1] through [4] suggest that short sales might have more difficulty moving prices given the improvement in liquidity during our sample. Further, the marginal positive estimates for our short selling measures when examining 10-day post-announcement returns are consistent with liquidity providers earning fair but modest returns for providing liquidity to short sellers in the period immediately following announcement. Perhaps an examination of liquidity provision surrounding merger announcements might be a fruitful area for future research.

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Authors and Affiliations

  1. Huntsman School of Business, Utah State University, 3565 Old Main Hill, Logan, UT, 84322, USA

    Benjamin M. Blau

  2. School of Business, University of Mississippi, 244 Holman Hall, University, MS, 38677, USA

    Kathleen P. Fuller

  3. College of Business, Mississippi State University, 312 M McCool Hall, Mississippi State, MS, 39762, USA

    Chip Wade

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  1. Benjamin M. Blau
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  2. Kathleen P. Fuller
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  3. Chip Wade
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Correspondence to Chip Wade.

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Blau, B.M., Fuller, K.P. & Wade, C. Short Selling and Price Pressure Around Merger Announcements. J Financ Serv Res 48, 143–160 (2015). https://doi.org/10.1007/s10693-014-0197-3

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  • DOI: https://doi.org/10.1007/s10693-014-0197-3

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