We examine the economic determinants of short-sale supply, and its consequences for future stock returns. Lendable supply increases with expected borrowing costs and decreases with financial statement constructs that indicate overvaluation. Although rising loan fees help ease supply constraints, we find shares are still least available when they are most attractive to short sellers. Using a number of firm characteristics, we derive useful instruments for real-time loan supply and demand conditions in the lending market. Further, we show that (1) when lendable supply is binding (non-binding), short-sale supply (demand) is the main predictor of future stock returns, (2) abnormal returns to the short-side of nine well-known market anomalies are attributable solely to “special” stocks, and (3) loan fees significantly reduce the profitability of the short side and several of these anomalies cease to be profitable. Overall our evidence highlights the central role played by the supply of lendable shares in equity price formation and returns prediction.

Applying a “co-search” algorithm to Internet traffic at the SEC׳s EDGAR website, we develop a novel method for identifying economically related peer firms and for measuring their relative importance. Our results show that firms appearing in chronologically adjacent searches by the same individual (Search-Based Peers or SBPs) are fundamentally similar on multiple dimensions. In direct tests, SBPs dominate GICS6 industry peers in explaining cross-sectional variations in base firms׳ out-of-sample: (a) stock returns, (b) valuation multiples, (c) growth rates, (d) R&D expenditures, (e) leverage, and (f) profitability ratios. We show that SBPs are not constrained by standard industry classification, and are more dynamic, pliable, and concentrated. We also show that co-search intensity captures the degree of similarity between firms. Our results highlight the potential of the collective wisdom of investors — extracted from co-search patterns — in addressing long-standing benchmarking problems in finance.

ABSTRACT We examine the financial health and performance of reverse mergers (RMs) that became active on U.S. stock markets between 2001 and 2010, particularly those from China (around 85 percent of all foreign RMs). As a group, RMs are early-stage companies that typically trade over the counter. However, Chinese RMs (CRMs) tend to be more mature and less speculative than either their U.S. counterparts or a group of exchange-industry-size-matched firms. As a group, CRMs outperformed their matched peers from inception through the end of 2013, even after including most of the firms accused of accounting fraud. CRMs that receive private investment in public equity (PIPE) financing from sophisticated investors perform particularly well. Overall, despite the negative publicity, we find little evidence that CRMs are inherently toxic investments. Our results shed light on the risk-performance trade-off for CRMs, as well as the delicate balance between credibility and access in well-functioning markets. JEL Classifications: G34; M41; N20