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Is It Right to Sell Others Short?

4/10/2021

8 Comments

 
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by David Hagenbuch - professor of Marketing at Messiah University -
​author of 
Honorable Influence - founder of Mindful Marketing


You’re a basketball player whose team just won the NCAA Division I national championship!  You run courtside to celebrate with family but your mother is visibly upset.  “Mom, what’s the matter?  “I’m sorry,” she stammers.  “It’s just that . . . I bet against you.”
 
No athlete, or anyone, likes to be picked to lose.  However, life is full of potential successes and failures that people need to predict.  For some, those predictions offer significant money-making opportunities.  But, is it right to earn a living betting against others? 
 
As for many, the practice of short selling stocks burst onto my radar screen when GameStop’s shares took their rollercoaster ride several weeks ago.  With more than a casual interest, I followed the ensuing events, including Robinhood CEO Vlad Tenev’s testimony before Congress.  Along the way, I gained a better grasp of what short selling is, but ever since, I’ve been wondering whether anyone should be doing it.
 
In case you’ve forgotten how short selling works:  Investor A borrows from a broker 100 shares of XYZ at $100 per share and sells the stock to Investor B at the same prevailing market price, or $10,000 total.  Over the next week, XYZ’s stock price drops to $75.  Investor A then buys 100 shares of XYZ for $7,500 and returns them to the broker, pocketing $2,500 in the process, less any interest and commissions the broker has charged.
 
The Securities and Exchange Commission (SEC) has made short selling legal.  However, even with this regulatory approval, the practice should raise at least two red flags, or moral concerns, that lead one to ask:  Is short selling ethical?
 
Before addressing the two concerns, I imagine some may be wondering what short selling has to do with marketing—the other half of this blog’s two-pronged focus.  Short selling is marketing in that many stockbrokers, including very well-known ones like Interactive Brokers, TD Ameritrade, and Charles Schwab, market short selling among their investment services, or ‘products.’
 
For instance, Interactive Brokers’ website contains a Shortable Instruments (SLB) Search tool:  “a fully electronic, self-service utility that lets clients search for availability of shortable securities from within [the firm’s] Client Portal account management platform.”  The relative ease with which an investor can sell short makes its moral implications all-the-more important.
 
First Red Flag
 
‘Selling something that one doesn’t own’ was the short selling issue that initially gave me pause.  Peddling another’s property certainly appears problematic, until one begins to consider the many ways in which such leveraged transactions regularly occur: from apartment subleases, to bank loans, to consignment clothing.  Individuals and organizations often sell others’ property on consignment.
 
Of course, just because consignment occurs doesn’t mean it should.  Still, the fact that all parties involved 1) willingly participate and 2) typically benefit are good signs that most of these activities are above-board.
 
Second Red Flag
 
The prior examples differ from short selling, however, in the second of the two ways:  While the participants in apartment subleasing, etc., generally rise and fall together financially, a short seller’s success comes courtesy of two others’ failures, namely 1) those of the company whose stock the short seller has borrowed and 2) the person who buys the stock from the short seller.  The short seller makes money when the other two parties lose theirs.
 
In contrast, consider again the clothing consignment example:  If I take an unwanted suit to a consignment shop, both the consignor and I will want a high price when the suit is sold.  Conceivably, the suit’s maker also would like its aftermarket products purchased for higher prices because such resale value reflects favorably on the brand, not unlike the way higher vehicle resale prices benefit automobile manufacturers’ brands.
 
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On the other hand, the suit’s buyer would like to pay a lower price, but even he really doesn’t want the price to be too low, since perceptions of the brand are tied, at least in part, to the price that he and others are willing to pay for the suit.  Most importantly, each time he wears the suit, he extracts value from it.
 
The suit is this example is analogous to the stock.  Whereas everyone ‘invested’ in the suit seems to want it to retain its value, investors who short stocks clearly want the value of those securities to decline.  Short sellers are betting against the very companies whose financial instruments they have borrowed and sold, as well as the individuals on the receiving end of those stocks.
 
The zero-sum game, or winner-loser outcome, that underlies short selling is certainly atypical of most economic exchanges, but it’s not without precedent.  Casinos win when their customers lose, as do many “rent-to-owe” retailers like Rent-A-Center and Aaron's.  Any kind of predatory lender falls under the same unseemly umbrella, including certain credit card companies that don’t make money unless people fail to pay off their account balances and become locked into an endless cycle of exorbitant monthly interest payments.
 
However, many argue that short selling does not do anything nearly so destructive.  In fact, some contend that the practice produces several important economic benefits, the primary one being liquidity, “the efficiency or ease with which an asset or security can be converted into ready cash . . . . ”
 
In my research, I found market liquidity to be the factor cited first and most often in the defense of short selling.  However, at least one financial markets expert suggests that advantage is exaggerated.
 
Dwayne Safer is a chartered financial analyst (CFA) whose career has included significant roles in investment banking, corporate finance, and strategy.  For the last five years, he’s been a professor of finance and my colleague at Messiah University.  When asked about short selling and market liquidity, he offers a contrarian analysis: “the liquidity offered by short selling for most stocks is negligible.”
 
Safer supports his suggestion by sharing a Bloomberg Terminal screenshot (below) that shows that shares sold short represent only about 3.5% of trading volume on the New York Stock Exchange (NYSE).  He also cites an example from the financial crisis in late 2008, when the SEC temporarily banned the short selling of financial stocks “without any noticeable degradation of liquidity in those stocks.”
 

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Safer recognizes that there may be some “modest liquidity benefit” for certain heavily shorted stocks; for instance, at the time we spoke, 21% of Dick’s Sporting Goods’ shares available for trading were short.  Still, he affirms: “If shorting wasn’t permissible, liquidity would be brought into the market by the broker-dealers and market makers who would stand ready to buy and sell shares of a given company to generate trading revenue.”
 
So, does the elimination of liquidity as a main benefit of short selling leave no morally tenable ground on which short sellers can stand?  Not necessarily.
 
Safer continues by saying that although he doesn’t agree with conventional wisdom that short selling adds significant market liquidity, he does believe short selling offers other meaningful market benefits:
  • It provides the ability to hedge/protect a portfolio from downward movement in stock prices, mitigating portfolio volatility.
  • The in-depth research short sellers often conduct can expose fraudulent companies.  For example, short selling hedge funds warned about the frauds at Enron, Tyco, Fannie Mae and more recently Luckin Coffee and Nikola.
  • Shorting helps prevent overinflated securities prices that waste valuable capital and harm investors, as occurred in the dot-com bust in 2001.  Former SEC chairman Christopher Cox once stated, "We need the shorts in the market for balance so we don't have bubbles.”

Before beginning to write this piece, I was unaware of these important benefits of short selling.  Still, how do we reconcile such consequences with the moral principle of respect, or as my second red flag/concern described: not betting against another person.
 
That moral principle certainly has merit, but my earlier discussion probably represented too narrow a view of short selling.  Safer’s observations have helped me see that there are other factors to consider and parties to take into account, e.g., other investors, firms’ customers and employees, and the economy as a whole.
 
I’m also helped by remembering a story I heard just a few days ago:  A guest speaker in our capstone marketing course mentioned that a former client of his used to tell him, “I pray for my competitors.”  This very successful business owner was not being sarcastic—he truly wanted his competitors to succeed both because he genuinely cared about them and because he understood that “a rising tide lifts all boats.”
 
Returning to the basketball metaphor that began this piece, no serious athlete wants to be on the winning side of a forfeit.  Basketball players need competitors, who also happen to have fans rooting for them.
 
However, choosing loyalties isn’t unique to picking stocks or selecting sports teams.  Each day we make dozens of similar decisions when choosing what clothes to buy and where to order takeout.  Each selection of a company is essentially a vote against another; however, other people are voting for the competitors.  In fact, the next time one of those ‘other’ votes may be ours.
 
Meanwhile, a ‘no vote’ conveys valuable information to all who are willing to listen and learn from it.  When companies assimilate such negative feedback, they make themselves better, their industries stronger, and stock markets more stable.
 
It’s very unlikely that a mother bets against her own daughter or son for anything, but other ‘no votes’ are not necessarily bad.  Short selling a company’s stock can be a good or bad bet for the investor.  It also can be “Mindful Marketing.”


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8 Comments
Makenzie Janson
4/22/2021 08:15:49 pm

i find it extremely interesting how the man who spoke at the marketing convention spoke about praying for his competitors. i think overall short selling has a negative and unethical connotation. i believe that it is people like this who flip that script and help bring morality into what seem to be some of the most unmoral concepts.

Reply
Ken Burkholder
4/26/2021 08:54:30 am

Currently my wife and I are in the market for a house but prices seem overinflated to me; every time we don't purchase a house we're "betting" against the current prices and helping rein in a possible bubble. In general, all economic activity/non-activity is either "going long" or "going short". I see no moral objection.

Reply
Josh Gerber
4/27/2021 06:32:16 pm

While the concept of "betting against someone" seems immoral and personal, that lack of liquidity indicated by Prof. Safer at least begs the argument that short selling, unless taken to an extreme, may well just be an expected part of trading which allows investors to develop a comprehensive and diversified strategy.

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Elaine Brandenburg
4/28/2021 10:25:18 pm

Overall, short selling appears to have negative implications and effects. However, as discussed in the article, there are some benefits that short selling can bring to light, such as exposing fraudulent companies or helping to cause positive change within companies. Whether or not short selling can be determined to mindful marketing is questionable but I could at least see where this could be a possibility.

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Christian Yeager link
4/29/2021 12:01:12 pm

I thought this article about short selling was very interesting to read. You hear often about short selling happening, but never really about the specifics of what happens as consequences of it, whether that be good or bad. I thought the way that was discussed in the article was fascinating to read about. That some good can be done even when it comes to short selling. It can cause a company to know what changes need to happen to make more positive changes for the future.

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Sarah Stubbe
4/30/2021 11:18:42 am

I find it intriguing how this article presented that concept that "opposing bets" produce value in products. I had simply never considered this before. However I think it is notable that these opposing bets only produce value when the product (or individual, service, etc.) being bet against is successful despite the opposition; otherwise, it certainly would suffer value loss.
Regardless, I appreciate the new mindset I have acquired regarding opposition in the marketing field. Simply stated, it is not always a terrible thing.

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Wilson Sheker
4/30/2021 12:27:13 pm

I believe that short selling is not ethically and that it does raise concerns for those involved. It can create a loss and many can suffer from it. It can only cause little good and opposing bets tends to only offer reward for those with information on the service or product. It can be an unfair outlet for many and is not an ethical source of income.

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Kyle Luce
9/15/2021 11:34:52 pm

I found it interesting how you related the idea of short-selling to marketing. I also have that initial reaction that it seems like short-selling appears to be immoral. In many ways, you are taking a risk with money that doesn't belong to you without permission. However, I do think that Safer makes a decent point about the liquidity benefits. Overall, I still think that short selling should be somewhat contained. It can be beneficial in some cases, but it can also be abused.

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