Short sellers and capital structure dynamics

Abstract

Managers tend to issue equity when a firm is overvalued. Short selling is more frequent among overvalued firms. By conditioning short selling on overvaluation, we show that short selling increases leverage, lenghtens debt maturity, and speeds up adjustment to target leverage. The leverage increase is more pronounced in firms with independent boards and an increased likelihood of misvaluation, is driven by overvaluation relative to long-run value, and occurs through lower equity issuance and higher long-term debt issuance. Analyses using the exogenous shock to the short-selling environment from the US Securities and Exchange's Reg SHO pilot program suggest these results are causal.