We study the consumption-portfolio problem in a setting with capital gain taxes and multiple risky stocks to understand how short selling influences portfolio choice with a shorting-the-box restriction. Our analysis uncovers a novel trading flexibility strategy whereby, to minimize future tax-induced trading costs, the investor optimally shorts one of the stocks (or equivalently, buys put options) even when no stock has an embedded gain. Alternatively, an imperfect form of shorting the box can reduce aggregate equity exposure ex post. Given these two short selling strategies, it is common for an unconstrained investor to short some equity while a constrained investor holds a positive investment in all stocks. With no shorting, the benefit of trading separately in multiple stocks is not economically significant.

We show theoretically that optimism can lead a risk-averse Chief Executive Officer (CEO) to choose the first-best investment level that maximizes shareholder value. Optimism below (above) the interior optimum leads the CEO to underinvest (overinvest). Hence, if boards of directors act in the interests of shareholders, CEOs with relatively low or high optimism face a higher probability of forced turnover than moderately optimistic CEOs face. Using a large sample of turnovers, we find strong empirical support for this prediction. The results are consistent with the view that there is an interior optimum level of managerial optimism that maximizes firm value.