Bear Raids and Short Sale Bans: Is Government Intervention Justifiable?

If managers, creditors, or other firm counterparties use stock prices when making decisions, short sellers may attempt to manipulate prices, inducing decisions that reduce firm value. However, an informed long-term shareholder has a natural incentive to ensure that prices send the right message so that the value of his existing stake is not harmed. While he can achieve that by buying enough shares to counter the shorts, he is likely to incur significant trading losses in the process. We find that for a large enough existing stake, the value of ensuring the right decision offsets these trading losses. However, when his existing stake is inadequate, short sellers succeed in destroying value. Whether this justifies intervention depends on the expected value loss from inefficient decisions versus the costs of intervention.