U.S. regulators have banned short selling on as many as 800 stocks, mostly financial services companies. The move is intended to help stabilize capital markets. The jury is out on whether it will have the anticipated effect, with a number of financial columnists questioning whether the move only limits market efficiency (although the recent "efficiency" of capital markets is in doubt anyway).
But Dr.Andrew Tucker of University College of London, who I met over breakfast last June in the U.K., thinks there may be a more interesting problem with limiting short sales. He proposes that we think of short sellers as in essence reputation watchdogs. Dr. Tucker argues that short selling is a method of testing a company's reputation against its market capitalization:
"More surprising is to see regulators defending companies like GE and GM who have much more robust - and more expensively acquired - reputations in place from short sellers. Surely these companies' reputations should be allowed to be tested by the market? If they are not as valuable as their proponents claim, then the sooner found out the better. In which case a lot of senior managers, accountants and PRs have been talking up a share price worth much less than deserved."
The warning . . . short sellers may be greedy and trade on negative news, but they test the substance of reputation. A company needs to ensure that the claims underlying its reputation track closely to its character, performance and behavior. Don't let the language of reputation stray too far from true value.