Short Sellers and Financial Misconduct

Abstract

We examine whether short sellers detect firms that misrepresent their financial statements, and whether their trading conveys external costs or benefits to other investors. Abnormal short interest increases steadily in the 19 months before the misrepresentation is publicly revealed, particularly when the misconduct is severe. Short selling is associated with a faster time-to-discovery, and it dampens the share price inflation that occurs when firms misstate their earnings. These results indicate that short sellers anticipate the eventual discovery and severity of financial misconduct. They also convey external benefits, helping to uncover misconduct and keeping prices closer to fundamental values. Copyright (c) 2010 the American Finance Association.

Mispricing of Book-Tax Differences and the Trading Behavior of Short Sellers and Insiders

“…8 Evidence of short arbitrage of accounting-related information includes Dechow et al (2001) for stocks with low fundamentalto-price ratios; Desai et al (2006) for restatement announcements; Karpoff and Lou (2010) for SEC enforcement actions; Hirshleifer et al (2011) for accruals;and Drake et al (2011) for analyst recommendations.…”

Short Selling and Executive Pay-for-Performance Sensitivity

“…The process of mining negative information by short sellers increases the risk that managers fail to disclose the positive information in time, so it will motivate managers to disclose information timely and accurately. Karpoff et al (2010) [4], Hirshleifer et al (2011) [5] found that short selling can restrain the financial fraud. Chen et al (2015) [12], Fang et al (2016) [13] found that short selling can restrain earnings management and improve the reliability of financial information.…”

“…Karpoff, Lou (2010) [4], Hirshleifer et al (2011) [5], investigated the effect of short selling mechanism on the quality of financial information; Grullon et al (2015) [6] and Jin et al (2015) [7] examined the impact of short selling mechanism on corporate investment behavior. There is little literature on the impact of short-selling on executive pay contracts.…”

Corporate Governance and Hedge Fund Activism

“…6 Other market participants may also influence the shareholders of firms in this way; however, the short-selling channel is particularly powerful because short sellers are known to be good at processing negative information (e.g., Hirshleifer et al,, 2011;Karpoff & Lou, 2010). mechanism to monitor management via board representation.…”