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Public news announcements, short-sale restriction and informational efficiency

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Abstract

In this paper, we address the question that with differences in opinion in reality, how quickly stocks incorporate news shocks when they are subject to different levels of short-sale constraints. Specifically, we examine the impact of short-sale restriction on stock price efficiency when firms make public earnings announcements. Using data from the Hong Kong stock market, where some stocks are eligible for and others are prohibited from short selling, we find significantly lower post-announcement returns with high economic magnitude for short-sale prohibited stocks with both positive and negative news shocks. The reduction in informational efficiency due to short-sale restriction persists several months after the earnings announcement. The informational inefficiency due to short-sale restriction is particularly severe for firms with negative announcement period shocks and subject to greater differences in opinion.

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Notes

  1. The New York Times, September 19, 2008.

  2. The New York Times, April 30, 2008.

  3. Rubinstein (2004) has a comprehensive survey on this topic.

  4. Other theoretical models on overvaluations include Harrison and Kreps (1978), Scheinkman and Xiong (2003), and Hong and Stein (2003). Diamond and Verrecchia (1987) build a rational expectation model and show that prices incorporate negative information slowly in the presence of short-sale constraints.

  5. For example, Chen et al. (2002), Jones and Lamont (2002) and Asquith et al. (2005), among others, have documented instances when short-sale constraints have led to overvaluation by finding a negative future return following a period of costly shorting.

  6. Under the assumption of delayed recognition of earnings surprises, Boehmer and Wu (2012) examine the responses of short sellers specifically to negative surprises. They do this because “it is not clear how to interpret changes in short selling after positive surprises” (Boehmer and Wu (2012), p. 303). In our empirical model, with the presence of differences in opinion, even in the case of positive news shocks, optimistic investors may cause overvaluations and short seller may have the incentive to exploit the opportunity.

  7. See Table 2. When interaction terms with differences in opinion proxies are included in regression analyses, the coefficients for Short_Prob are even more negative, see Table 3.

  8. Depending on the short-selling cost, some short-sale eligible stocks may also be subject to the overvaluation in Miller’s context but the contrast will be sharper across the eligible versus prohibited groups.

  9. In fact, Nagel (2005) finds that stocks with low institutional ownership (a proxy for short sell constraints) underreact to bad news about future cash flows.

  10. For a detail description, see http://www.hkex.com.hk/eng/market/sec_tradinfo/regshortsell.htm.

  11. The authors thank Craig Doidge for providing part of the data on changes in short eligibility status.

  12. Results are very similar for alternative screening windows after the announcement dates.

  13. Approximately US $12.9 million using an exchange rate of US $1 = HK $7.75, which is roughly constant over the sample period.

  14. While quarterly earnings announcement is not mandatory, some firms in the Hong Kong Stock Exchange do report quarterly earnings but DataStream does not have a complete record on interim announcement dates. Our post-announcement window ends at +60 days to avoid results confounded by the next earnings announcement if the firm reports quarterly. Only annual earnings announcements are used in this paper.

  15. We also used an alternative definition of “neutral cases” as CAR (− 1, + 1) being within the band of (− 0.5%, + 0.5%). The qualitative results remain similar.

  16. Measures on opinion dispersion generated at the announcements are not readily available. For example, the literature is still unresolved on the interpretation of a turnover shock at the announcement: it can proxy a change in visibility, a change in risk, or disagreement (for example, Garfinkel and Sokobin (2006) and Lerman et al (2008)).

  17. Data errors in the IBES announcement dates also deter us from using IBES. Upon manual check with the exchange website, there are frequent cases when announcement dates from IBES does not match with the actual one and the mismatches are sometimes greater than 1 week. In contrast, DataStream’s announcement dates are correct in general. Acker and Duck (2009) also find significant errors from IBES database using U.K. firm announcements.

  18. Notice that including Short_Prob, NSign, and Short_Prob*NSign in the same specification introduces the issue of multi-collinearity because they are all binary variables.

  19. Blau and Wade (2013), and DeLisle et al. (2015) address the issue whether options and short positions are complements or substitutes and which trading position is more informative about future prices. In Hong Kong, the status of being an index component is often accompanied by the existence of stock futures or equity options, and therefore index status is a subset of the Derivatives dummy.

  20. By construction, Short_Prob*Nsign and Short_Prob*Quin_CAR are highly correlated. Coefficients for these two variables should be interpreted with caution.

  21. Note that turnover is but return volatility is not a criterion used by the exchange to decide short eligibility status.

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Acknowledgements

The authors acknowledge helpful comments on earlier versions of this paper from Warren Baily, Hank Bessembinder, Craig Doidge, Jay Ritter, Laura Starks, Cong Wang and seminar participants at the Shanghai University of Finance and Economics, University of Toronto, 2008 Northern Finance Association meeting, and 2010 FMA meetings.

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Authors and Affiliations

  1. King’s Business School, King’s College London, 30 Aldwych, London, WC2B 4BG, United Kingdom

    Siu Kai Choy

  2. Department of Finance, The Chinese University of Hong Kong, Shatin, NT, Hong Kong

    Hua Zhang

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  1. Siu Kai Choy
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  2. Hua Zhang
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Correspondence to Hua Zhang.

Appendix

Appendix

See Tables 10 and 11.

Table 10 Variables definition
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Table 11 Benchmark Return Models
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Choy, S.K., Zhang, H. Public news announcements, short-sale restriction and informational efficiency. Rev Quant Finan Acc 52, 197–229 (2019). https://doi.org/10.1007/s11156-018-0707-8

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