The Information in Fail-to-Deliver Short Sales : Implications for Research and Regulation

When a short seller sells shares on day t (trade date) but fails to deliver those shares on day t+3 (settlement date), non-existent (electronic) shares are in circulation. Corporate executives and regulators often contend that high “fail-to-deliver” (FTD) levels indicate that short sellers are forcing a company’s stock price down by artificially increasing the number of shares in circulation. This study investigates three sequential research questions relevant to price discovery: Are FTDs information-based? How does the information compare to that in covered short sales (CSS)? Is the information due to stocks that are expensive to borrow (“on special”)? For each research question, we consider two types of information: 1) accounting and market fundamentals used in financial statement analysis and shown to be associated with stock prices, and 2) future returns, which incorporate a broad information set. We conduct analyses for two time periods, with different SEC enforcement rules and economic conditions. Our results show that FTDs are information-based, the information exceeds that in CSS, and much of the information is due to stocks on special. Finding that FTDs are more information-based than previously known has important implications for regulating short selling. For researchers, FTDs provide a new source of data to study short sellers’ valuation information, including the extent that constraints on their trading limit arbitrage