We develop a model of corporate dividend policy based on the idea that management values operating flexibility. By reducing dividends and conserving cash, management increases its flexibility. This improves its ability to invest in projects that it believes are good for the shareholders in the long run but which shareholders would not provide the capital for because they think the projects are value reducing. However, the cost of not paying dividends is a reduction in the current stock price. Management trades off these two aspects of dividends. Flexibility considerations help us understand various dimensions of dividend policy that existing theories do not explain. Our theory generates numerous testable predictions that we confront with the data. The evidence is supportive of the model.

Christophe et al. (2010) find evidence of abnormal short activity prior to analyst downgrades and argue that short sellers may be violating SEC insider-trading laws by trading on information obtained from analysts about upcoming downgrades. However, observing abnormal shorting prior to downgrades is not tantamount to determining that short sellers are trading on tips from analysts unless shorting is abnormally low prior to upgrades. This paper revisits this issue. While we observe abnormal shorting prior to downgrades, we also find markedly higher shorting prior to upgrades. In fact, the short-selling patterns surrounding both downgrades and upgrades are remarkably symmetric indicating that short sellers during the pre-recommendation period are not unusually informed about the direction of upcoming recommendation changes. If anything, our findings indicate that short selling prior to analyst recommendations is more likely speculative than informed.

Recent research finds that investors, broadly defined, react to the linguistic tone of quarterly earnings conference calls; there is a positive relation between firms' stock returns and call tone (a measure of “sentiment” related word tabulations). However, this type of soft information can be subtle, context-specific, and difficult to interpret. Moreover, the literature suggests cross-sectional variation in information processing skills among investors. Thus, we test whether sophisticated investors interpret earnings conference call tone differently than investors at large by examining short selling activity and its relation to earnings conference call tone. We find that short sellers target firms with simultaneous high earnings surprise and abnormally high management tone. The combination of positive earnings surprise and unusually positive tone strengthens short sellers' return predictability. This result indicates that short sellers interpret revealed “inflated” call language by managers more completely than naïve investors. The incomplete stock price reaction by naïve investors due to the lack of reliability that they place on this soft information results in overpricing of the stock. However, it also suggests that managers are unable to maintain prolonged overvaluation of their stock by striking an overly optimistic posture in the interactive conference call disclosure forum since short sellers' trades provide additional price discovery.

A broad stream of research shows that information flows into underlying stock prices through the options market. For instance, prior research shows that both the Put–Call Ratio (P/C) and the Option-to-Stock Volume Ratio (O/S) predict negative future stock returns. In this paper, we compare the level of information contained in these two commonly used option volume ratios. First, we find that P/C ratios contain more predictability about future stock returns at the daily level than O/S ratios. Second, in contrast to our first set of results, O/S ratios contain more predictability about future returns at the weekly and monthly levels than P/C ratios. In fact, our tests show that while P/C ratios contain predictability about future daily returns and, to some extent, future weekly returns, the return predictability in P/C ratios is fleeting. O/S ratios, on the other hand, significantly predict negative returns at all levels: daily, weekly, and monthly. While Pan and Poteshman (2006) show that signed P/C ratios, which require proprietary data, have predictive power, we find that unsigned P/C ratios, which do not require proprietary data, also have predictive power.

We examine the effect of home market short-sale constraints on securities that also trade in other countries that have more liberal short-sale rules. In particular, we focus on the case of ADRs traded in the US, as in some cases, the home markets of these ADRs prohibit short selling. We find that short sellers more heavily trade ADRs from countries where short selling is prohibited than from markets where short selling is allowed. Furthermore, we find that the greater levels of short selling in ADRs with binding home-market constraints is driven by stocks with greater dispersion of investors’ opinion, low fundamentals-to-price ratios, and recent price increases. Our results support the hypothesis that short sellers target ADRs with home market short-sale constraints because these ADRs are more often subject to temporary misvaluation.

Prior research argues that the process of intermediation is opaque and produces uncertainty about the riskiness of banks, which may adversely affect the efficiency of bank stock prices. Using the Hou and Moskowitz (2005) measure of price delay, which captures the inefficiency of stock prices, we test for, and find evidence supporting the idea that opacity is positively associated with price delay. Bank stocks have markedly higher delay than similar non-bank stocks. This higher level of delay is driven, in part, by market-based measures of informational opacity as well as the asset composition of the bank's balance sheet. Combined, our findings suggest that bank opacity reduces the efficiency of financial markets.

Political involvement has long been shown to be a profitable investment for firms that seek favorable regulatory conditions or support in times of economic distress. But how important are different types of political involvement for the timing and magnitude of political support? To answer this question, we take a comprehensive look at the lobbying expenditures and political connections of banks that were recipients of government support under the 2008 Troubled Asset Relief Program (TARP). We find that politically-engaged firms were not only more likely to receive TARP funds, but they also received a greater amount of TARP support and received the support earlier than firms that were not politically involved.