Short-sellers, believe it or not, are usually "smart" money. Meaning, on average, an average short-seller is more sophisticated and knowledgeable than your average standard investor. If you find yourself in an argument with a short-seller over the future prospects of a company, you may want to listen closely to what they are saying, even if you disagree with them.
Also, some of the biggest scams have been discovered by short-sellers. Why? Because they are on the prowl for these overbloated issues, and will normally do extensive research on the company to support their decisions. Because your losses are potentially unlimited in a short position, you need to be pretty confident in your position if you are short. They will do extensive investigations on a stock and will normally know the balance sheet inside and out. Again, it would probably be to your benefit to listen to what they are saying. Some of the biggest scams (Enron, etc.) have been initially unearthed by short-sellers.
Also, short-sellers provide the stock market with liquidity. When you sell a stock, someone has to be on the other side of your trade. Short-sellers buy, or "cover", when you sell, and sell when you buy. If a stock gets completely crushed overnight after announcing bad news, they are the reason for most of the buying pressure off the open, as they are covering their positions. In the case of a bankrupt stock, short-sellers can often be the only reason that you can get ANYTHING back for your virtually worthless equity position.
Lastly, short-sellers can help to self-police the equity markets. The SEC can't investigate every company, but a short-seller can do extensive investigations on a company if they feel as though the company is not on the up and up. The short-seller can then publicize his findings, giving you a chance to exit the stock if what you hear alarms you. Contrary to what you might think, short-sellers do a great service for the ordinary Joe Average investor. >P> Of course, naked shorts are different altogehter. They are nothing short (no pun intended) of criminal. It is nothing more than electronic stock counterfeiting. The failure of the SEC to bring even ONE case to court for failure of regsho is enough reason to dismantle theat whole corrupt inefficient, phenomenally lazy excuse for a "regulatory" body.
Thank you, and tesla, for the informative replies.