Abstract
The global financial crisis has led to a resurgence of interest in the regulation of short selling as the practice is typically blamed for rapidly declining prices during a market downturn. It is argued that the measures taken by many countries to regulate and curb short selling are ineffective, unfair, not easily implementable, discriminatory, and not feasible in terms of costs and benefits. It is suggested that regulators can do a better job by addressing more serious problems than short selling and that shareholders will be better off if CEOs refrain from taking their firms to the brink and blaming short sellers for the consequent mishap.
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REFERENCES AND NOTES
It is not that Fuld was hurt personally by short sellers. In the few years, preceding the collapse (when conditions were rosy and the name of the game was going long), he paid himself some US$500 million in compensation. Meanwhile, he was destroying Lehman by indulging in a bonanza of subprime products. In the process, he made the bank a target for short sellers, but (unlike the miserable shareholders) he kept the money he had made.
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The valuation model referred to here is the dividend discount model, which postulates that a ‘fair’ price of a stock is the present value of future dividends. The formula representing the model has dividends in the numerator and the discount rate (a measure of the required rate of return that is determined by risk) in the denominator.
In other words, the short sale is executed without a ‘locate’.
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Recall the case of the first ever short seller, Issac Le Maire, who lost everything as a result of indulging in short selling. At least in theory, there is no limit to how much a short seller can lose whereas the gain has a limit that is reached when the underlying stock price goes to zero. If anything, short selling can be more detrimental to the short sellers themselves than the targeted companies. Hence, indulging in short selling is like any risky but legitimate business operation.
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While this case was not about short selling, it helps explain a general principle pertaining to the issue under consideration here.
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Acknowledgements
I am grateful to the editor of this journal and to the reviewers for useful comments and for bringing my attention to important related articles that I had overlooked. I would also like to thank Kelly Burns for providing research assistance.
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Moosa, I. The regulation of short selling: A pragmatic view. J Bank Regul 13, 211–227 (2012). https://doi.org/10.1057/jbr.2012.6
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DOI: https://doi.org/10.1057/jbr.2012.6