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  • Activist Short-Selling

    by

    Wuyang Zhao

    A thesis submitted in conformity with the requirements for the degree of Doctor of Philosophy

    Rotman School of Management University of Toronto

    © Copyright by Wuyang Zhao 2017

  • ii

    Activist Short-Selling

    Wuyang Zhao

    Doctor of Philosophy

    Rotman School of Management

    University of Toronto

    2017

    Abstract

    Activist short-selling – short-sellers publicly talking down securities to benefit their short

    positions – attracts attentions from a broad range of market participants, but is largely ignored by

    the prior literature. Combining information from Seeking Alpha and Activist Shorts Research, I

    collect more than 6,000 activist short-selling cases against listed companies from 2006 to 2015

    and conduct two large-sample studies on this controversial phenomenon.

    Chapter 1 examines the determinants and consequences of activist short-selling,

    highlighting the critical roles of ex-ante available firm characteristics. I find that (1) activist short-

    selling leads to much larger market reactions than comparable level of short-selling without public

    talking-down, (2) activist short-sellers are more likely to target firms with severe overvaluation

    and uncertainty features, (3) targets’ overvaluation (uncertainty) features are increasingly

    (decreasingly) important in predicting returns from the short term to the long term, (4) their

    overvaluation features predict short-selling allegations that focus on valuation issues such as

    “bubble,” while their uncertainty features predict allegations that sound severe such as “fraud,”

    and (5) uncertainty features also predict targets’ likelihood of responding to allegations.

  • iii

    Chapter 2 focuses on the consequences of activist short-selling on a specific group of

    market players: sell-side analysts who cover target firms. Since the sell-side business model

    discourages analysts from publishing negative opinions, the demand for negative information is

    met by other sources, such as activist short-sellers who frequently accuse analysts’ talking-up as

    the main driver of overvaluation. I find that analysts react to activist short-selling by revising their

    target-price forecasts. The variation in the timeliness and direction of the reactions can be

    explained by the ability and incentives of analysts as well as the initial impact of activist short-

    selling. More importantly, analysts’ reputation can be severely damaged by activist short-sellers,

    particularly when analysts talk-up too much previously, when short-sellers seem to be right, and

    when analysts take too long to respond. However, the direction of analysts’ reactions (i.e., revising

    up or down) seems unrelated to the reputation loss. Finally, analysts are more likely to move to

    smaller brokerage houses if their covered firms are targeted by activist short-sellers.

  • iv

    Acknowledgments

    Frequently I ask myself: what if I had not come to Rotman for this accounting PhD? I can

    think of a lot of possibilities, but under no situation could I be as happy, optimistic, and self-

    fulfilling as I am now – not even close. Now this Ph.D. is coming to its end; I have a lot of people

    to thank.

    First of all, I thank the Chair of my advising committee: Professor Ole-Kristian Hope. As

    evidenced by the several thousand emails we had in the past four years, he had substantial impact

    on every single important event I have had. Here are some examples. Attending his seminar in

    Norway in the summer of 2012 led to my admission into the Rotman Accounting PhD program.

    Reading a book given by him (i.e., Fooling Some of the People All of the Time) ignited my interest

    in short-selling. He is also a key coauthor of my two published papers. As always, I have received

    his incredible support and guidance in developing this dissertation. I have been and will always be

    learning from him on how to become a successful scholar: hard-working, optimism, confidence,

    and care for younger generations.

    I also want to thank my four committee members for their valuable support in developing

    the dissertation and hunting for a job: Alex Edwards, Partha Mohanram, Baohua Xin, and

    Dushyant Vyas. Interacting with them helps me to be a better researcher and a better person.

    Specifically, Alex was my mentor in the first year, and since then I have learned how to be a good

    colleague from him. Partha’s seminar course on valuation prepared me for the research on activist

    short-selling. Also, his broad knowledge about almost everything reminds me of the importance

    of being an interesting person. Baohua’s theory seminar led me to think of my dissertation topic

    in a deeper level, and I have learned from him how to strike a balance between being humble and

    being confident. Dushyant was among the first who made me determined to focus on activist short-

    selling, mostly because this is a topic that is highly relevant to practice. He has shaped my taste on

    what constitutes good research.

    I am grateful to my external examiner, Prof. Michael Welker from Queens’ University, for

    his encouragements and highly constructive comments. I still remember that I was talking with

    Michael about the attack by Citron Research against Valeant on Oct. 21, 2015 at PCAOB/JAR

    conference in D.C. That case makes me to seriously consider to focus on activist short-selling.

  • v

    I wish to thank all the Rotman professors who helped me during the Ph.D. process. I have

    discussed my dissertation with almost every faculty member individually, including Francesco

    Bova, Jeff Callen, Feng Chen, Gus De Franco, Daehyun Kim, Nan Li, Scott Liao, Gord

    Richardson, Christopher Small, Franco Wong, Aida Wahid, Minlei Ye, and Ping Zhang. I also

    wish to thank all the fellow Ph.D. students who made my life easier during the four years, including

    Muhammad Azim, Mahfuz Chy, Danqi Hu, Ross Lu, Barbara Su, Mingyue Zhang, and particularly

    Stephanie Cheng, with whom I was very fortunate to start the program at Rotman.

    I thank my coauthors and friends outside Rotman, especially Han Wu at HEC Paris and

    Forester Wong at USC. They are always available for random chats, which not only makes the

    research work less lonely but more enjoyable.

    Finally, I am grateful to my family, especially to my wife and my best friend, Dr. Jessie

    Yin Zhu. Equally well-educated and probably more talented, she contains her own aspiration and

    ambition, but accompanies me wholeheartedly on an uncertain journey. I am grateful to her

    dedication to love, her sacrifice to the family, and her unmatched trust and confidence in me. I

    dedicate this doctorate thesis to her and our daughter Grace Shuman Zhao.

    In addition, I want to thank people who provided comments on my dissertation, including

    Pat Akey, Stefan Anchev, Karthik Balakrishnan, Mark Bradshaw, Wenjiao Cao, Shuping Chen,

    Ted Christensen, Dain Donelson, Yiwei Dou, Fabrizio Ferri, Robert Freeman, Pingyang Gao,

    Jonathan Glover, Amy Hutton, Ross Jennings, Alon Kalay, Bin Ke, Steve Kachelmeier, Mark Ma,

    John McInnis, Stephen Penman, Shivaram Rajgopal, Scott Richardson, Sugata Roychowdhury,

    Lakshmanan Shivakumar, Hun Tong Tan, Florin Vasvari, Brian White, Brady Williams, Eyub

    Yegen, Yong Yu, Ronghuo Zheng, Emanuel Zur (FEA Discussant), and seminar participants at

    Boston College, Columbia University, London Business School, Nanyang Technological

    University, National University of Singapore, University of Texas at Austin, 2016 AAA Doctoral

    Consortium, 2016 CMU Accounting Mini Conference, 2016 Conference on Financial Economics

    and Accounting (FEA), and 2017 Financial Accounting and Reporting Section midyear meeting

    (FARS) for comments. Last but not least, I thank Adam Kommel from Activist Shorts Research

    for generously sharing his data, and Mingqi Li for Python assistance.

  • vi

    Table of Contents

    Abstract ........................................................................................................................................... ii

    Acknowledgments.......................................................................................................................... iv

    Table of Contents ........................................................................................................................... vi

    Introduction ......................................................................................................................................1

    Chapter 1 Activist Short-Selling: A Large-Sample Study on the Determinants and

    Consequences .............................................................................................................................3

    1 Introduction .................................................................................................................................3

    2 Related Literature and Hypotheses Development .......................................................................8

    2.1 The Differences between A