Doing Battle with Short Sellers: The Role of Blockholders in Bear Raids

If short sellers can destroy firm value by manipulating prices down in a “bear raid,” an informed blockholder has a powerful natural incentive to protect the value of his stake by trading against them. However, he also has an incentive to use his information to generate trading profits. We show that these conflicting objectives create a multiplier effect, whereby the buying quantity needed to defeat the shorts becomes a large multiple of the expected amount of short selling. This increases trading profits when the blockholder buys at favorable prices, but also increases losses when he must buy at unfavorable prices. Thus, his existing stake needs to be large enough to absorb these losses. Importantly, though, the multiplier shrinks as the potential for value destruction increases, meaning a smaller stake is sufficient precisely when a successful bear raid would be most harmful. These results add a new dimension to the existing debate on when/whether intervention against short sellers is warranted.