Thanks for your question. First, let me request that if any of the
following is unclear or if you require any further research please
dont hesitate to ask me for a clarification.
What an interesting little financial riddle to ponder...
The simple answer is of course that you cannot short more shares then
are outstanding. Theoretically, if the transactions are taking place
within a very short window (maybe a few seconds), it could appear,
temporarily, that a scenario similar to what you have described had
played out - but once the brokers try to clear the transactions they
will realize something is wrong, and some of the transactions will not
go through, generating errors in the respective accounts.
As for your scenario - when you short sell a stock, you are selling a
stock that you do not own, betting that the price will go down and you
will make a profit. Since you are selling the stock, not buying it,
you cannot sell it on to customer C. Customer A can sell his stock,
of course, in which case we still have only 100 shares in play, but
they are now owned by customer C. When customer D tries to short the
stock, he will be told that there are no shares to short.
Note the following -
"Short-Selling a stock is a way to capitalize on the decrease in value
of a stock. In simplified terms, short selling involves you selling
stock that your broker "borrowed" from someone who already owned it
(with the obligation of you to replenish that stock
sometime--indefinitely--in the future). If the stock goes down in
value, you can replenish the stock (by buying it back on the market)
at a later date and lower price than what you initially sold the stock
for, thereby generating a profit. Of course, the risk is always
present that the stock will go up in value."
The broker who is allowing you to short must therefore know who he is
borrowing the stock from - and if A sells to C then your broker now
holds C's shares rather than A's.
I hope this response adequately addresses your request. Please let me
know if you are in need of additional information concerning this