A very insightful question there, mate. Yes, you've nailed the...

A very insightful question there, mate. Yes, you've nailed the basic mechanics.

There are a range of reasons why your Party A (the original and beneficial owner) might be prepared to lend out their shares to a shorter who could, foreseeably, be seen as part of the problem in driving the SP lower.

Here's one very narrow example that comes to mind. Probably not the best one, but I'm in a bit of a hurry now:
A funds manager who has a mandate to hold all of the stocks comprising a certain stock index &/or particular sector (i.e. a thematic fund). In this scenario the fund is not a 'stock picker' per se but, rather, a thematic holder (eg: of an index, specific sector, etc, etc), according to its mandate. They basically wont ever sell unless forced to due to index rebalancing or perhaps because a given stock holding in a sector holding gets delisted (think takeover, for example). They'll simply ride the ups and downs, regardless. Smaller active funds, super managers, HNI's investors, or others might choose to cycle in an out of this fund at different points in the cycle. In this particular example this fund isn't really focussing on any near-to-mid-term capital gains from the particular stock they hold. It might bank some divvies. In order to enhance the returns for shares that it 'must' hold, regardless of market conditions it has the bright idea of making some of its shareholdings available to be rented by enterprising types who might want to borrow them for a time. In return the fund receives interest while on loan which aids a bit in its overall investment income.

That's the logic behind one such scenario. I'm not suggesting that it's particularly smart, but I suspect that a key driver behind it (for the lending fund) goes something along the lines of, "Well, if we don't do it then a competitor large holder will. The SP will end up where the SP ends up, so we might as well earn some interest and participate in the practice too."

*If* I was Sheik Z, the fabulously wealthy sheik of Zland, would I lend out any of my vast stock holdings? Almost certainly not. Why? Because I would have an owner's mindset, rather than a fundies mindset. Even though I might have a LLLT mindset, I'd have a problem in becoming part of the so-called problem by chasing pennies, which I concede would almost certainly happen even without my participation.

Cheers.
Z