Experts — including Warren Buffett — say short selling can be beneficial for markets

  • Many respected investors believe short selling plays an important role in public markets, improving price discovery and rational capital allocation, preventing financial bubbles and finding fraud.
  • "The situations in which there have been huge short interests very often — very often have been later revealed to be frauds or semi-frauds,” Warren Buffett said during Berkshire Hathaway's annual shareholder meeting in 2006.
Warren Buffett
David A. Grogan | CNBC
Warren Buffett

Wall Street is buzzing over the battle between Tesla CEO Elon Musk and investors who are betting against the company's stock.

On Thursday, Musk blasted short sellers and mocked the Securities and Exchange Commission on social media.

But many respected investors and experts have said short selling plays an important role in public markets, improving price discovery and rational capital allocation, preventing financial bubbles and finding fraud.

Shorting is a trading strategy that involves selling a borrowed stock with a view that it will drop in value and can be bought back later at a lower price.

One legendary investor actually welcomes traders who want to bet against his company.

Warren Buffett explained during Berkshire Hathaway's annual shareholder meeting in 2006 that financially-sound companies can benefit from short sellers because those traders are forced to buy the stock in the future. His remarks on the subject can be found in the CNBC Warren Buffett archive.

"We have no objection to anybody selling Berkshire short at all," he said. "The more shorts, the better, because they have to buy the stock later on." Berkshire's A shares were trading around $110,000 at the end of 2006, and its B shares around $73.

The Oracle of Omaha believes short sellers tend to sniff out wrong-doing and shady behaviour.

"There's nothing evil, per se, about — in my view — about selling things short," Buffett said. "Short sellers — the situations in which there have been huge short interests very often — very often have been later revealed to be frauds or semi-frauds," he added.

For example, Kynikos Associates' Jim Chanos is famous for being one of the early short-seller skeptics in Enron even while Wall Street analysts cheered on the energy company. Enron collapsed in late 2001 after revelations of a massive accounting fraud there.

Muddy Waters' Carson Block said corporate leaders tend to blame short sellers when business fundamentals are deteriorating.

"When CEOs criticize short selling, it's usually because they're looking to deflect blame for their own failings, and obscure the uncomfortable truth that their long holders are losing confidence and are selling," Block said in an email Friday.

Block is known for his short selling research, which led to several government corporate fraud investigations and financial restatements. He has repeatedly argued short selling is positive force for investors and financial markets.

Academic research has shown the stocks of companies that complain about short sellers tend to falter.

Yale School of Management professor Owen Lamont wrote a paper in 2004 examining 266 companies that had threatened or taken action against short sellers. His analysis found these companies lagged the market by nearly 2 percent on average per month in the year after the companies publicly denounced their skeptics.