72 Pages Posted: 6 Mar 2008 Last revised: 9 Jun 2010
Date Written: August 5, 2009
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: Suggested Citation
Karpoff, Jonathan M. and Lou, Xiaoxia, Short Sellers and Financial Misconduct (August 5, 2009). Journal of Finance, Forthcoming; AFA 2008 San Francisco Meetings Paper; EFA 2008 Athens Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1102853
By Eli Ofek