Editorial - June 2008

<< GO BACK | JUNE 2008 | ISSUE NO 176

Owner? Lender?

‘Neither a borrower nor a lender be’ – wise words in their time and still worthy of reflection nowadays, particularly when looking at short selling from a corporate governance angle.

An investor with a negative view on a company’s prospects shorts its shares now in the expectation of being able to buy back those shares at a lower price in the future. Usually the investor borrows the shares that are being sold to create the short position. The lenders tend to be the long-term, mainstream institutional investors, seeking to make a small ‘rent’ on shares that would otherwise be dormant.

Shorting has long been a feature of exchange trading in stocks, shares and commodities and is the true foundation of ‘hedge’ funds. However, there are concerns that those who invest in the hope of making a profit from the failure of a company are somehow less legitimate investors than those who invest in a company’s success. And there is suspicion that short-sellers are more inclined than those with long-only positions to spread false rumours or resort to underhand tactics. This suspicion is exacerbated in volatile (especially declining) markets when confidence is already dinted.

There is clearly a responsibility on the long-term owners of a company’s shares to consider carefully the costs and benefits of their stock lending activities. It is a nonsense to turn a small profit on stock lending but to lose a fortune on the underlying shares.

One solution proposed recently was that institutional investors ought to be required to disclose to a company any lending of that company’s shares. In this way, directors who believe that the lending activity (or rather the short selling that it enables) is detrimental to the long-term stability of the company can address these concerns to the institutional investor and request a recall of the lent stock. If nothing else this would promote a more open director-share owner dialogue. But it is likely to also reduce the supply of stock available for loan, increasing the cost of borrowing (and thus shorting) and reducing the attractiveness of short selling which may well in turn increase the underlying share price.

Directors often feel quite aggrieved by short selling of their company’s shares. Giving them the information to enable them to influence the long-term share owners lending stock would at least ensure that lenders were fully cognisant of the effect of their actions on their assets.

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