Does Short-Selling Predict Future Demand Decline?

Purpose: Short-selling in South Korea has been criticized as uninformed trading that enables institutional investors to exploit retail investors. While several studies have used stock returns to argue that short-selling in the Korean stock market is an informative trade, it is difficult to conclusively demonstrate the informativeness of short-selling because stock prices are influenced by trading volume. This study empirically tests whether short-selling is informa-tionally deceptive about future demand by exploiting firms' cost behavior. Design/methodology/approach: This study employs multivariate regression analysis to test the this conjecture by extending the cost behavior model of Anderson, Banker, and Janakiraman (2003) by incorporating a short-selling measure. Findings: The empirical analysis in this study shows that short-selling in prior fiscal periods is associated with the prospect of lower demand in the long run. Additional analyses confirm the robustness of these results. Research limitations/implications: This study provides evidence that short-selling reflects long-term, information-based trading, supporting the legitimacy of short-selling-related regulation in the Korean stock market. Originality/value: This is the first study to empirically demonstrate the informativeness of short-selling in the Korean stock market using cost behavior, avoiding the confounding effect of trading volume changes due to short-selling.