Short sales constraints and price adjustments to earnings announcements: Evidence from the Hong Kong market

- Non-shortable stocks are overvalued before publication of negative information.
- Non-shortable stocks react stronger to publication of negative information.
- Prices of non-shortable stocks reverse following publication of negative information.
- It takes longer for non-shortable stocks to fully adjust to negative information.

This study examines how short sales constraints affect the stock price adjustment to the release of public information in the Hong Kong Stock Exchange. Using a unique feature of this market that allows us to directly investigate the impact of short sales restriction, we find the following. First, non-shortable stocks react more strongly to the publication of negative information than shortable stocks do. Second, non-shortable stocks are overpriced before negative earnings announcements. Hence, part of the strong market reaction of non-shortable stocks on announcement day could be due to the correction of such overpricing. Third, the prices of non-shortable stocks reverse following the announcement of negative information, suggesting that investors overreact to negative information on announcement day. Fourth, it takes longer for the prices of non-shortable stocks to adjust to negative earnings information. On the whole, our results support the research that finds short sales restrictions reduce the efficiency of stock markets.