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New Academic Research Shows Activist Short-Sellers Might Be Onto Something

Activist short-sellers like Muddy Waters, Spruce Point Capital Management and Hindenburg Research are known as much for the very public nature of their short positions as they are for the results of their calls, but new academic research shows that firms like these might be onto something.

New research developed by Luc Paugam, an associate professor of financial accounting, Hervé Stolowy, professor of financial accounting, both at HEC Paris, and Yves Gendron of the Université Laval, looks at the impact activist short-sellers have on the markets through the publication of a series of their “research reports”, which are primarily developed to denounce fraud and malpractices of publicly-listed companies. Deploying Narrative Economics to Understand Financial Market Dynamics: An Analysis of Activist Short Sellers’ Rhetoric, to be published in the journal Contemporary Accounting Research in 2021, finds that companies targeted in the reports published by activist short-sellers register significant market value losses which last well over six months after publication. More significantly, the authors also found that close to half of the firms targeted were classified either as bankrupt, delisted, or suspended from stock exchanges.

The authors have observed that three days after a report is published, the average market-adjusted stock return of companies targeted falls by -11.2%: this represents a reduction of $416mn of market value on average. Two months after publication, cumulative abnormal returns are persistently negative: -14.5%. This continues into a period of six months with cumulative abnormal returns of -22.6% on average.

Though efforts have been made and technology developed to detect and address fraud, it is generally seen as an enduring problem. In this context, the activities of activist short sellers might be welcomed practices in the fight against financial irregularities. Through this paper, the authors show that activist short sellers are endowed with a potential to convince a fair number of market participants that fraudulent behaviour took place in specific settings.

“We found that private sector practices, such as those of activist short sellers, are indeed able to play an important role in financial markets, by demonstrating that fraud can be identified and acted upon through the verdict of the market,” the authors said.

Additionally, the authors also praise the potential role activist short sellers could have in addressing corporate fraud when compared to the failures of traditional gatekeepers such as auditors, boards or regulators. They analysed 383 research reports targeting 171 firms from six prominent activist short sellers, and conducted three first-hand interviews with activist short sellers, for their research.


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