External Governance and Internal Resource Allocation

We exploit Regulation SHO as a natural experiment to investigate the effects of short selling threats on intrafirm capital allocation. Using detailed data on the foreign operations of multinationals, we find that the marginal effect on aggregate investment masks a significant effect on intrafirm reallocation. Managers reallocate investment and R&D expenditures across borders toward productive subsidiaries and R&D centers, respectively. Treated firms shifted 30% more capital toward foreign subsidiaries with strong recent performance. These results provide new evidence on the scope and potential benefits of governance by short sellers and demonstrate the importance of cross-border spillovers of capital markets regulation.