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Do short sellers care about Environment, Social and Governance?

7 July 2023

The article at a glance

CERF Fellow Oğuzhan Karakaş, and research collaborators Pedro Saffi (a former CERF fellow) and Mehrshad Motahari (a former CERF Research Associate), analyse whether the short sellers can anticipate negative ESG incidences of firms, and make money from the negative price reactions to the news announcement of such incidences.

Short selling is a financial transaction to profit from prices going down. A short seller borrows an asset and sells it today to, hopefully, buy it back in the future for a lower price. The literature finds that short sellers can forecast firm underperformance and are efficient in processing of public information and uncovering private information.

In a project titled “What does short selling reveal about ESG?”, Oğuzhan Karakaş, Pedro Saffi and Mehrshad Motahari  analyse whether the short sellers can anticipate negative ESG incidences of firms, and make money from the negative price reactions to the news announcement of such incidences.

The authors find that short sellers anticipate the bad ESG news months before the corresponding negative ESG incidences occur. This finding corroborates the earlier research findings that short sellers can predict financial misconduct, earnings management, and credit downgrades in firms. The authors find that stock prices decrease following the bad ESG news, particularly companies with above-average ESG scores and abnormally high short selling interest. This suggests that observing the behaviour of short sellers may help identifying greenwashing (a firm’s ESG compliance being overstated, intentionally or unintentionally), which is notoriously difficult to define and detect.

Short sellers may not be particularly interested in the non-financial effects of the ESG developments in firms. However, their interest in the ESG materiality may prove fruitful for the short sellers’ role in enhancing the market efficiency and in helping the efforts for a more sustainable financial system.

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