Short sales around M&A announcements

In: Journal of financial economic policy, Volume 1, Issue 2, p. 177-197

Abstract

PurposeThe purpose of this paper is to examine changes in short‐sale transactions of target firms and acquiring firms around merger and acquisition (M&A) announcements using daily short‐sale transaction data from the New York stock exchange and NASDAQ. The paper further aims to investigate the link between short‐sale transactions and trading costs.Design/methodology/approachTwo abnormal short‐sale measures are developed. Two regression models based on the two short‐sale measures are constructed and ordinary least squares is used to estimate the regressions. Two samples to test bid‐ask spreads (BAS) before and after M&A announcements t‐test are used.FindingsThe paper finds that target firms experience significant excess short sales (ES) from day−1 to day+7; while acquiring firms experience significant ES from day 0 to day+20. For acquiring firms, the five‐day pre‐announcement abnormal short sale is negatively related to the announcement day return and is positively related to post‐announcement return. Such a relationship for target firms is not observed. For target firms, it is found that changes in short activity are not significantly related to changes in trading cost. For acquiring firms, short activity changes are positively related to quoted spreads and percentage quoted spreads. The short‐sale activity changes are negatively related to effective spreads.Research limitations/implicationsThe paper is a first step to understanding whether short sales affect market liquidity around M&A announcements; therefore restriction is necessary. Additional research can be done which should extend the current study to include the options market.Practical implicationsFrom the results, the paper cannot conclude that short sellers are informed traders around M&A announcements. Therefore restrictions on short sales around M&A announcements may not be warranted.Originality/valueThe paper fills an important blank in the existing literature by examining short‐sale transactions around M&A announcements. Such an investigation is of particular interest to market regulators as they try to update the short‐sale rules.