Implications of Shorting on Cost of Capital and ESG: Empirical Evidence
Research Paper
April 19, 2022
Preview
Overall, shorting is an essential part of financial-market activity, though it is relatively new in ESG investing. Sometimes there is a debate around short-sales restrictions, and their timing and usefulness in managing market volatility and extreme events. But the debate about the relationship between the shorting of particularly low-ESG-scoring companies and its impact on cost of capital has been consistently one-sided, and this is the topic of this study.
Certain activist investors and advocates of penalizing ESG laggards have claimed that shorting stocks usually leads to an increase in the stock's cost of capital. While this may be the case for particular activist actions, it is not clear whether an increase in a stock's shorting demand per se will have a similar effect.
In this report we looked at the relationship between stock-shorting demand and the cost of capital of the constituents of the MSCI World Index, during the period between August 2015 and December 2021. Our findings do not support the hypothesis that an increase in shorting demand leads to an increase in cost of capital. If anything, we find that low-short-interest stocks have had slightly higher cost of capital compared to high-short-interest stocks, though these results were not economically significant.
No significant evidence that higher levels of short selling raise companies' cost of capital
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