Short Sellers and Financial Misconduct

72 Pages Posted: 6 Mar 2008 Last revised: 21 Jun 2017

Jonathan M. Karpoff

University of Washington - Michael G. Foster School of Business

Xiaoxia Lou

University of Delaware - Alfred Lerner College of Business and Economics

Date Written: August 5, 2009

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 when firms provide incorrect financial information.

Keywords: Short sales, financial misrepresentation, market efficiency, information

JEL Classification: G14, G38, M41, M43, M45

Suggested Citation

Karpoff, Jonathan M. and Lou, Xiaoxia, Short Sellers and Financial Misconduct (August 5, 2009). Journal of Finance, Vol. 65, No. 5 (October 2010), pp. 1879-1913; AFA 2008 San Francisco Meetings Paper; EFA 2008 Athens Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1102853

Jonathan M. Karpoff

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States
206-685-4954 (Phone)
206-221-6856 (Fax)

Xiaoxia Lou (Contact Author)

University of Delaware - Alfred Lerner College of Business and Economics ( email )

419 Purnell Hall
Newark, DE 19716
United States

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