Short Sellers and the Informativeness of Stock Prices with Respect to Future Earnings

Abstract

In this paper, we examine whether short interest improves the informativeness of stock prices with respect to future earnings. We find that short selling strengthens the relation between current returns and future earnings, especially in settings where short sellers are likely to possess an information advantage, such as when a firm’s information environment is weak or when analysts are highly optimistic about future earnings growth. Collectively, our results illustrate the important role that short sellers play in improving the extent to which current stock prices reflect information about future earnings and thus, in improving market efficiency.

Keywords: Short sellers, short interest, future earnings response coefficient (FERC), market efficiency

JEL Classification: G17, M40, M41