Investors know the impact short selling can have on stock prices but does short selling actually hurt the company behind the stock? The answer to this question is not clear, and it requires us to analyze the negative impact of short selling and the positive consequences.
Can short selling hurt a company?
Yes, short selling can have a harmful impact on the company, its shareholders, and its employees. When a stock is shorted that means that the market consensus view on the company is negative. This is not reflected only in the stock price. Some of the consequences of a highly shorted stock are:
- Impacts financing
- Affects corporate governance
- Affects how the company deploys capital
- Impact on the company’s growth
- Difficulty in attracting employees
- Impact on operations
One of the major consequences of a highly shorted stock is how it affects the company’s financing options. Since the stock price of a company reflects how the market feels about its future, a highly shorted stock usually implies that the company has a real probability of going bankrupt.
When this happens lenders are less likely to want to finance these companies. It also makes it difficult for the company to issue bonds or even issue shares.
Even if the company is able to finance itself the terms will be worse than if the company had a stable or growing stock price.
Affects corporate governance
Whether we like it or not, the stock price is an important reflection of corporate governance. The stock price is extremely important for shareholders, and it affects not only how they perceive the company but also how corporate decisions are made.
A highly shorted stock can impact corporate governance. It is common that when a short report is released, some companies announce a buyback in order to demonstrate how financially strong the company is. The question is would the company conduct this buyback if the stock was not being shorted?
Affects how the company deploys capital
Since companies are concerned with their stock price, and what message it passes to investors they might change how they deploy capital in order to support the stock price - mostly using buybacks. While it is impossible to tell whether a buyback is good or bad, because it depends on the company’s specific situation, it seems that companies that are shorted are sort of forced to do buybacks.
This limits the ability of the company to make decisions and allocate capital in the most optimal way possible.
Impact on the company’s growth
This can have a direct impact on the company’s growth prospects, since it may be forced to deploy capital in a non-optimal way just to deal with short-sellers. The inability to get financing at the best possible terms can also deeply affect a company’s growth. Additionally, not deploying capital in the most optimal way can also negatively growth.
There are also other factors that affect the company’s growth like being able to attract and retain talented workers. A lower stock price due to heavy short selling will prevent the company from attracting certain employees.
Difficulty in attracting employees
The stock price is an important way of attracting employees who might see working for the company as a great way to also get equity. Since some companies rely on equity packages for employees, if the stock price is down it might not be so attractive to work for that company.
Impact on operations
Finally, all of these ways that short selling hurt a company ultimately affect the day-to-day operations. The company might not be able to find the best employees or raise capital to improve one of its segments. All of these factors combined, end up having a devastating impact on the company.
Can short sellers destroy a company?
While short sellers can have a negative impact on the company, the truth is that short sellers are unable to destroy a company. Unless a company was on the verge of bankruptcy, short sellers might only speed up the process. Other than that short selling a stock is not enough to destroy a whole company.
How short selling can be beneficial to a company
Although most of the time short selling could hurt a company, it can also be beneficial. For example, if the company has a lot of cash at hand, and its share price declines significantly, it might conduct a buyback at very attractive levels.
Another situation in which short selling can be beneficial for the company is if a short report is released and it includes some reasons why the company should be shorted. A management team that is able to look past its own mistakes, might find use for that and incorporate it into its governance.
However, most of the time short selling ends up harming the company, but there are still situations in which it can be beneficial. Although short selling can hurt a company, the practice should not be banned. Since there are so many benefits for the market as a whole. Investors are looking for ways to make money, and not directly harm companies and their stakeholders.