Short Selling and Earnings Management: A Controlled Experiment

• In Event: Earnings Management

Abstract

During 2005-2007, the SEC ordered a pilot program in which one-third of the Russell 3000 index were arbitrarily chosen as pilot stocks and exempted from short-sale price tests. Pilot firms’ discretionary accruals reduce during this period, and revert to pre-experiment levels when the program ends. Conditional on committing financial misconduct, pilot firms are more likely to be caught. Pilot firms’ earnings response coefficients decline and coefficients of current returns on future earnings increase, then revert to pre-experiment levels after the program. We conclude that decreases in short selling costs constrain firms’ opportunistic reporting behavior and enhance share price informativeness.

Authors

• Vivian Fang, University of Minnesota

• Allen Huang, Hong Kong University of Science & Technology

• Jonathan M Karpoff, University of Washington