Short Interest as a Signal of Audit Risk
Cory A. Cassell
University of Arkansas
Michael S. Drake
Brigham Young University - Marriott School
Stephanie J. Rasmussen
University of Texas at Arlington
April 14, 2011
Contemporary Accounting Research, Vol. 28, No. 4, Winter 2011
Motivated by evidence from the empirical accounting and finance literatures suggesting that short sellers target firms with suspect financial reporting, we investigate whether short interest provides a signal of the degree of audit risk. We find a positive association between audit fees and short interest (total shares sold short scaled by total shares outstanding) after controlling for other determinants of audit fees. This finding suggests that short interest is an indicator of audit risk that reflects information not captured by traditional client risk measures. We also find an increase in the magnitude of the association between audit fees and short interest after events in the early 2000s (corporate scandals, the collapse of Arthur Andersen, and the implementation of new auditing standards) which increased auditors’ responsibilities to deter fraud and made the implications of fraud particularly salient to external auditors. Our findings are important because they suggest that auditors’ sensitivity to client risk information increased post-2002, indicating that efforts by regulators and standard setters (e.g., the PCAOB and the AICPA) to increase auditors’ attention to risk have been successful.
Number of Pages in PDF File: 39
Keywords: Auditors, Audit Fees, Fraud Risks, Short Sellers, SAS 99
JEL Classification: M41, M42
Date posted: October 23, 2010 ; Last revised: November 1, 2011
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