Hedge funds ESG short selling and implications to stock market

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School of Business | Master's thesis
Degree programme
70 + 28
The effect of ESG information on short selling is still somewhat shrouded in mystery as the existing literature has reported contradicting findings. We aim to shed light on the matter as we study the ESG information’s effect on hedge funds’ short positions from multiple angles. Our research studies how hedge funds utilize ESG information in decision-making as to whether they sell short a target company or not. We found that hedge fund preferences have shifted during our sample period as for initial years, the hedge funds preferred lower ESG stocks in their short selling, but in later years, the preference shifted to higher ESG performing companies. This effect is more pronounced on lower deciles while simultaneously, the short selling is more focused on the higher ESG companies, indicating that hedge funds favor “greener” stocks in their short selling. Similarly, we studied how the target company’s ESG performance affects the size of the hedge fund’s short selling. We find that hedge funds seem to increase their short positions when ESG controversies arise, while a strong ESG and its sub-pillar performance decreases the net short position’s size. We also studied the short selling’s implications on the target company’s profitability and risk. We find that the size of the short-selling position decreases the profitability measured by cumulative abnormal return and price return alike which would indicate that the short selling is profitable and that the short sellers hold valuable information. The size of the short-selling position also increases the target’s volatility which indicates that the short-selling decreases the target stock’s profitability and increases its risk as the volatility increases. These findings suggest that either the hedge fund holds valuable information about the targets or the short-selling actions have a signaling effect on other market participants. Our findings continue the already existing but scarce academic discussion on ESG information’s effect on short selling by suggesting that hedge funds' short positions are profitable and that higher ESG performance attracts more short sellers, but their short positions are smaller in size compared to lower ESG performance that is targeted with fewer short sellers but with more significant short positions.
Thesis advisor
Knüpfer, Samuli
hedge funds, short selling, ESG, European
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