We predict and find that short-selling constraints combined with investor disagreement cause prices to respond more strongly to bad earnings news than to good earnings news, an asymmetry characterized by Skinner and Sloan as the “torpedo effect.” However, in the absence of short-sales constraints, the price reaction to good and bad news is entirely symmetric, regardless of the level of investor disagreement. Our findings contribute to the ongoing debate about the existence and causes of the torpedo effect. In particular, we extend Skinner and Sloan’s explanation of this effect by showing that short-selling constraints are essential for such an effect to occur; in their absence, there is no torpedo effect, even if investors are overoptimistic. Moreover, this asymmetric effect is not intrinsic to growth stocks; even value stocks are torpedoed in the presence of short-selling constraints and disagreement.
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