[beagle3]

The problem is that insiders can actually (and easily, and even subconciously) change that price.

Let's say I believe that the company I work with is horribly mismanaged. I short it. Then, all of a sudden, an announcement comes ("corp X is going to buy our company") that raises the price and makes me lose my pants. I have two choices now:

a) lose my pants, or

b) use the due-diligence period to try to kill the deal from the inside.

Are you willing to hold stock of a company in which (b) is likely to happen? I don't.

Furthermore, even though a 5% discrepancy is already huge, in many cases it is much larger than that: valeant recently dropped 70% in a few weeks, and insiders knew all about the irregularities1; If allowed to short, a new employee, upon discovering those irregularities, has a great incentives to quit, short, and go to the newspaper. While this would deliver justice much more swiftly to the company, it would do so to the benefit of that individual at the expense of everyone else. We disallow vigilante justice in general for good reasons and this is no different.