Hats off to Xiaoxia Lou of the University of Delaware and Jonathan M. Karpoff of the Michael G. Foster School of Business at the University of Washington, who have just published a report on short selling that you can download here.
It seems that according to the authors, short sellers are not the villains that politicians and regulators would have us believe. They say that listed companies are often inclined to inflate their reported profits with accounting mischief, and I would concur with that. Look at the accounting tricks posted by RBS and Barclays reported here last week for evidence, and in corporate America the practice is not restricted to the likes of Enron and Worldcom.
The authors identified firms that misrepresented their financial statements, the spotting of that overstatement of profits and share price declines until the time when the accounting treatment is widely known. According to the authors, uninformed investors who trade during the average firm’s violation period benefit from lower prices to the extent of ranges between 0.19% to 1.53% of the firm’s equity value.
They say that their research indicates that short sellers anticipate the eventual discovery and severity of financial misconduct. Short selling also conveys external benefits to uninformed investors, by helping to uncover financial misconduct and by keeping prices closer to fundamental values when firms provide incorrect financial information.
Somehow, I don't think financial regulators will be congratulating the authors on their report.