39 Pages Posted: 23 Oct 2010 Last revised: 1 Nov 2011
Date Written: April 14, 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.
Keywords: Auditors, Audit Fees, Fraud Risks, Short Sellers, SAS 99
JEL Classification: M41, M42
Suggested Citation: Suggested Citation
Cassell, Cory A. and Drake, Michael S. and Rasmussen, Stephanie J., Short Interest as a Signal of Audit Risk (April 14, 2011). Contemporary Accounting Research, Vol. 28, No. 4, Winter 2011. Available at SSRN: https://ssrn.com/abstract=1695996