Does Stock Manipulation Distort Corporate Investment? The Role of Short Selling Costs and Share Repurchases

Abstract

We characterize the effect of short selling costs on interactions between informed and uninformed speculators, showing how this dynamic impacts corporate decisions such as investment and share repurchases. Manipulation coexists with informed trading at low shorting costs, reducing price informativeness and investment. Manipulation becomes less profitable as shorting costs increase, making prices more (less) informative and boosting (hindering) investment if speculators are less (more) likely to be informed. At high shorting costs, informed shorting is unprofitable even without manipulation threats, resulting in low price informativeness and constraining firm financing. Our model shows that the ability to pre-commit funds before prices reflect speculators' information yields a negative relation between investment and shorting costs. Critically, it demonstrates how managers can stop manipulative shorts through repurchases, leading to efficient investment. Stock liquidity, cash flow uncertainty, and management-creditor agency problems shape the impact of shorting costs on corporate policies.