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> The issue is that you can short any high risk high reward play and make money if they fail

Or (as a short) you can lose massive amounts of money if they're incredibly successful - in fact, your losses are actually uncapped.

And anyway, that seems like a good thing - there should be a force tempering high risk endeavors.

> But then enough shorting can cause them to fail, because it makes it more difficult to raise money by selling new shares or using shares as collateral.

That sounds like a good thing.

If your company has an appreciable amount of short interest the likely reason is that the company's overvalued, not that Jim Chanos is colluding with Andrew Left and Bill Ackman just to bring down your company and profit off your failure.

Further, I don't know that I've ever seen a mid+ cap company take any sort of significant hit from short interest where there was nothing to substantiate the short's claims, and there have been plenty of inverse situations (companies growing in value even when there were substantial issues brought to light by a short seller).

EDIT: Actually I take that back, I have seen some - because the SEC brought fraud charges against them. It's the short version of P&D and it's just as illegal.

> And causing a large undertaking to fail when it otherwise wouldn't have is obviously not efficient.

On the flip side, causing a large undertaking to fail faster when it was doomed from the beginning is obviously more efficient.

> It also increases volatility because on one side the existence of the shorts makes the company more likely to fail

Many people are worried that volatility is too low these days (thus why Feb was such a big deal), so I'm not sure that's a great argument.

> And anyway, that seems like a good thing - there should be a force tempering high risk endeavors.

The point is that it does the opposite.

Suppose you have a high risk company with a million shares and a would-be share price of $1000, but 20% of the shares are shorted so the share price is $900.

Now if the company fails, the total losses to the actual shareholders are 8% higher even though the price per share was lower because there are de facto more shares in existence.

Meanwhile if the company succeeds, the shareholders make significantly more, because there are de facto 20% more shares in existence and the shareholders paid $900 each instead of $1000, with the shorts having to pay the difference. Which is why the total (e.g. $900 times 1.2M instead of $1000 times 1M) is more -- because it's attracting more total investment into the stock by having the shorts reduce the cost of buying shares today and then heavily subsidize potential gains tomorrow.

> If your company has an appreciable amount of short interest the likely reason is that the company's overvalued, not that Jim Chanos is colluding with Andrew Left and Bill Ackman just to bring down your company and profit off your failure.

Haven't they tended on average to lose money on shorting?

> On the flip side, causing a large undertaking to fail faster when it was doomed from the beginning is obviously more efficient.

True in theory, but is that actually what happens? Large companies rarely do anything fast. Even when the shorts are right, it's usually months or years before it all shakes out. And as above, when they're right what they're really doing is increasing total third party exposure to the loss.

> Many people are worried that volatility is too low these days (thus why Feb was such a big deal), so I'm not sure that's a great argument.

People are worried about volatility as an indicator, not because it's a good in its own right that society benefits from creating artificially.

> there are de facto more shares in existence.

> because there are de facto 20% more shares in existence

Sorry, what? Am I misunderstanding you? How does short selling increase outstanding shares? It's hard to parse the rest of this given what seems like a grave oversight.

Once you borrow the shares from firm A and sell them to person B, person B is the holder of record for those shares now. Firm A doesn't own them anymore - that's why you have to pay out company dividends to firm A from your own pocket while you're borrowing them.

Regardless of how they track their positions, the only thing firm A owns is an obligation from you to give them shares back at some point. There's no change in the number of outstanding shares.

Or are you talking about naked shorting? Because that's been illegal since 2008 (regardless of whether it still occurs).

> People are worried about volatility as an indicator, not because it's a good in its own right that society benefits from creating artificially.

Well, for one: People are worried that volatility has become a good in its own right - hence the famous "Volatility has become a player on the field" quote and why the $XIV delisting was such a big deal.

For two: You said that short selling increased volatility. I said volatility is really low, to the point that some people are concerned it's too low. Clearly, short selling hasn't had a major impact on volatility.

> Sorry, what? Am I misunderstanding you? How does short selling increase outstanding shares?

Selling short requires borrowing shares. It's the same way that banks create money. There were 1000 shares, then 200 more were borrowed and resold. The buyer of the 200 shares have shares, so in practice does the original lender who is owed a share by the short seller. The IOU isn't technically a share but for most practical purposes it is. If you want to sell it, it's worth a share. If the share price goes up or down, so does the IOU price. If the share price gains $1, the owner and the lender make $1 each. If it falls $1, they each lose $1.

> Firm A doesn't own them anymore - that's why you have to pay out company dividends to firm A from your own pocket while you're borrowing them.

Right, which is why it acts like another share again -- the original dividend is paid to the person the short seller sold the share to but the lender still gets it too. There are de facto two dividends because there are de facto two shares.

There are actual differences of course (e.g. IOUs can't vote), but for questions of exposure to price fluctuations and that sort of thing, it's effectively creating a new share.

> the original dividend is paid to the person the short seller sold the share to

It is not. Whatever side bets people may have with each other may result in money changing hands, but it's not the "original dividend".

There are still 1000 shares, 1000 votes, 1000 dividends paid, 1000 dividends collected, 1000 ownership claims on residual assets. The bookkeeping can be confusing, but there's no shares being generated.

> for questions of exposure to price fluctuations and that sort of thing, it's effectively creating a share.

If you and I agree that if Apple goes up at least 10% by this time next week, I'll pay you $500, otherwise you'll pay me $300, then we both now have exposure to price fluctuations. How many shares, exactly, do you think we've created? I'd love to see your math. :)

Just because you have exposure to X doesn't mean you own X, and it certainly doesn't mean you've created X out of thin air.

The company only has 1000 shares, but because the lender effectively has a share and may not even know it was lent, investors hold 1001 shares. If a dividend is paid, the company pays 1000 dividends, and investors receive 1001 dividends. If the company goes bust, all 1001 shares have lost their value. If there's a shareholder lawsuit with a payout, there will be 1001 claims , although the company will only be willing to pay 1000, which can be a big mess for a court to figure out -- see some earlier articles from the same author as this.

In your case, we've jointly made a wager. I wouldn't be an investor in Apple, like I would be if I held shares, and would still be, if my shares were lent out.

> the company pays 1000 dividends, and investors receive 1001 dividends.

You missed out the last part of that, which is "and investors pay 1 dividend". Investors as a class receive 1000 dividends on net. It all just nets out.

> If the company goes bust, all 1001 shares have lost their value.

And the person who sold a borrowed share will have gained money. The net change across the economy is the value of 1000 shares, not 1001 shares.

> If there's a shareholder lawsuit with a payout, there will be 1001 claims

This usually doesn't happen, but when it does, it's a paperwork error, and an artifact of the fairly archaic way share ownership is recorded in the US. It's not inherent to the system, and it doesn't tell you anything about how short selling works in principle.

A shareholder who lends their share to a short seller is not entitled to a claim for dividends from the company. They must get the dividends from the short seller.

Yes, that's what I said: the company pays out 1000 dividends, and 1001 shareholders receive a dividend.

Maybe the right answer is that high risk companies should not be public.

If you take the notion of “ongoing concern”, then there is a good argument for this thinking.

I have no problem with high risk firms being shorted. Too many times they should not have gone public.

> But then enough shorting can cause them to fail, because it makes it more difficult to raise money by selling new shares or using shares as collateral.

That's one of those ideas that looks kinda of plausible on paper, but doesn't really work in the real world. There's just no real evidence that this is a thing that actually happens, and the people who complain the loudest about it are invariably not victims of it.

The current standard-bearer for the "shorts are evil and make people fail!" camp seems to be Musk right now, and there is absolutely zero evidence to support this in the case of Tesla. None of Tesla's issues (with funding or anything else) can be traced back to people shorting the stock.

(Well, Musk's strange "taking Tesla private" tweet may have hurt Tesla's ability to raise funding, and perhaps that was part of some sort of incredibly ill-advised response to shorts, but even if so, the cause of Tesla's issue there is Musk, not short-selling per se.)

> It's not exactly a moderating influence.

On balance, overall, it is. There's extensive evidence of this. For example, China has a list of stocks which you can't short, and when stocks are placed on this list, their volatility increases, even controlling for other factors.

> That's one of those ideas that looks kinda of plausible on paper, but doesn't really work in the real world. There's just no real evidence that this is a thing that actually happens, and the people who complain the loudest about it are invariably not victims of it.

Can you explain what part of it doesn't really work? It seems kind of odd to ask for evidence of something which is a mathematical formula. If shorts reduce the share price by X before you sell Y new shares then you consequently have X times Y less new capital than you would have. Is the argument supposed to be that shorting the stock doesn't lower the stock price?

Granted this doesn't always matter. If a company is not trying to raise funding, what does it matter their cost to raise funding? But sometimes they are.

> On balance, overall, it is. There's extensive evidence of this. For example, China has a list of stocks which you can't short, and when stocks are placed on this list, their volatility increases, even controlling for other factors.

I can see the argument for it can be, which goes like this: Buyers are overly exuberant so people take out short positions which keep the price from going too high. Then the news is middling and the stock falls somewhat, but the shorts closing their positions keep it from falling more as they buy back shares.

But that's assuming the shorts were right. If they're wrong they push the price the opposite of the way it should be going and when the news comes it snaps even harder the other way.

> Can you explain what part of it doesn't really work? It seems kind of odd to ask for evidence of something which is a mathematical formula.

Counterexample: It turns out that planes can't fly! This is easily demonstrated by reference to the standard formula for calculating buoyancy, F = V x (d1 - d2) x g, where F is the force lifting the plane into the air, V is the volume of the plane, d1 is the density of air, d2 is the density of the plane, and g is the force of gravity. A moment's research shows that a Boeing 747 is heavier than the equivalent volume of air, meaning F will always be smaller than 1.

QED, planes can't fly. The fact I can hear one flying overhead right now is, I admit, evidence I may have missed some other factor, but we don't need evidence to evaluate the truth of mathematical formulas, right? :)

In other words: Just because something is A factor doesn't mean it's a relevant factor, or isn't overwhelmed by other factors. And we have zero (literally, zero) evidence that short selling is a factor in the ability of firms to raise funds, or in their cost of funds, once we control for other factors. And we have plenty of examples of firms targeted by short sellers who have raised funds on favourable terms.

> If they're wrong they push the price the opposite of the way it should be going and when the news comes it snaps even harder the other way.

Right, but again, on balance, this effect ends up being drowned out by other effects. You've made a great stab at an explanation for something that isn't really happening, so doesn't really need an explanation.

You don’t need evidence for the formula, you need evidence that the formula accurately describes some dynamics in the real world. Things like “the formula predicts X, and we saw X”.

> you can short any high risk high reward play and make money if they fail

You can make a lot more money, much more quickly and with far less risk, squeezing misplaced shorts. There is a lot of capital in the markets scanning for accumulations or nonsensical shorts.

Could you provide an example where this was the case? I'm not familiar with any companies with a sound business model that were hurt by shorts.

Choose any company that was shorted and nearly succeeded but didn't.

Are you questioning the mechanism by which it operates? If you raise borrowing costs for a company it hurts them and the ones already at the margin may fold.

So you can't provide a single example of a company whose downfall was due to shorts?

If it was that common, seems like it would have been easy for you to just list a few dozen examples instead of handwave it away.

> So you can't provide a single example of a company whose downfall was due to shorts?

How is someone supposed to prove that in a specific case? It would be the case for a company that failed by a specific margin whose total borrowing costs were increased by more than that margin. Which requires speculating what their share price would have been in the alternative, calculating the resulting effect on their contemporary borrowing cost (which data is available where?), then evaluating their entire business to determine how much additional capital they would have needed to survive.

It would take hours to calculate and be subject to unlimited debate about the reasons and margins by which they failed.

But if you really want an example based on pure speculation, Kodak. They made their share of mistakes but if it had been easier for them to raise funding to compete in digital markets once they changed course they might not have ended in bankruptcy.

And I still haven't heard any argument as to the flaw in the general principle.

> How is someone supposed to prove that in a specific case?

As one example: they could show a specific company that violated its margin constraints as a result of short selling pressure, which resulted in an unplanned margin sell, that forced it to sell assets at firesale prices, that triggered a liquidity spiral resulting in material harm. You could see this in a financial institution with a weak balance sheet that is forced to unwind long/illiquid positions.

(This is why the SEC banned short-selling of financial institutions during the GFC; the ban lasted about three weeks before it expired.)

Another mechanism would be short selling triggering a bank run, as debtholders & counterparties see a falling share price and think that signals a weakening balance sheet.

It may take hours to calculate but it seems like the kind of thing that academics, journalists, and aggrieved CEOs would have already done the legwork on. A few hours to publish an academic paper or write an article for Bloomberg isn't much investment, after all.

I'm not aware of any even theoretical models about how short-selling hurts non-financial institutions in material ways. Most corporations are primarily debt financed, not equity financed, aren't they? The historical debt-to-equity ratio of the S&P 500 is 1.7, I think.

The flaw to that argument (from my perspective) is that if a company wants more capital they can find lenders, issue bonds, or even issue new shares. If Kodak has a real way to pivot they could have raised money. Instead, it is pretty clear their business was dying and they had no way to compete against larger tech companies who could provide a better product with cheaper costs to consumers.

> The flaw to that argument (from my perspective) is that if a company wants more capital they can find lenders, issue bonds, or even issue new shares.

Well yes, but that's the problem. If you issue new shares when your share price is lower, you get less money and it may not be enough. You can't just sell an unlimited number of shares, each one dilutes the others and at some point no one will buy them. And all the other lenders rely on your ability to issue new shares to pay them back if it comes down to that, so they won't lend to you if your share price is too low, or will demand interest rates you can't afford.

> Instead, it is pretty clear their business was dying and they had no way to compete against larger tech companies who could provide a better product with cheaper costs to consumers.

They could have at least been GoPro if not the company supplying the cameras in half the phones on the market.

The shorts are symptom, not the cause.

Kodak was a hot mess. Even raising a ton of money couldn’t have saved them from their incompetence. If they didn’t have the vision to see digital cameras, what makes u think they could dig themselves out of the hole they were in?

Agree to disagree! Maybe no one will buy them because the business plan is crap!

Please humor us with three examples where this actually occurred.