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Go long to resist short selling

The idea that companies facing market pressure from traders shorting their stocks sometimes react by cutting corners on workplace safety may seem like something from the distant industrial past, but our research has shown that it is indeed the case, and that such short-termism can increase work accidents by about 10% in a company.

However, not all companies react this way. We look at why some are able to maintain a long-term perspective, including on workplace safety.

Traditionally, short sellers have taken advantage of quiet market settlement periods, selling stocks they don’t own and buying them in the future, before the settlement date, at an anticipated lower price. Today, with much faster settlement times, the process is implemented by the short seller who borrows the shares, sells them and then buys them at a lower expected future price to return them to the lender.

Two facts emerge from this sketch of short selling. The first is that there is no guarantee that the short seller made the right choice; if the stock price rises rather than falls, the short seller will be out of pocket – caught, as the saying goes, in a bear trap.

The short seller therefore has every interest in seeing the stock price fall rather than rise. If the seller has analyzed the company and correctly concluded that the stock is overvalued, events can take their course and a profit will be made.

But such a hands-off approach may not be successful on its own; in which case the short seller will have to play a more proactive role. This could involve attempts to uncover the type of alleged corporate wrongdoing that, when made public, could adversely affect the stock price, or it could involve the dissemination of negative information about the company. company intended to drive down its share price.

Respond to the threat

In such a situation, the target company would be vulnerable to predatory practices and market risk. How should he react?

Intuitively, one would expect to reduce investment to ease downward pressure on stock prices. But some studies suggest a different response to this pressure, with companies trying to improve employee relations, including ensuring workplace safety. That wouldn’t be entirely selfless, given that workplace accidents are the kind of bad news that could drive the stock price down. Better treatment of employees would protect the company against social risk.

Whatever the motivation, it is not part of our argument, namely that the pressure of short selling is likely to lead to the neglect of the interests of non-shareholder stakeholders, and that this is manifested in particular by a reduction in security. at work.

Why would this surface in an era of short-selling pressure? The short answer is that markets don’t always immediately value stakeholder relationships. Sometimes, in fact, they do the opposite, when activist shareholders interpret excellent stakeholder relations as a sign that the company is not sufficiently committed to shareholder value and is letting resources seep into that which is considered non-productive activities related to non-financial stakeholders such as employees.

So, for management, there is always a gravitational pull to prioritize short-term performance, but this is amplified when companies look for ways to avoid negative events, because potential losses, such as the fall share prices, are more immediate and visible than potential gains, such as higher productivity, which may be more distant in realization.

The price of short-termism

Unsurprisingly, since the pressure of short selling can give rise to short-term reactions, the response of the company concerned is itself time-sensitive. One obvious way to boost the price of a stock that is withering under the watchful eyes of short sellers is to relentlessly focus on short-term profits.

To take just one example, Nobilis Health Corporation of Houston, Texas, beat short sellers by delivering quarterly profits that exceeded estimates by more than 97%. As far as bear traps go, that’s certainly impressive.

But such efforts to boost short-term results come at a price. They exhaust the resources available for training personnel and improving machinery. Reducing expenses that may be considered incidental or non-essential reduces opportunities for employees to become better acquainted with security policies and procedures.

Under such circumstances, obsolete machines are more likely to be kept running, with obvious safety implications. It’s not just this hardware that’s in danger of being overworked. More limited resources increase the likelihood of employee burnout, leading to less care and more injuries, and companies may also be tempted to go even further and impose heavier workloads. Overall, the result is to deplete mental and physical strength, leading to more injuries.

The scale of workplace injuries in the United States is startling, even considering that its labor force of 163.7 million is much larger than that of other Group of Seven economies, which range from 68, 6 million from Japan to the 29.5 million people of the UK.

In 2016, according to the US Occupational Safety and Health Administration (OSHA), there were 5,190 fatal workplace injuries in the US private sector and 2.9 million non-fatal injuries and illnesses. OSHA defines these injuries and illnesses as those that “result in days off work, work restrictions, or transfer to another job” as well as “loss of consciousness or medical treatment beyond the first rescue”.

The economic cost to the United States of these injuries is $550 billion, equivalent to 4% of global GDP.

But if the pressure induced by the short sale is, all things being equal, likely to produce a short-term response from the company concerned, with deleterious consequences for the well-being of the employees, this process has nothing of automatic. It depends on the nature, culture and structure of the company concerned and its external stakeholders. Some companies contain built-in compensating factors that can repel such pressures; factors arising from the interests of stakeholders other than short sellers.

One of these stakeholders is the company’s senior management, the decision makers responsible for allocating capital. If they are convinced of the link between employee well-being and long-term shareholder value, they will be better able to resist the pressures stemming from short selling.