Doing Battle with Short Sellers: The Conflicted Role of Blockholders in Bear Raids

Abstract

If short sellers can destroy firm value by manipulating prices down, an informed blockholder has a powerful natural incentive to protect the value of his stake by trading against them. However, he also has a potentially conflicting incentive to use his information to generate trading profits. We show that a speculator can exploit this conflict and force the blockholder to buy a disproportionately large amount to prevent value destruction. This is costly for the blockholder because the trades must sometimes be executed at inflated prices. Given reasonable constraints on short sellers, a sufficiently large blockholder will have the incentive to absorb these losses and prevent a bear raid. However, conditions exist under which outside intervention may be warranted.