Dr. Young Jae Choi honored with the Best Paper Award at the American Law and Economics Conference

Please join us in congratulating Dr. Young Jae (Jay) Choi, Assistant Professor in the Department of Economics and Finance, for being honored with the Best Paper Award in the Securities Law and Finance category at the American Law and Economics Conference on June 9, 2023

This year the organizers for each area were given the option to nominate the best paper that they received.

Title  Zombie stocks

Authors: Young Jae Choi, Joseph Engelberg, Frank Partnoy, Adam V. Reed & Matthew C.
Ringgenberg

URL to paper: https://sites.google.com/view/youngjaechoi/research

We contribute to the academic literature on stock markets by examining a previously unstudied example of how legal rules lead investors to overpay for stocks. Numerous studies have shown that short sellers tend to be informed traders, so that disincentivizing them harms markets. We show how legal rules harm short sellers of “zombie stocks” by trapping them when stocks are delisted and deregistered.

We use the term “zombie stocks” to describe shares of companies that appear to be “dead,” but nevertheless create financial horror for short sellers. We examine how brokers impose significant risks and costs on short sellers, including retail investors, even when someone has speculated correctly against a company’s shares. The central problem occurs when short sellers are unable to purchase shares to satisfy their borrowing obligations and instead become stuck paying increased equity loan fees and posting collateral, potentially indefinitely.

We focus on short selling, an area where numerous studies have shown that regulatory risks and costs can be a significant limit to arbitrage that impedes the ability and willingness of informed traders to correct stock mispricing. We explain for the first time in the literature how the existing legal framework imposes costs because of how shares are held, loaned, and traded in public markets.

We collect and analyze a unique dataset of thousands of stocks that were delisted during 2002 to 2019, and we examine the risks and costs of stocks becoming zombies. We demonstrate that these risks and costs are substantial: for more than 250 firms in our sample, we show that short sellers could have been trapped in a position for at least a month, and possibly much longer. We quantify the increased lending fees brokers charge to short sellers after delisting, when their clients arguably should be released from their positions and not pay fees at all.

Finally, we propose and assess several policies to address the existence of zombie stocks. We contribute to the law and finance literature by providing the first evidence of zombie stocks as a barrier to short selling and by providing policy responses that could reduce the risks and costs associated with zombie stocks. We suggest that stock markets work best when short sellers have proper incentives to find overpriced stocks, bet against them, and profit.