We examine the effect of short sellers on corporate innovation. To establish causality, we use a policy experiment that exogenously removes the short-selling constraint for a randomly selected subsample of Russell 3000 firms. We find that innovation quality, value, and efficiency of treatment firms improve significantly more than those of control firms surrounding the policy shock. The exposure to patenting-related litigation initiated by short sellers is a plausible underlying mechanism through which short sellers discipline firm managers and enhance innovation. Our paper provides new insights into an unintended real effect of short sellers, specifically their improvement of technological innovation.

The IPO volume in the US significantly decreased after 2000, as more entrepreneurial firms exited through acquisitions rather than IPOs. Using proprietary U.S. Census data on private firms, we examine several new hypotheses to explain these phenomena. Our results support explanations based on standalone public firms’ greater sensitivity to product market competition as well as private firms’ obtaining access to more abundant PE financing in the post2000 era. In contrast, we do not find evidence consistent with an eroded private firm base after 2000 or with the economies of scope explanation that mainly focuses on firm size.

Consistent with theories on the equilibrium matching between capital structure and employee job risk aversion, we find a robust, positive association between a firm’s leverage and its employees’ family labor income diversification. Higher-Leverage firms also recruit new employees with greater income diversification. For identification, we exploit two policy shocks that exogenously change employee income diversification and firm leverage, respectively. Individual employee-level tests further reveal that workers with differential risk attitudes adjust their job choices and household labor income portfolios in response to significant shifts in their employers’ leverage. Finally, human bankruptcy costs contribute to the general level of corporate risk-taking.