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Firm Investment Efficiency Is a Key Indicator of Sectoral Market Friction

This article explores the tellativeness of short selling on identifying firm investment fraud, how investors adjust their internal opinions to use their data advantage to favor short selling on firm investment fraud, and finally how short sellers use news releases to influence short position positions in the stock market. The paper also describes two new types of trading strategies that have recently developed to exploit regulatory failure, one of which highlights the ability for traders to execute short trades on regulatory failure and the other highlights the power of institutional traders to manipulate share price. The paper concludes by describing a third type of trading strategy, where traders can trade the news, anticipating that firms will announce record earnings based on distorted economic data. This paper is part of a special mini-symposium on “The Day Trading Community,” which took place during the annual meeting of the American Society of Real Estate Agents in New York. The symposium brought together real estate professionals from across the country to discuss the complex topic of day trading.

Firm Investment

The first major problem faced by real estate investors during the post-recession period has been firm investment fraud, as investors have been systematically overpricing and selling properties during this period. Most real estate investors blame the subprime mortgage fiasco for the current crisis, but the main problem was excessive leverage, risky mortgage loans, and bad pricing behaviors. When the housing bubble burst, the same problems were at work, but on a smaller scale. Investors with too-big-to-fail brokerage firms made large profits on subprime mortgages without considering the effects on the broader economy. The Financial Accounting Standards Board (FASB) has defined a number of indicators to help investors detect fraudulent transactions. Although these indicators have helped to reduce the amount of fraud in the past, we still see too many problems in the marketplace.

Short selling is a form of self-promotion where firms sell their own stock to the highest possible price in order to inflate the stock price and receive a higher price for the sale. Unfortunately, short selling can also lead to market friction because it makes existing shares drop in price. This action causes firms to suffer in other ways. First, companies selling short their stock may receive unwanted publicity. Second, short selling firms spread the impact of their short sales throughout the market, making the effect of overall stock price volatility appear worse than it really is.

A firm’s financial statements are the best way to determine if a firm is using unrealized firm investment profits to offset higher costs or if they are using the funds for other purposes. The first indication that the investment could be benefiting someone other than the firm is if the account is not being used to earn tangible benefits. In an accounting sense, these unrealized firm investments are known as retained earnings. Real estate firms are notorious for keeping earnings on property that is not making money, such as rental properties. Companies that have similar practices are generally referred to as’real estate realty’ firms. Reacquiring these properties will allow investors to determine whether they are paying excess costs or if they are getting a fair return on investment.

Another indicator that investors should look for is a decline in dividends. Dividends are payments made by a firm to its shareholders. If the dividend rate has been consistently declining over time, this could be a sign of market friction. Market participants may be hesitant to pay high dividend rates given the potential for governmental intervention. If a market participant continues to pay high dividend rates despite increased costs, this could signify a lack of firm investment efficiency. In response, a firm could adopt more efficient investment practices and reduce the number of transactions that require excessive government intervention.

The current economic stimulus package provides the opportunity to observe and record firm investment efficiency. Government agencies such as the SEC have developed new regulations to help reduce transaction costs and increase efficiency across the investment marketplace. As these reforms begin to take effect, more institutional investors and broker dealers are likely to adopt these new measures. The increased efficiency will likely result in less market friction and increased firm value. This opportunity to observe and record investment practices offers a significant opportunity for individual investors to capitalize on these improvements in economic stimulus package practices to achieve a stronger investment portfolio.