Third-Party Consequences of Short-Selling Threats: The Case of Auditor Behavior

• In Event: Responses to Risk Factors

Abstract

Most prior research on short selling focuses on its impact on targeted firms. In contrast, this study examines how short-selling threats affect other market participants, in particular auditors. During 2005-2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index firms were arbitrarily chosen as pilot stocks to be exempted from short-sale price tests. As a result, these pilot stocks faced significantly higher short-selling threats. We use this controlled experiment as our identification strategy and implement a difference-in-differences test to show that auditors react to the threats and charge higher audit fees to the pilot firms. Further, consistent with our predictions, we find that the impact only exists when auditors are concerned with the down-side risk caused by short sellers or when auditors have greater bargaining powers. The results are robust to numerous controls, alternative partition methods, firm fixed-effects estimation, and alternative model specifications. In additional analyses, we find that auditors are more likely to switch in the presence of short-selling threats (but only for clients with higher bankruptcy risk). This paper is among the first to document a third-party consequence of short-selling threats and to explore a specific cost of short-selling threats on shareholders (i.e., increased audit fees). In addition, we establish a causal impact of short-selling threats as a determinant of auditor behaviors.

Authors

• Ole-Kristian Hope, University of Toronto - Rotman School of Management

• Danqi Hu, University of Toronto - Rotman School of Management

• Wuyang Zhao, University of Toronto - Rotman School of Management