If investors believe shares of these companies are a ripoff, they can sell any holdings and / or abstain from buying. Just like they can do in nearly every other type of market.
If a used car salesman is trying to rip me off, I walk away from the deal. I don't need to be able to short his inventory! And the supply / demand dynamics of the used car market will trend toward equilibrium without any such shorting.
ok, but what incentives does anyone have to actually look at potentially fraudulent situations, especially if the stock is ripping, as in the case of Valeant Pharmaceuticals? In fact the incentives are so perverse that it pays _not_ to state your research on why the company is not worth what it is. Even the time value spent on research is non trivial.
Your example would make more sense if the car they were selling a what may seem as a perfectly fine Lambo, but in actuality it was a lemon. And the only way to find out if it was a lemon or not is to tear it apart piece by piece.
How does that make any sense? If the stock was growing 15% year over year without any indication that there are any issue, why would any investor want to provide any information or do any research on why that isn't the case? If an investor knew that there was fraud going on they would probably keep it to themselves and simply invest in the company anyways, because the financial incentive is there.
In your hypothetical example, a stock is going up and up, and I suspect it might be fraudulent, and you believe I have no incentive to pull my money out before the house of cards collapses?
Getting my money out is all the incentive I need! I bet plenty of Theranos investors would've loved to do exactly that. And there was no shorting involved in that company.
Sorry, but fixing one wrong with another is not the way. Are you honestly saying that stock shorting is the only incentive someone has to look at fraud? I don't buy that one bit.
You answered it, fix regulators, and heavily punish fraud, don't let people get away with a slap on the wrist. This is literally the job of the justice system. You may as well say what benefits do police or FBI have for catching criminals. The reward is a stable and just society, on top of their salaries.
On a side note, this is one aspect that religion addresses. Ripping people off is not going to end up well when facing God.
that's because it wouldn't do you any good. if, however, the used car salesman is engaging in fraud and selling expensive cars way under their market value while buying inventory at inflated prices, you could expose this by borrowing a friends mercedes, selling it for USD 100000 (then buying it back at USD 1000, so you can return it to your friend) making a nice profit along the way.
If a used car salesman is trying to rip me off, I walk away from the deal. I don't need to be able to short his inventory! And the supply / demand dynamics of the used car market will trend toward equilibrium without any such shorting.